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4 Reasons You Should Make Biweekly Mortgage Payments

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4 Reasons You Should Make Biweekly Mortgage Payments

The vast majority of people make monthly payments on their mortgage either until they sell their property or the mortgage balance has been repaid. Like the beige paint on the walls in your apartment, monthly payments are fine, but maybe there’s a more appealing alternative. One choice is to split your mortgage payment in half, paying every two weeks instead of making one lump-sum payment each month.

Biweekly mortgage payments could actually save you more in the long term, says Jim Lestitian, senior loan officer at Federated Mortgage Corp.: “This is a great and easy way to prepay your loan (shorter term) and reduce the amount of interest paid over the term of the loan.”

When you pay off the principal more quickly, less interest accrues, and you also reduce the amount of time it will take you to pay back the loan. When biweekly mortgage payments are set up properly, it’s possible to accomplish just that.

In this post, we’ll break down the pros of making biweekly mortgage payments and show how this strategy differs from making additional mortgage payments.

4 Benefits of Biweekly Payments

  1. You’ll gain equity in your home a lot faster

Arguably the most valuable benefit of biweekly payment is that you can gain more equity in your home. Equity accumulates more quickly when you pay twice monthly, because the money you borrowed from the bank has less time to accrue interest.

Why does equity matter?

When you buy a house, the ultimate goal is to live in your home without owing the bank any more money. The amount of ownership you have in a home also fluctuates constantly with the current market value. The difference between the current market value of your home and your mortgage is called equity. Therefore, when your mortgage is completely repaid, the total value, or equity, in the house belongs to you. If you sell your house before your mortgage is repaid, some or all of the proceeds from your sale are used to repay the outstanding mortgage balance.

  1. You’ll pay less interest over time

When you first take out a mortgage, the bank gives you a fixed or variable interest rate. This is the “rent” the bank will charge, and it is typically applied to your balance daily. Since your “rent” is charged daily, you want to spend as few days as possible “renting” the bank’s money. In other words, pay back the principal of the mortgage as quickly as possible to reduce your overall interest expense.

Biweekly mortgage payments help to reduce your interest expense because instead of making one payment against interest and principal each month, you’re making two. While the two separate payments are individually smaller, they both have a more significant impact, because each payment slightly reduces the amount of principal. So, if less principal means the bank can charge less “rent,” then the total “cost” of your mortgage will be reduced with biweekly payments.

  1. You’ll pay off your mortgage faster

The third rider on this tandem bicycle of home financing is duration, or the length, of your mortgage. Most often, mortgages are based on 15- or 30-year terms. However, when biweekly payments are made, your mortgage’s principal is reduced more quickly, so less interest is charged. As a result, you simply won’t need the full term of your loan to pay back the balance.

  1. The secret extra payments

Why the emphasis on biweekly payments, rather than twice-monthly payments?

What is 52 divided by 2? OK, what is 12 times 2? These two problems produce two different numbers, don’t they? By making a payment on your mortgage every two weeks, you’ll make an additional two payments over the course of a year.

The inherent benefits of the secret extra payments compound the three perks listed above: you’re going to have a lower interest expense, by chipping away at your principal more quickly, thereby shortening the amount of time you will need to pay off the balance.

Though, just as there’s more than one way to build a house, there’s a second approach to the 13th payment: additional payments toward principal.

Biweekly Payments vs. Additional Payments

Biweekly payments are not your only option for a shorter, more inexpensive mortgage. Additional payments are a great alternative and applicable to any loan. An additional payment is entirely separate from your total monthly payment and then applied directly to principal. An additional payment can also be any amount you wish, made with any frequency that suits your budget.

Additional payments are totally within your control. In the event that biweekly payments are unavailable or not in your best interest, nothing is stopping you from saving one or more months of mortgage payments (a good idea regardless) and then contributing that balance directly to principal. This approach will simulate the secret extra payments created by biweekly payments, but without the need to adopt a biweekly structure.

Similar to biweekly payments, additional payments will reduce your total interest expense and loan duration. When you’re devoting additional cash to accelerate the repayment of a loan, however, you must consider if this is the best use for your money. For instance, the amount of your additional payment could be used to pay other debts, grow more liquid investment accounts, or increase your emergency fund. These are important considerations because you don’t want to find yourself in a position where you need money that is inaccessible due to being tied up in your home.

When you make an additional payment, be sure to call your lender and tell them to apply it to the principal. You would never want to find yourself in a position where you’ve sacrificed the benefits of an additional payment due to a clerical error by a bank employee.

4 Questions You Must Ask Before Signing Up for Biweekly Mortgage Payments

  1. Are biweekly payments available with my lender?

Just as every landlord won’t offer the same amenities, all lenders won’t offer the option to make your mortgage payments on a biweekly schedule rather than monthly installments. Since interest rates do not vary significantly from one lender to the next, most often this payment structure is used as an additional selling point to entice a potential borrower. So why would a lender not offer a biweekly payment structure to its borrowers?

Biweekly payments are more complicated to administer, feasibly doubling the amount of work on the part of the lender. In addition to being more labor intensive, biweekly payments also generate less income for the lender over the lifetime of the loan. Remember, a mortgage is just another product offered by a lender, so when you make biweekly payments, you’re essentially receiving a discount on the total price of your mortgage.

If your lender does not offer the option of a biweekly payment structure, third-party vendors do exist to fill the gap. These companies simulate biweekly payments by coordinating with your lender to fulfill your monthly mortgage payment on your behalf. Then, you make biweekly payments to the third-party vendor, most often with the addition of an initial and/or ongoing fee.

  1. Are there additional fees associated with a biweekly payment structure?

Since a biweekly payment structure means more work for the lender, many lenders charge fees to enroll. Lestitian often sees lenders or third-party vendors apply a $200 to $400 fee to establish a biweekly payment structure and/or charge an ongoing monthly transaction fee. Therefore, unless you are going to save more in interest by making biweekly payments than you’ll pay in fees, it probably doesn’t make sense to pay biweekly.

  1. When will my lender apply my second payment to my mortgage balance?

Lenders don’t always treat biweekly mortgage payments the same. Some lenders will apply your biweekly payments to your mortgage balance as soon as your payments are received. Other lenders will simply hold your first payment until your total payment has been received.

If your lender is not applying your biweekly payments immediately, there is no point in signing up for biweekly payments. Stick to the usual monthly payment or consider refinancing with a lender who will honor extra payments. The benefit of biweekly payments is only realized if the payments are applied to your mortgage balance immediately.

  1. How does my lender calculate interest?

Your bank will calculate the interest due on a daily, weekly, or monthly basis. This detail is important to note because it dictates how much value you will be able to derive from making biweekly mortgage payments.

If interest is calculated daily, then you will save 14 days of interest expense with every biweekly payment. Similarly, if interest is calculated weekly, you will save two weeks of interest expense, with every biweekly payment. The lynchpin for biweekly payments is if interest is calculated monthly, which is very rare. If this is the case, however, you will not realize any additional benefit by making biweekly instead of monthly payments. So you’re better off sticking to once-a-month payments.

The Bottom Line

Biweekly payments, when structured properly, are a great way to shorten the duration and lower the interest expense of your mortgage, all while enabling you to build equity in your home more quickly. Though remember that the devil is in the details.

Before signing on the dotted line, make sure that your biweekly payments are applied to your balance immediately and not held until the end of the month. You also need to be cognizant of how interest accrues on your mortgage and any associated fees, because both components play a major role in how much additional value you will gain from making biweekly payments.

Another point to consider is whether or not biweekly payments are even the best option for you. Your alternative option is to make additional payments toward principal, which can help to produce the same benefits as biweekly payments but without the lengthy commitment. Though whether or not biweekly payments are appropriate for you, your mindset is a prudent one. To be focused on strategies for building equity and reducing expenses as quickly as possible is likely to pay dividends for years to come.

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How to Speed Up Your Mortgage Refinance

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Clock time deadline

When you’re refinancing your mortgage, timing is everything.

Once a lender offers you a rate, they only give you a certain amount of time in which to take advantage of it — a period called a “lock.” Locks come in 15-day increments. The shortest is 15 days, followed by 30 days, followed by 45 days, and so on. Shorter locks generally mean better rates, while longer locks mean higher rates.

If you’ve found an amazing interest rate with a short lock period, you’ll want to make sure things go as quickly and smoothly as possible so you don’t lose that fantastic deal. Here are the best ways to speed up the mortgage refinance process so you can take advantage of lower interest rates.

Related Article: Guide to Refinancing Your Mortgage

Be Honest on Your Application

You may be tempted to omit some debt on your application in order to get approved for a larger loan. Don’t do it. Lenders will find out if you’re withholding information about debts, and the ensuing paperwork will slow down the process. Avoid the headache now and be forthright about all of your finances.

You do not, however, need to disclose all of your assets. In fact, Casey Fleming, mortgage adviser and author of The Loan Guide: How to Get the Best Possible Mortgage, cautions against it if you want the process to go quickly.

“Typically, [you only need to disclose] enough to pay for all closing costs, plus a little more than three months of reserves,” Fleming advises. One month of reserves is the sum of the principal, interest, taxes, insurance, mortgage insurance, and any HOA dues you may incur with your new property.

“Providing more assets than this just gives the underwriters more paperwork to plow through and more opportunities for more questions,” Fleming says. “It is not considered fraudulent to understate your assets.”

Know How to Access Your Paperwork and Return Documents Quickly

Because each individual’s situation is different, it’s very hard for borrowers to know what paperwork they will need to include in their application before applying. Fleming does, however, recommend knowing how to get necessary paperwork should it be requested. This includes knowing how to print out e-statements from financial accounts and obtaining copies of pay stubs and deposited checks.

Throughout the process, you will be asked to submit additional supporting documentation, along with signing and returning new documents issued by the financial institution. This is one of the biggest things that slows down mortgage refinances, and it’s completely in your hands. Return all requested paperwork expediently.

Stay at Your Current Job

If you’re thinking of making a career move, hold off until you close. Stability is a big deal when lenders are making their decisions, and switching employers before closing could negate the entire deal.

Don’t Take on New Debt

If you’re looking for a fast refinance, it is wise to stop taking on new debts 60 days before you apply. It can take this long for lenders to report new loans to the credit bureaus. If your new loan doesn’t appear on your credit report, the financial institution issuing the mortgage refinance will have to get in touch with the credit bureaus directly, which costs both additional time and money.

Note: Taking on new debt, even prior to 60 days before your application, can temporarily reduce your credit score. This can affect the interest rates you are offered or even keep you from qualifying.

You may think you’re golden after you have been approved, but that simply isn’t true. Your lender will pull your credit report on the day of closing, enabling them to see any new debt you’ve taken on since they approved your application. Don’t do anything that would change your debt-to-income ratio.

Find a Lender Who Uses Appraisal Waivers

In the past, common industry advice instructed borrowers to schedule their appraisal as soon as possible, and to keep their own schedule flexible so they could accommodate that of the appraiser. Because physical property appraisals take a long time, this was one of the best things you could do to speed up the process.

However, technology is now offering better and quicker options both for the lender and the borrower.

“More and more automated approvals are requiring only an automated valuation — a software-generated estimate of value,” says Fleming. These valuations are similar to Zillow Zestimates, but they are more accurate as they are based on more data points. “This is commonly known as an appraisal waiver. It is faster and, of course, cheaper than a real appraisal.”

Fleming says that the cost of a typical home appraisal would likely run somewhere between $400 and $500, though he notes these numbers can vary depending on region.

“Appraisal waivers used to be $75,” says Fleming, “but I understand that Fannie [Mae] is experimenting with waiving the appraisal waiver fee.” That means that the appraisal waiver is potentially free to your financial institution.

Not all lenders use appraisal waivers equally. Before applying, you can ask different lenders what percentage of their loans were approved with appraisal waivers in the past 12 months. This can help you identify lenders who will save you a lot of time during the appraisal process.

If you can’t find a lender with competitive rates who also uses appraisal waivers, stick to the old advice and book your appraisal as early as possible.

Refinances Will Move Faster This Year

If you applied for a mortgage refinance in 2016, you probably noticed that the process took a long time. There was a reason for that.

“Interest rates stayed much lower than expected,” Fleming explains. “The purchase market is not highly sensitive to interest rates, but the refi market is. Purchase applications were about as predicted [in 2016], but the refi market was much larger than anticipated.”

Because interest rates stayed so low, more people applied for mortgage refinances. Financial institutions weren’t expecting the increased demand, so many found themselves severely understaffed.

In 2017, Fleming doesn’t predict the same problem. In fact, he anticipates that mortgage refinances will close much more quickly.

“With rates up about 0.5% or more from the lows of last year, it is estimated that 25% to 50% of the refi market is no longer viable,” says Fleming. “It no longer makes sense for [many homeowners] to refinance. So, in 2017 the purchase market will stay about steady, while the refi market will drop precipitously.”

That means staffing should not be an issue and lenders will be eager for your business. The entire process is anticipated to move very quickly in the new year, which is good news for those securing competitive interest rates with short lock periods.

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Mortgage

Guide to Getting a Mortgage When You’re Self-Employed

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

For some Americans, self-employment is the ultimate dream. Roughly 15 million people (10.1% of the total U.S. workforce) were self-employed in 2015, according to the U.S. Bureau of Labor Statistics. Self-employment offers workers the kind of flexibility that can be hard to find in a traditional 9-to-5 job, not to mention the potential for higher earnings.

However, self-employment does come with its own challenges, and, unfortunately, one of these difficulties can be homeownership. Despite earning a solid income, self-employed borrowers face a unique set of hurdles when it comes to determining whether they are eligible for a mortgage. In this guide, we will cover a number of requirements borrowers should begin preparing for as early as possible into their home-buying journey.

The Self-Employed Challenge

In order to gain a deeper understanding of what it takes to be approved for a mortgage as a self-employed borrower, it’s helpful to know how mortgages work in the U.S. For starters, most banks bundle up mortgages and sell them to Fannie Mae, Freddie Mac, or private investors.

To make those investments as safe as possible, Fannie Mae and Freddie Mac have a strict set of guidelines for lenders to follow when deciding which borrowers qualify for a mortgage. Because self-employed borrowers’ income can be unpredictable, they are considered higher-risk borrowers than W-2 workers. That means these guidelines are especially strict for self-employed borrowers.

Requirements for Self-Employed Borrowers: Fannie and Freddie

Although there are a variety of options for mortgages available, we are going to focus on eligibility requirements for self-employed borrowers seeking financing through Fannie Mae and Freddie Mac. Why? If you’re eligible for these loans, you will have access to the lowest interest rates and safest mortgages.

Fannie Mae

Fannie Mae’s Selling Guide outlines a strict set of rules about income for self-employed borrowers. Fannie Mae notes your business income (from a partnership or S corporation) reported on IRS Form 1040 may not necessarily represent the income that has been distributed to you. They point out it’s important to review business income distributions that have been made or could have been made while determining the viability of your business.

Eligibility for Fannie Mae

First and foremost, all borrowers (whether self-employed or not) need to meet Fannie Mae’s normal eligibility requirements:

  • You must be a natural person (living human being) who has reached the age at which a mortgage is legal in the area where the property is located. There is no maximum age limit for the borrower.
  • You must have a valid Social Security number or Individual Taxpayer Identification Number.
  • Per Fannie Mae’s Eligibility Matrix, credit scores must meet the following criteria:
    • Manually underwritten loans – 620 for fixed-rate loans, 640 for adjustable-rate mortgages (ARMs)
    • Desktop Underwriter loans – 620 for both fixed-rate and ARMs
    • Mortgages insured or guaranteed by a federal government agency (HUD, FHA, VA, and RD) – 620
  • The purchase of a single unit principal residence must have a loan-to-value (LTV) of no higher than 97%. If your loan-to-value ratio is less than 75%, a credit score as low as 620 is allowed.
  • Your debt-to-income (DTI) ratio should be no greater than 36%. If your DTI ratio falls between 36% and 45%, a credit score above 680 is required.
  • Fannie Mae now offers a 3% down payment option.

In addition to these requirements, self-employed borrowers have some additional hoops to jump through.

Verification of Income

In order to verify your employment and income, a lender will ask for a copy of your signed income tax returns (individual and sometimes business, as well) from the past two years. This paperwork must include all applicable forms.

A lender may also use IRS-issued transcripts from your individual and business federal income tax returns from the past two years. If you are using these, the information must be complete and legible.

If you use two years of signed individual federal tax returns, the lender may waive the need to see your business tax returns if:

  • you are using your own personal funds to fund the down payment and closing costs and can satisfy the reserve requirements;
  • you have been self-employed in the same business for at least five years; and
  • your individual tax returns show an increase in self-employment income over the past two years.

In certain situations, Desktop Underwriter, Fannie Mae’s automated underwriting system, will only require one year of personal and/or business tax returns if lenders document your income by:

  • obtaining signed individual and business federal income tax returns for the most recent year,
  • confirming the tax returns reflect at least 12 months of self-employment income, and
  • completing Fannie Mae’s Cash Flow Analysis (Form 1084) or any other type of cash flow analysis form that applies the same principles.

Analysis of Your Personal Income

Your lender will prepare a written evaluation of your personal income, including your business’s profit or loss, as reported on your income tax returns. This will help them determine how much stable and continuous income you have. It’s important to note this step isn’t required if you qualified using income you didn’t receive from self-employment. Examples include qualifying for the loan using a traditional W-2 salary or your retirement income.

Freddie Mac

Freddie Mac’s Selling Guide also provides an outline for lenders on how to assess the income for self-employed borrowers. Although there are differences, Freddie Mac and Fannie Mae use similar criteria when it comes to assessing self-employed borrowers.

Freddie Mac uses Loan Product Advisor, an enhanced automated underwriting system, to help ensure loans meet their eligibility requirements. Even if you aren’t using self-employed income to qualify for a Freddie Mac mortgage, they must enter your self-employed status into this software.

Verification of Income

Your lender will calculate your average monthly income based on a review of your complete federal individual income tax returns (Form 1040) including W-2s and K-1s and your complete business tax returns (Forms 1120, 1120S, and 1065).

Analysis of Your Personal Income

If you are self-employed but not using self-employment income to qualify, your lender will request to see your individual federal tax returns to see if there is a business loss that may have an impact on the stable monthly income used to qualify. If a business loss is reported on your individual tax returns, your lender may need to obtain additional tax returns to fully assess the impact of a business loss on income for qualifying.

Eligibility for Freddie Mac

In addition to these special requirements for self-employed borrowers, you also must meet Freddie Mac’s normal eligibility:

  • If you are a non-U.S. citizen who is lawfully living in the U.S. as a permanent or nonpermanent resident alien, you are eligible for a mortgage on the same terms as a U.S. citizen.
  • For a manually underwritten mortgage, your credit history must have at least three credit accounts (on or off your credit report) or four noncredit payment references. Noncredit payment references must have existed for at least 12 months.
  • You must have a valid Social Security number or Individual Taxpayer Identification Number.
  • Per Freddie Mac’s Minimum Indicator Score Requirements, credit scores must meet the following criteria:
    • For a single unit and primary residence with an LTV less than or equal to 75%, you must have a minimum credit score of 620.
    • For a single unit and primary residence with an LTV greater than 75%, you must have a minimum credit score of 660.
  • Your monthly housing expense-to-income ratio should be no greater than 25% to 28%.
  • Your monthly debt-to-income ratio should be no greater than 33% to 36% of your stable monthly income. If your debt-to-income ratio exceeds 45%, you won’t be eligible for a Freddie Mac loan.
  • The purchase of a single unit principal residence must have an LTV of no higher than 97%.
  • Freddie Mac now offers a 3% down payment option.

Requirements for Your Business

In addition to looking at your personal financial situation, Fannie Mae and Freddie Mac also are required to evaluate the financial health of your business.

Fannie Mae

Fannie Mae says you are self-employed if you have 25% or greater ownership interest in a business. In order to qualify, Fannie Mae also analyzes several components of your business.

Length of Self-Employment

Fannie Mae asks lenders to review a two-year history of your previous earnings. However, if you have a shorter period of self-employment (12 to 24 months), your most recent signed federal tax return must reflect your income. It’s important your past income was earned in a field similar to your current business. In these cases, the lender will give careful consideration to your level of experience and the amount of debt your business has acquired.

Analysis of Your Business Income

If you are relying on self-employed income to qualify for a mortgage, and you don’t meet the requirements to waive your business tax returns (as mentioned in the previous section), your lender will also prepare a written evaluation of your business income. Your lender will use their knowledge of your industry to help determine the long-term stability of your business.

The primary goal of this analysis is to:

  • consider the recurring nature of your business income, including identification of pass-through income that may require additional evaluation;
  • measure year-to-year trends for gross income, expenses, and taxable income for your business;
  • determine (on a yearly or interim basis) the percentage of gross income attributed to expenses and taxable income; and
  • determine a trend for the business based on the change in these percentages over time.

Your lender may use Fannie Mae’s Comparative Income Analysis or other methods to determine your business’s viability.

Use of Your Business’s Assets

If you are planning to use assets from your business for a down payment, closing costs, or financial reserves, your lender will need to perform a cash flow analysis to make sure this transaction won’t have a negative impact on your business. This may require additional documentation, like several months of recent business asset statements, to evaluate your cash flow needs over time.

Freddie Mac

Freddie Mac also characterizes self-employed borrowers as people who own at least 25% of a business. Your business can be a sole proprietorship, a partnership, an S corporation, or a corporation. You may notice several similarities when it comes to how Fannie Mae and Freddie Mac evaluate your business. However, there are some distinctions you should be aware of.

Length of Self-Employment

For Freddie Mac, the lender will be required to document a two-year history of your self-employment to ensure your income is stable. If your self-employment history is less than two years, the lender must evaluate your company’s products and services in the marketplace. They will also need to document your two-year history prior to self-employment to show you’re currently earning the same or a greater income in a similar occupation. The lender must consider your experience in the business before looking at your income, and your tax returns must show at least one year of self-employment income.

Analysis of Your Business Income

Your lender will analyze your tax returns and provide a written analysis of your self-employed income. Noncash items like depreciation, depletion, and amortization can be added back to your adjusted gross income. Documented nonrecurring losses and loss carryovers from previous tax years can also be added back to your adjusted gross income.

If you are using self-employment income to qualify, Freddie Mac requires lenders to analyze tax returns and provide a written analysis of your self-employed income. If your income has significantly increased or decreased, you will need to provide sufficient documentation to prove your income is stable. Additional tax returns may be needed if your self-employment income has fluctuated.

Freddie Mac recommends lenders be careful when including additional income you have drawn from your corporation, partnership, or S corporation as qualifying income. Your lender will need to confirm you have a legal right to that additional income. Your lender also needs to verify your percentage of ownership from a review of your business’s tax returns.

Location of Your Business

If you are moving to another region, your lender must consider your company’s service or products in the new marketplace before reviewing your income. You will need to document how your income will continue to be stable in a new location.

Use of Your Business’s Assets

If your business’s assets are used for a down payment, closing costs, financing costs, prepaid or escrows, and reserves, these assets must be verified and must be related to the business you own. The withdrawal of assets from a sole proprietorship, partnership, or corporation may have a negative impact on your business’s ability to continue operating. The impact of this transaction will be considered in your lender’s analysis of your self-employed income. You will need to provide documentation of cash flow analysis for your business using your individual and/or business tax returns. You can learn more about the required documentation here.

What Types of Properties Are Eligible for a Fannie or Freddie Mortgage?

When you are comparing mortgage options, it’s important to know which types of properties are eligible. Here are the basics to keep in mind as you are assessing each choice.

Fannie Mae

Fannie Mae is willing to purchase first-lien mortgages that are secured by residential properties for dwellings that consist of 1-4 units. However, there are some cases where the number of units may be restricted. The property must be located in the United States, Puerto Rico, the U.S. Virgin Islands, or Guam.

The property must be safe, sound, and structurally secure and must be adequately insured per Fannie Mae’s guidelines for property and flood insurance. It must be the best use of the property, must be readily accessible by roads that meet local standards, and must be served by local utilities. Lastly, the property must be suitable for year-round use.

Freddie Mac

Freddie Mac expects lenders to equally assess both a borrower’s eligibility and the adequacy of the property as collateral. Freddie Mac is willing to purchase mortgages secured by residential properties in urban, suburban, and rural market areas. The property must be residential, be an attached or detached dwelling unit(s) located on an individual lot.

The property must be safe, sound, and structurally secure and must be covered by property insurance that meets Freddie Mac’s hazard requirements. It must be the best use of the property, have legal access, and have utilities and mechanical systems that meet local standards. It must be suitable for year-round use and not be subject to a pending legal proceeding.

Where to Go if Fannie and Freddie Reject You

If you don’t qualify for a mortgage backed by Fannie Mae or Freddie Mac, there are a number of private lenders worth exploring. These are considered nontraditional lenders. Some of the more reputable ones include SoFi, Quicken Loans, and PenFed, among many others. Additionally, you may want to reach out to major banks to learn about their nonconforming product options.

SoFi

SoFi’s unique proprietary underwriting uses free cash flow as the primary criterion in determining your eligibility. They also look at a history of financial responsibility and professional responsibility. For qualified borrowers, they offer mortgages with 10% down payments and no mortgage insurance for their 15-year and 30-year mortgage products. They also offer a 30-year 7/1 ARM. This is a hybrid mortgage that begins with seven years at a fixed rate, and changes every year after that.

Interest rates depend on your qualifications and the overall mortgage rate environment, but typically fall in the low 3% to low 5% range for both 15-year and 30-year mortgages.

SoFi estimates 10% of their borrowers are self-employed, so they are well equipped to assess each individual’s unique financial position. They cite their unique underwriting model and commitment to personal service as creating a friendly environment for self-employed borrowers. Additionally, SoFi doesn’t impose restrictions or rate adjustments for self-employed borrowers.

Quicken Loans

According to Quicken Loans, self-employed borrowers are eligible for all the same loans and terms as traditionally employed W-2 borrowers. The key difference is self-employed borrowers need to provide tax returns documenting their business’s income. They like to see two full years of tax returns with stable to increasing income. However, there are some situations on conventional loans that only require one year of tax returns if your business has existed for 5 or more years.

Quicken Loans points out some self-employed borrowers tend to keep all of their assets in business accounts. This can complicate documentation requirements when funds for closing are not from personal accounts. In these types of situations, they usually require business tax returns to review cash flow. This ensures the funds being used to buy a home won’t jeopardize the health of the company.

Conventional loans over 80% LTV require mortgage insurance, while FHA and VA loans have insurance built into the program, regardless of LTV.

Here are their general credit and debt-to-income guidelines for each type of loan:

  • Conventional – minimum FICO 620 and maximum DTI 45%.
  • FHA and VA – minimum FICO varies but is typically 580. DTIs will vary by lender but typically are permitted to 50%.
  • Jumbo – minimum FICO is typically 700 and the maximum DTI is typically 43%.

When it comes to eligibility, there is no difference between self-employed and traditionally employed borrowers for credit score, loan-to-value, or debt-to-income ratios. Quicken Loans also noted self-employment isn’t a deciding factor for interest rates. However, it’s important to know you probably won’t be approved with an income decline of more than 25%.

PenFed

PenFed, a national credit union headquartered in Alexandria, VA, verifies income of self-employed borrowers through copies of personal and business federal tax returns from the past two years. You are required to provide complete tax returns, including all schedules and supporting documents. In some cases, you may also need to provide corporate tax returns for companies you have significant ownership in.

PenFed reviews and averages your net income from self-employment that is reported on your tax returns to determine your income that can be used to qualify. If your income hasn’t been reported on your tax returns, it won’t be considered. Usually PenFed requires a one-year and sometimes a full two-year history of self-employment to prove your income is stable.

Nonconforming Loans from Traditional Lenders

It may not be the first option that springs to mind, but some banks do originate loans. These loans tend to be nonconforming and have higher interest rates.

For example, Chase offers jumbo mortgages for loans between $417,000 and $3 million. These are both fixed-rate and ARM loans for up to 30-year terms.

For these types of products, Chase typically will only work with existing customers, depending on their assets. If you don’t have a prior relationship with the bank, you won’t be eligible. If you’re interested in a nonconforming product, Chase recommends starting by applying for pre-qualification here.

In order to be approved for these types of products, you must meet the following requirements:

  • Credit score – 680 minimum
  • Down payment – 15% without mortgage insurance
  • Reserve balance – 18 to 24 months
  • Debt-to-income ratio – no more than 45%

When it comes to interest rates, Chase factors in all the above criteria. However, the larger the loan, the better rates are available. They prefer to use your pre-qualification information as a starting point and work through interest rate options from there.

How to Comparison Shop for a Mortgage Loan

Did you know nearly half of mortgage borrowers don’t comparison shop? A recent Consumer Financial Protection Bureau (CFPB) study found 77% of borrowers only apply with one lender or broker. These same borrowers were quick to rely on salespeople rather than doing their own research.

As we have outlined, mortgages are available through a variety of types of lenders. Because the process of qualifying for a mortgage when you are self-employed requires additional legwork, and may be more expensive, it’s even more important to shop around.

The CFPB’s interest rates tool is a great place to start. By plugging in your credit score, state, home price, and down payment percentage, you can see a graph of lenders and interest rates being offered in your region. Although this tool doesn’t state which lenders are offering these rates, you can Google the rate + your state + mortgage to find out exactly where it is being offered.

Remember, lenders want your business, and knowing what else is available will only give you more leverage. Like any other mortgage, you will want to ask about points, mortgage insurance, and closing costs. You can compare each lender’s Loan Estimates before making a final decision.

For conforming loans, backed by Fannie Mae or Freddie Mac, you can try the above tactic for shopping around. You can also try local banks and credit unions. For private lenders like SoFi, Quicken Loans, or PenFed, you are better off reaching out to these companies directly. For nonconforming loans from traditional lenders, it’s easiest to start with banks you have an existing relationship with.

Here is an example to help you determine what is right for you:

Conforming Loan from Fannie Mae or Freddie Mac

This example is for the state of Tennessee:

Credit score – 680-699
Home price – $200,000
Down payment – $6,000 (3%)
Loan amount – $194,000
Rate type – fixed
Loan term – 30 years
Interest rates – 4%-4.625%
Total cost for interest rates at 4% – $333,360
Total cost for interest rates at 4.625% – $358,031

Nonconforming Loan from SoFi

Credit score – 680-699
Home price – $200,000
Down payment – $20,000 (10%)
Loan amount – $180,000
Rate type – fixed
Loan term – 30 years
Interest rates – 3%-5%
Total cost for interest rates at 3% – $273,240
Total cost for interest rates at 5% – $347,860

Keep in mind credit score, home price, and down payment will all affect your interest rates. You should ask about points, mortgage insurance, and closing costs, which are not included in these examples.

Start Preparing Now

The entire process may feel daunting, but there are a number of things you can start doing now in order to put your best financial foot forward:

  • Stay Organized Keeping pristine records of your company’s profits and/or losses is a smart practice whether you are applying for a mortgage or not. Staying on top of paperwork from the beginning will be helpful for both you and your loan officer.
  • Avoid Co-Mingling Funds One of the biggest mistakes self-employed individuals make is co-mingling personal and business funds. Lenders may want to see separate statements for your credit card, checking, and savings accounts. If you are feeling overwhelmed by the process, you can start by comparing our favorites.
  • Improve Your Credit Score A recent Zillow study found self-employed borrowers are twice as likely to have a FICO score below 680. It’s never too soon to start making improvements. Start by pulling free reports from all three credit bureaus — Experian, Equifax, and TransUnion — once per year from AnnualCreditReport.com. Once you are armed with your current scores, you can take action with our credit score guide.
  • Pay Down Debt Regardless of your employment status, it is nearly impossible to be approved for a mortgage if your debt-to-income ratio is above 45%. In most cases, a maximum debt-to-income ratio of 33%-36% is preferred. If you are above that range, paying down debt will improve your chances of being approved.
  • Save a Larger Down Payment Offering a larger down payment may provide additional leverage when it comes to eligibility.
  • Build Up Your Cash Reserves Having a sizable emergency fund can signal to lenders you are prepared for the inevitable dips in income self-employed borrowers face. Help ease your bank’s nerves about irregular income by having extra cash on hand.
  • Carefully Evaluate Tax Deductions If you are planning to purchase a home within the next few years, it’s critical to begin weighing the pros and cons of your business’s tax deductions now. It may be worth writing off fewer business expenses in order to qualify for a less expensive conforming mortgage. This step is worth discussing with a trusted tax professional. For more information on self-employed taxes, you can visit the Self-Employed Individuals Tax Center.

Final Thoughts

When it comes to homeownership, there is a lot to think about, and being approved for a mortgage is just the beginning. The stress of buying a home is only elevated for self-employed borrowers, who face additional hurdles each step of the way. However, the process doesn’t have to be overwhelming. By crafting a game plan as early as possible, and sticking with it, you will have the best possible chance of being approved.

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Mortgage

Guide to Getting the Best Rate on Your Mortgage

Advertiser Disclosure

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Guide to Getting the Best Rate on Your Mortgage

A house is the single largest asset that most Americans will ever buy. The median price of a home sold in the United States is up to $301,300, and the median household income of a homeowner is $60,000. This means that a house now costs more than five times the income of a typical homebuyer.

With prices so high, it’s more important than ever to find a great rate on your mortgage. Finding the lowest rate can save you tens of thousands of dollars over the lifetime of a loan. But finding the best rates on the loans with the right features can be a challenge. In this guide we’ll teach you how to find the best mortgage rates.

Finding the best rate on a mortgage

When it comes to buying a house, you don’t just need to house hunt; you need to shop for a mortgage. According to the Consumer Financial Protection Bureau (CFPB), just 53% of Americans shop for mortgages, but comparing lenders has a huge payoff. Saving 1% on your rate will save you tens of thousands of dollars over the life of your loan. Your mortgage can make or break the affordability of a house, and it’s up to you to find the best rates. These are the steps you can take to find the best rates.

Compare rates using the CFPB’s handy tool

The CFPB offers a tool that allows you to compare the prevailing interest rates on various types of loans. To use the tool, you need to know your credit score, the amount you intend to borrow, and how much money you have for a down payment.

By exploring the different options, you can determine the best rates in your state, and the most common rates.

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This tool will give you an idea of the rate landscape in your state. However, you still need to do work to get the best rates.

Next, find lenders that offer the lowest rates

Once you know the lowest interest rates, you can find the lenders offering those rates through search engine queries. Enter the following formula: “State Mortgage, X% Interest Rate, Loan Type.”

For example, “Alabama Mortgage, 3.75% Interest Rate, 30-Year Fixed Rate.”

The bank or credit union with the best rate should emerge near the top of the search rankings. You will find mortgage comparison websites that will help you connect with the banks. Mortgage comparison websites can be a helpful resource, but they require your contact information. If you use a comparison site, expect to receive phone calls or email solicitations.

Continue to cross-reference the rates from comparison sites with information from the CFPB. The rates on a mortgage comparison site should be as good as those on the CFPB’s site.

If a lender has already pre-approved you, they may be willing to match the lowest rate. Talk with your loan officer about the rate you saw on the CFPB’s website. Ask them to match the rate. If they will, the conversation saves you time and money.

Get pre-approved for a mortgage from multiple banks

Once you find the banks with the best rates, consider getting pre-approved for mortgage rates from a few different banks. A pre-approval means that a bank plans to give you a loan at a given rate. You will need to submit documentation to a loan officer to get pre-approved. Typical documentation includes W-2 forms, tax returns, credit reports, and evidence of assets.

The bank will review your documentation and give you a pre-approval letter. The letter explains how much you can borrow and at what rate. If you’re denied at this stage, you can find out why.

A pre-approval is not a contract. It is not subject to underwriting or an appraisal. Rates can change after you get a pre-approval. That’s why we recommend getting multiple pre-approvals if you can.

When you’re pre-approved, a bank will give you a letter that you can submit with offers on a home. Home sellers want to see a pre-approval letter because it means that you’re likely to have access to the financing to close a deal.

Once you have pre-approvals in hand, start shopping for houses. You can submit a bid and negotiate a price using your pre-approvals.

Request loan estimates from lenders

Once a seller accepts your bid, request loan estimates from all the banks that pre-approved you.

A loan estimate is a three-page document that contains an estimated interest rate, monthly payments, and closing costs for the specific loan. It explains everything you need to know about the loan if you choose to move forward.

Compare all the loan estimates before committing to a particular mortgage lender. Loan estimates allow you a true apples-to-apples comparison of interest rates.

A loan estimate isn’t a contract. The bank may deny the loan based on the home’s appraisal values or due to underwriting problems. But a loan estimate will allow you to make an informed decision.

Factors that influence your interest rate

Shopping for a mortgage isn’t the only way to find the best interest rate. You can influence the rate by controlling these factors.

Credit score

The better your credit history, the better your rate will be. In some cases, the difference can be a full percentage point or more. Fixing your credit score is one of the best ways to influence your mortgage rate. Depending on your credit history, you might be able to fix your credit score on your own within a few months.

When you’re shopping for a mortgage, pay your bills on time and keep your credit usage low. Try to use 10% or less of your total available credit. Don’t close old credit accounts or apply for new accounts when mortgage shopping. These actions promote a high credit score while you shop for a mortgage.

Down payment & PMI

In general a bigger down payment means a lower interest rate.

If you put down at least 5%, you will probably qualify for the lowest advertised rates. But don’t confuse the lowest interest rates with the lowest cost financing. Most banks require you to purchase private mortgage insurance (PMI) if you don’t put at least 20% down on a home. PMI adds about .5%-1% per month on your mortgage. You won’t be able to remove PMI until you’ve built up at least 20% equity in your home. You build equity when your home rises in value and when you pay down your mortgage.

If you have a down payment less than 5%, you’ll need to look at FHA loans or VA loans. VA loans don’t require PMI, but you will have to pay an upfront financing fee. This is a fee that doesn’t help you build equity, but VA loans have competitive rates for people who don’t have a down payment. Check the fee schedule for VA loans to see if the financing fee is worth it to you.

FHA loans require just a 3.5% down payment, but FHA loans have require mortgage insurance premiums (MIP). The MIP is an upfront fee (usually 1.75% of the total mortgage) and monthly interest rate hike of around .5%. You can’t get rid of MIP unless you get rid of your FHA loan.

Location

Buyers looking for a mortgage in a rural area may see higher rates compared to equally qualified buyers in nearby urban areas. Most lenders have less familiarity with lending in rural areas. This leads to higher rates. In rural settings, you may get the best rates from nearby banks and credit unions.

Rates also differ on a state-by-state basis. States that have laws that make foreclosure difficult tend to have higher mortgage rates than states with looser foreclosure laws. Likewise, states that require lenders to have a physical presence in the state raises interest rates.

Loan size

Interest rates on small mortgages (less than $50,000) tend to be higher than rates on typical mortgage sizes. Small mortgages are less profitable than other loans, and many banks won’t issue this size mortgage. Borrowers may need to work with local banks or credit unions or government lending programs to find a micro-mortgage.

At the other end of the spectrum, jumbo mortgages tend to track closely to conforming loan interest rates. Banks can’t sell jumbo loans in the secondary market, so they are riskier for the bank compared to other mortgages. Usually, banks compensate higher risk with higher interest rates. However, the rigorous underwriting on jumbo loans may drive many poor prospects out of the market.

Length of loan (Loan term)

Mortgages with shorter terms have lower rates than those with longer terms. A longer term represents more risk for the bank. Banks compensate their risk with higher interest rates. This doesn’t mean that a shorter term loan is always the right choice. Choose the loan term that fits your needs before you compare rates. That way you’ll get the best interest rate on the right mortgage for you.

Fixed or variable rates

Adjustable-rate mortgages put more risk onto borrowers. You’ll initially pay a lower interest rate if you take out an adjustable-rate mortgage, but the rate might increase.

When you’re considering an adjustable-rate, learn when and how the interest rate adjusts. Most loans adjust based on a set index. In a low interest rate environment, you can expect rates to increase, but you need to guess how much. Weigh whether the low rates now are worth a potential high rate in the future.

Conforming vs. FHA vs. VA vs. conventional

The company that backs your loan may seem unimportant, but it influences your rate.

Conforming loans (those that can be purchased by Fannie Mae or Freddie Mac, the largest purchasers of mortgage loans in the U.S.) tend to have the lowest interest rates. Despite their low interest rates, conforming loans are profitable for banks. Banks can easily sell conforming loans to Fannie Mae or Freddie Mac and reinvest the proceeds in making more loans. Conforming loans require at least a 5% down payment and good credit. For conforming loans, put 20% down to avoid paying PMI.

FHA loans have more lenient down payment and credit standards. They tend to be expensive for well-qualified buyers. However, an FHA loan may be the right option if you have a low down payment or a poor credit score. Only you can determine if the extra cost is worth it for you. VA loans are available to veterans, and they charge an upfront fee. However, they offer competitive rates for first-time homebuyers. If you can qualify for a VA loan, look into it as an option.

Conventional loans can’t be purchased by Fannie Mae or Freddie Mac. They require more shopping around to find the best rates. Not every lender issues conventional loans. If you qualify, the rates should be competitive with rates on conforming loans.

If you’re taking out a jumbo mortgage, you need to qualify for conventional underwriting. Likewise, condo buyers may need to qualify for a conventional loan. Fannie Mae and Freddie Mac will not purchase a mortgage if the property is part of an association that has more than 50% renter occupants.

Buying points

Many lenders offer to let borrowers buy “discount points” off of a mortgage. This means that you pay a set fee in exchange for the lender to lower your rate. In some circumstances buying discount points makes sense. Divide the cost of the point by the change in your monthly payment. This will tell you the number of months it takes for the prepayment to pay off (in terms of savings). If you expect to stay in the house significantly longer than the payoff period, go ahead and purchase the points. Otherwise, pay the higher interest.

Closing costs

An advertised interest rate doesn’t account for your total cost to borrow money. Most banks make their real money by charging closing fees. Banks might charge loan origination fees, recording fees, title inspection fees, underwriting fees, and application fees.

All the financing charges will be disclosed on a loan estimate. The loan estimate will also provide you with an annual percentage rate (APR), which expresses the total cost of borrowing money including the financing fees.

Special programs

Cities and states often issue special interest rates on loans for homebuyers who meet certain criteria. For example, Raleigh, N.C., subsidizes a $20,000 down payment loan for low-income, first-time homebuyers in distressed neighborhoods. Check your city, county, and state websites to see if you qualify for special rate programs. These programs often have favorable borrowing terms in addition to great rates.

Accelerating payments

Some borrowers cut their total interest costs by accelerating their mortgage payoff. If you make a half mortgage payment every two weeks, you’ll make an extra mortgage payment every year. This cuts a 30-year mortgage down to 23 years.

Making extra payments early in the life of your loan will help you achieve 20% equity faster. This will allow you to drop PMI payments or refinance at a lower rate.

Determining a budget for your loan

Finding a great rate on a loan that you can’t pay back is a sure way to destroy your credit. Before you apply for a loan, establish a realistic budget for your monthly mortgage payment. Avoid borrowing more than you can comfortably pay back.

When banks approve you for a mortgage, they will lend based on your current debt-to-income ratio without considering your other costs of living. Lenders have some limits, but you need to establish your own limits. Most of the time, lenders will not extend mortgage loans to borrowers whose monthly debt liabilities eat up more than 43% of their gross monthly income.

To understand debt-to-income ratio, consider this example. A person with a $60,000 annual income and a $500 monthly car payment applies for a mortgage.

A bank will allow them to carry a debt load up to $2,150 per month (($60,000/12)*43%). The bank subtracts the $500 from the maximum allowed debt load and determines that this person can afford $1,650 in house payments each month.

The bank in this example determines that $1,650 a month is an affordable budget.

No matter how large a loan you can get, you need to be a savvy consumer. The Consumer Financial Protection Bureau recommends that your entire housing payment (including taxes, insurance, and association dues) should take up no more than 28% of your gross income.

The CFPB’s advice may seem too strict, but you need to determine your non-mortgage-related cost of living before committing to a new loan. Calculate costs like income taxes, transit expenses, and child care or education costs. If you pay alimony or for out-of-pocket health care, consider those costs too. Plus, you’ll need to factor in the costs of home maintenance. Experts recommend setting aside 1%-3% of your home’s purchase price for maintenance and upgrades.

A 43% debt-to-income ratio may be manageable for people who expect a significant salary bump in the near future. But for many, such a high ratio could get you into credit trouble.

If you’re seriously shopping for houses, use Zillow’s advanced affordability calculator to determine how much mortgage makes sense for you. You can also learn if buying makes financial sense by using the Rent vs. Buy Calculator from realtor.com.

Before you start shopping for houses, determine how a mortgage will fit into your budget. Don’t succumb to pressures to overextend your budget. A burdensome mortgage has the power to turn a dream house into a nightmare. You can avoid the nightmare by planning ahead.

Determining loan features you want

In addition to establishing a budget, you need to understand how to find the right features on a mortgage. A great rate on a bad mortgage could spell financial ruin. When you’re shopping for loans, ask yourself these questions:

How long will you stay in the home?

Some buyers purchase houses with the intention of staying just a few years. Someone who plans to sell in a few years might consider a lower interest rate adjustable mortgage. However, an adjustable-rate mortgage is risky for someone who intends to live in a home long term.

How risky is your financial situation?

Do you and your partner have two steady jobs and a large cash cushion? In such a stable situation, you might feel comfortable putting 20% down. You might also feel good locking into a 15-year mortgage to save on interest.

People with less stable income and finances might feel more comfortable with a smaller down payment and a longer payoff period. This will mean paying PMI and higher financing costs, but they can be worth it for peace of mind.

Do you expect to have better cash flow in the future?

If you think that you’ll have more accessible cash flow in the future, you can borrow near the higher end of your limits today. An interest-only loan will allow you to get into a house with lower payments now and higher payments in the future. Of course, you need to be realistic about your future expectations. Your future income may be more modest than you hope, or you may face high costs in the future. An interest-only loan could leave you trapped in a house if housing prices decline.

Even if you expect a higher income, borrowing near the top end of your budget could keep you “house poor.” If the raise doesn’t pan out, you’ll be stuck in a house that you can’t comfortably afford.

Do you have access to other sources of financing?

Alternative sources of financing like a home equity line of credit make a loan with a balloon payment more viable. Alternative financing means that you’ll have options if your original mortgage payoff plan falls through.

Anyone considering a balloon payment loan should have a solid lead on alternative financing before they take out the loan.

How much cash do you have for a down payment?

You can purchase a house with almost no money down. For example, the Federal Housing Association (FHA) offers “$100 Down” home financing on select HUD homes, or down payments as low as 3.5% for FHA-backed loans. Veterans can purchase homes using $0 down VA loans.

On the other hand, if you have more money to put down, you may qualify for a conventional mortgage or a mortgage backed by Fannie Mae or Freddie Mac. The more cash you have, the more options you have for loan types.

Do you have compelling uses for cash outside of a home down payment?

Putting a large amount of money down on your home locks up the cash. You can access home equity through a home equity line of credit, but that introduces a new element of risk. Even if you have a large amount of cash, you may not want to use it to fund a down payment. For example, you may want to hold cash for an emergency fund, to start a business, or to fund some other purchase.

If you have a compelling reason to hold onto cash, you may intentionally narrow your mortgage search to low down-payment options.

How quickly do you want to pay off your house?

A paid-off home might be your top financial priority. In that case, you might want to look for options with a short payoff period. For example, you might prioritize the forced savings of a 15-year mortgage. You might even aim to payoff a 5/1 ARM before the first rate adjustment if you have sufficient cash.

How important is the monthly payment?

A lot of people prioritize a low monthly payment above any other factor. You can achieve a low payment by avoiding fees (like PMI), finding the lowest possible interest rate, and extending the terms of the loan. Even more important than those factors is borrowing an amount that you can easily afford under most circumstances.

Common mortgage terms

Sometimes the most difficult part about shopping for a mortgage is understanding the terms that lenders use. Below we’ve defined a few of the most common mortgage terms that you should know before you sign a loan.

  • Interest Rate – The amount charged by a lender for a borrower to use the loaned money. This is expressed as a percentage of the total loan amount.
  • APR – The annual percentage rate is the total amount that it costs to borrow money from a lender expressed as a percentage. The APR factors in closing costs and other financing fees.
  • Amortization Schedule – A table that shows how much of each payment goes to the principal loan balance versus the interest portion of the loan.
  • Term – A set period of time over which a fixed loan payment will be due (often 15 or 30 years).
  • Fixed-Rate Mortgage – A mortgage where the interest rate stays the same for the entire term of the loan.
  • Adjustable-Rate Mortgage – A mortgage where the interest rate changes based on factors outlined in the loan agreement. Often, the adjustment is tied to a certain publicly available interest rate like the Federal Exchange Rate. Adjustable-rate mortgages are considered riskier than fixed-rate mortgages due to the potential volatility of payments. Adjustable-rate mortgages (ARMS) include:
    • 1-Year ARM – A mortgage where the interest rate adjusts up to once per year for the life of a loan.
    • 10/1 ARM – A mortgage where the interest rate is fixed for ten years and then increases up to once per year for the remaining life of the loan.
    • 5/1 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every year for the life of the loan.
    • 5/5 ARM – A mortgage where the interest rate is fixed for the first five years of the loan and then increases up to once every five years for the life of the loan.
    • 5/25 ARM – Also known as the five-year balloon mortgage. A 5/25 loan is a subprime loan with a fixed rate for the first five years of the loan. If a borrower meets certain standards (usually a record of on-time payments), they will receive the right to refinance the remaining 25 years on an adjustable-rate mortgage. Otherwise, the bank requires a “balloon” or remaining balance payment after five years.
    • 3/1 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once per year for the life of the loan.
    • 3/3 ARM – A mortgage where the interest rate is fixed for the first three years of the loan and then increases up to once every three years for the life of the loan.
    • Two-Step Mortgage – A mortgage that offers a fixed interest rate for a fixed period of time (usually 5 or 7 years). After the fixed period, the rate adjusts to current market rates. Often, the borrower can choose either a fixed rate or an adjustable rate during the second step.
  • Interest-Only Mortgage – A mortgage where a borrower pays only the interest on a loan for a fixed period (usually 5-7 years).
  • PMI – Private mortgage insurance is a product that protects a bank if you default on your mortgage. Lenders often require borrowers with less than 20% equity to purchase PMI.
  • Jumbo Mortgage – A mortgage that is larger than the standards for a “conforming loan” set by government-backed agencies. In most parts of the U.S. a jumbo loan must be larger than $417,000. In some of the highest cost of living areas, a jumbo is in excess of $625,000.
  • Fannie Mae – The Federal National Mortgage Association is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Freddie Mac – The Federal Home Loan Mortgage Corporation is a government-sponsored enterprise that purchases mortgages that meet certain criteria from banks that issue the mortgages.
  • Conforming Loan – A mortgage that meets the funding criteria of Fannie Mae and Freddie Mac. The most stringent criteria is the loan size.
  • FHA Loan – A loan guaranteed by the Federal Housing Administration. Qualifying standards are not as stringent, but the fees are higher. In addition to a monthly premium (similar to PMI), borrowers pay a “borrowing” premium when they take out the loan.
  • VA Loan – A mortgage guaranteed by the Department of Veterans Affairs. Veterans can purchase houses with a $0 down payment when using a VA loan, provided the veteran meets other lending criteria.
  • Conventional Mortgage – A mortgage that is not guaranteed by any of the federal funding agencies. Certain homes or condominiums will only qualify for a conventional mortgage financing option.
  • Down Payment – The initial payment that a homebuyer supplies when purchasing a home with a mortgage.
  • Balloon Mortgage – A mortgage where a borrower pays fixed payments for a period of time (usually 5 or 7 years) after which the balance of the loan is due. This is considered a high-risk loan.

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Featured, Mortgage

Guide to Refinancing Your Mortgage to Lower Your Payments, Consolidate Debt

Advertiser Disclosure

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Happy black couple standing outside their house

According to the Consumer Financial Protection Bureau, mortgage lending between August and October 2016 was up nearly 50 percent over last year, “unusually large number likely due to a high rate of mortgage refinancing.”

There are many reasons you might consider refinancing your mortgage. For one, interest rates are continuing to creep up after several years of historic lows, driving many borrowers to refinance in hopes of locking in a lower rate now.

You may also have a long list of home repairs that need to be addressed. Cashing out on a refinance could provide you find the money you need to get the job done. You might also consider a mortgage refinance to help consolidate some of your high interest debt from credit cards or student loans.

But is any of this a good idea?

Today we’ll explore when refinancing a mortgage is a smart decision, and when it’s mathematically unwise. We’ll do this by looking at the cold, hard numbers and walk you through the process if you decide it is an avenue you’d like to pursue.

Refinancing to Lock in a Lower Mortgage Rate

Rates

As of this posting, the national average interest rate is at 4.15%. While that number is higher than it has been in the recent past, rates are still much lower than the average 6% rate you would have secured before the 2008 recession or the 10% average rate you would have had to pay in the 1980s.  If you originally financed or refinanced your mortgage prior to the recession, exploring refinance options could be a good path for you.

Fees

However, before you decide on interest rates alone, you need to be aware of all the associated fees that come along with a refi. These fees usually include escrow and title fees, document preparation fees, title search and insurance, loan origination fees, flood certification, and recording fees. These alone can easily add up to $4,700 or more, according to Trulia.

Do the math

Because each situation will have varying interest rates and fees, it’s important to run your own numbers before making a definitive decision. While we can’t run your numbers for you, we can take you through the mathematical process through an example. You can do the same by using your own, real-life numbers and this calculator from myFICO.

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Source: MyFICO

Let’s say you’re refinancing a 30-year mortgage with a 5.4% interest rate. You have been paying your mortgage for 10 years at this point. But today, you still have $205,285.94 to pay off. If you continue to pay on your current mortgage, you will pay it off in 2036 but you will have paid a staggering $255,377.71 in interest fees over the lifetime of the loan.

So you are considering a refi loan. Let’s say you prequalify for a 3.5% fixed mortgage refi rate over an additional 30 years.

If you decide to refinance to a 30-year mortgage, it will be like starting the clock over even though you already paid 10 years into your original loan. So, factoring in the total interest you paid over that 10 year period on the original loan and the interest you will accrue over the 30-year span of the new refi loan, you will pay a total of $251,720.

By refinancing, it looks like you will pocket $3,657.71 in savings. So refinancing is definitely the better option, right?

Hold your enthusiasm. Remember those fees that come along with a refi? Before you can actually refinance your existing mortgage, you could face an estimated $5,077 in fees, MyFICO’s calculator shows. With the additional interest and fees combined, you’ll end up paying  $256,797 over the lifetime of the loan — about $1,000 more than you would if you just stayed put.

That makes this particular refinance over $1,000 more expensive than continuing with your current mortgage. Plus, if you refinance, you’ll be paying on a mortgage for an additional ten years before you own your home outright.

Refinancing to Lower Your Monthly Mortgage Payments

House building, insurance, housewarming, loan, real estate, home concept

If you already have a low interest rate and are thinking about refinancing exclusively for lower monthly payments, think again. While the amount due monthly will go down, the amount you pay over the life of your loan will go up.

In our example above, refinancing to a lower rate of 3.5% would dramatically decrease your monthly mortgage payments before taxes —  from $1,403.83 per month to $922 per month. However, as we demonstrated using myFICO’s refi calculator, you’d end up spending $1,000 more over the course of the loan as a result.

Refinancing simply to lower your monthly payment is especially dangerous if you are in the first 5-7 years of paying off your current mortgage. That’s because interest charges are not spread out evenly over the course of your loan — they are front loaded. That means for the first 5-7 years, you’re paying more toward interest and very little toward the principal loan balance. In the meantime, you’re building very little equity. If you refinance during this time frame, you’re starting the clock over and delaying the opportunity to establish equity.

Suggest: Let’s back to our first example one more time. In this case, the homeowner is 10 years into their existing mortgage and has been making monthly payments of $1,403.83. By this time, roughly $477.89  goes toward the principal loan balance each monthly. But if they were to restart the clock and refinance to a new 30-year mortgage, only $325 of their monthly mortgage payment would go toward their loan principal.

Refinancing to Make Home Improvements

home improvement repair kitchen remodel

If you’re looking to refinance so you can cash out a portion of the new mortgage for home improvements, you may be onto a good idea. If you have a 20-year-old roof that needs to be fixed and no cash on hand, refinancing at at a lower rate could make more financial sense than using alternative financing options.

When you use a cash-out refinance, your financial institution will give you a new mortgage. Part of your monthly payment will go towards the amount you still owe on the home, while another part will go towards paying off the cash they give you at closing. You can usually only take 80%-90% of your established equity out as cash when using this method.

Another option is to take out a home equity line of credit (HELOC). This operates similarly to a credit card; the financial institution offers your a line of credit up to a specified amount, but you only have to pay on it if and when you choose to borrow. Because a HELOC is secured by your home, interest rates are much lower than on credit cards and may even be lower than the interest rate on a cash-out refinance. However, HELOC interest rates are typically variable, which could get you in trouble further down the line if you’re borrowing a lot of money for home repairs like a new roof.

Either way, you should be cautious. Making an upgrade for the sake of functionality is one thing, but making an upgrade for the sake of luxury is another. It’s inadvisable to make a lavish kitchen upgrade in the tens of thousands, even if you are under the illusion that it will build home value further down the line. If the luxury is something you really want, save up for it. Don’t finance it.

Refinancing to consolidate existing debts

Desperate young couple with many debts reviewing their bills. Financial family problems concept

Cashing out to pay off credit card debt

You may also be tempted to cash out a refinance in order to pay off other debt. Historically, homeowners have used this method primarily to pay off high-interest credit card debt. With interest rates so low, doing so may seem like a good idea. Rolling your credit card debt into a mortgage with 3% interest is better than paying it off with an average of 15%-25% interest — isn’t it?

It may seem like a good idea, but too often this method doesn’t change the root cause of the issue. If you had a spending or cash flow problem prior to the refinance, you’re likely to end up in credit card debt again, but this time you’ll have a bigger mortgage on top of it.

A better way to refinance your credit card debt could be applying for a balance transfer. Many credit cards include an initial offer of 0% interest on balance transfers for a certain amount of months. Zero percent is better than any interest rate you’ll find in the housing market. Though these cards come with balance transfer fees, those fees can be as low as 3%, and you only have to pay them once. Because there is a deadline on the 0% interest period, you’ll be more likely to find the motivation to pay the debt off quickly, building better financial habits along the way.

There are rare instances where rolling your credit card debt into a mortgage refinance can be advantageous. For example, if you’re a dual-income household and you lose a spouse without adequate life insurance, you may find yourself in a financial quandary.

In this scenario, if you have credit card debt in your own name and suddenly can’t afford to pay the monthly bills, refinancing your mortgage and cashing out a portion to pay off your high-interest debt may be one of the few feasible options.

Cashing out to pay off student loans

Recently SoFi, an online market lender, rolled out a new product that allows you to refinance your home and cash out a portion of the new mortgage to pay off your student loans. Let’s say you owed $30,000 on your home and had $20,000 in outstanding student loan debt. You would take out a $50,000 mortgage refinance with $20,000 of it paying off your student loan debt.

This can potentially be a smart idea. If the interest rate on the refinance is less than the interest rate on your student loans, you stand to save some money. If you ever sell your home, the sale will take care of the portion that went to pay off your loans.

The danger is you will lose all the benefits that come with federal student loans, such as income-based repayment and pay-as-you-earn options, as you will be swapping your Federal loans for a private loan issued by SoFi. For this reason, the vast majority of people who will benefit from this product will be those who already carry private student loans with relatively high interest rates.

How Should You Shop?

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Before you start shopping, you’re going to want to arm yourself with knowledge. First, find out what competitive interest rates look like in your area. You can do so by using this tool from the Consumer Financial Protection Bureau.

It’s good to know what the best rates are, but it’s even better to know if you’ll qualify for them. About six months before you plan on applying for a refi, get a free copy of your credit report from each of the three credit reporting bureaus to make sure everything on your report is accurate and up to date. Your credit report will be used to determine your credit score when you start submitting applications.

Many conforming loans will be backed by Fannie Mae’s Refi Plus program. To qualify for the lowest interest rates in this program, you will want to have a credit score of 740+. You can still qualify with a lower credit score, but the further down you are on this list, the higher your interest rate will be:

  • 740+ Best rates
  • 720-739
  • 700-719
  • 680-699
  • 660-679
  • 640-659
  • 620-639
  • Below 620 Worst rates, and you may have trouble even qualifying.

To find out which credit score range you fall into, pull your scores from several different sources using several different scoring models.

Variable vs. fixed rates

Another thing to consider before you shop is whether you prefer a variable or fixed rate. Variable rate loans are stable for one month to five years or more, after which the interest rate will adjust based on an index. Since rates are low at the current moment, the odds of your interest rates shooting up after five years is extremely high. Unless you know with certainty that you can afford your monthly payments when they rise, or you aren’t planning to stay in the home for long, taking this route is risky.

Because rates are so low, fixed is likely the way to go. The rates will be higher than the offers you receive for initial variable rates, but they will stay consistent for the entirety of your loan. When interest rates inevitably go up again, yours won’t if you lock in the fixed rates today.

Shop around — including your current lender

As with most shopping endeavors, the best way to find the best price is going to be getting quotes from several different lenders in your area.
There are two primary criteria you will want to examine. The first is obviously interest rates. The second is fees, which can eat into your savings.
When you start shopping, it’s easy to take the path of least resistance: your current lender. Typically, they will offer you lower fees than their competitors, but their interest rates may be potentially higher. Get outside quotes to use as leverage for negotiations in this arena.
Another possibility is your lender offers you the smallest fees and lowest interest rates among their competition, but the rate is still higher than you’d like it to be because of your credit score. While doing so doesn’t have a 100% success rate, you can try to negotiate for a lower rate based on customer loyalty.

When you’re applying, don’t forget to look at online marketplace lenders such as SoFi. Many times they have lower fees and involve less paperwork.

How Long Does the Process Take?

Clock time deadline

Many lenders will want to see if you are pre-qualified before you begin the full application process. This can be misleading because getting pre-qualified often takes mere minutes, and the interest rates you are offered are based only on a soft pull of your credit.

The full process of being approved for a loan will take much longer–typically between 30 and 45 days if you submit all of your paperwork in a timely manner. It will require a hard pull on your credit report and score, along with submitting a lot of personal documentation. Remember, just because you are pre-qualified doesn’t mean you will be approved. Once the financial institution has more information, they may adjust or redact their offer.

Paperwork to prepare

To make sure the application and approval process goes as smoothly as possible, gather up these commonly required documents before approaching your lender to fill out any forms:

  • Proof of income, including: past 2-3 months’ worth of pay stubs, employer contact information including anyone you’ve worked for in the past two years, W-2s and income tax documents for the past two years, and/or additional documentation of income for the past two years for self-employed individuals including Schedule C or K and profit/loss statements.
  • Proof of assets, including: a list of all the property you own, life insurance statements, retirement account statements, and bank account statements going back at least three months.
  • Accounting of debts. This includes statements for any outstanding loans or credit card debt you may have. Don’t forget your current mortgage!
  • Proof of insurance. For our purposes today, this generally refers to homeowner’s insurance and title insurance.
  • Know Your Customer information. Financial institutions are required to verify your identity before lending you any money or allowing you to open any type of financial account. Be prepared with your Social Security card, your driver’s license or other state-issued ID, and the addresses you have lived at for at least the past three years, including dates of residence.
  • Additional documents for special situations. If you receive income from disability, Social Security, child support, alimony, rental property, regular overtime pay, consistent bonuses, or a pension, be sure to prepare documentation for these income sources as well.

There may be additional documents required depending on your lender, but checking off this list is a great start.

If you have all necessary paperwork on hand, you can submit it via the internet or postal mail immediately after filling out your application online, over the phone, or in person. The modality of submission will depend on the lender.

Approval

A loan officer will look over your paperwork, which will hopefully end in approval. You will then be sent documents to review. It would be wise to do so with a lawyer, which is an additional fee you will want to calculate into your refinancing equation.

Closing

If you are agreeable to all terms, you will fill out your documentation for closing. You will have to issue payment for closing fees just as you did when you took out your original mortgage. Depending on the lender, you will submit this paperwork in person, through postal mail, or online. After the paperwork is processed, your current mortgage will be paid off and your refinanced mortgage will take effect.

Typically, the entire process takes somewhere between 30 and 45 days. >

Conclusion

If you’re refinancing solely for lower mortgage payments or in order to cash out for a chef’s dream kitchen, back up and reconsider. But if you’re refinancing for lower interest rates on a mortgage on which you’ve built significant equity, moving forward may be a good option. Be sure to run your numbers and sit down with a lawyer before signing on any dotted lines.

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Mortgage

Guide to Reverse Mortgages: Is the Income Worth the Risk?

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

old senior couple at home house on couch

If you own a home, chances are you’ve heard of a reverse mortgage. Despite increased attention and regulation, many homeowners still struggle to understand what reverse mortgages are and who should consider one. This guide will provide an in-depth understanding of exactly what a reverse mortgage is and the pros and cons of this complex financial product.

What is a reverse mortgage?

Most homeowners are familiar with a regular mortgage: You borrow money from a lender to purchase a home, then repay the loan in monthly installments over the course of several decades.

With a reverse mortgage, the lender pays you by taking some of your home’s equity and converting it into monthly payments to you. As long as you live, remain in your home, and continue to meet other obligations of the mortgage (discussed in more detail later), you do not have to pay the money back.

When you die, sell the home, or move out, you or your spouse or estate will have to repay the loan. If you signed the loan paperwork but your spouse didn’t, your spouse may be able to continue living in the home after you die, as long as they continue to pay property taxes, insurance, and maintenance costs. However, your spouse will cease to receive monthly payments from the reverse mortgage, since he or she wasn’t a part of the loan agreement. Once your spouse passes away or moves out of the home, your family or heirs may need to sell the home to repay the loan.

Example of how a reverse mortgage works

James and Mary, ages 73 and 72, are a retired couple who own their home outright. They want to stay in their home but need to supplement their monthly income from Social Security and James’s pension. They would also like to remodel their kitchen. James and Mary’s home is valued at $250,000, and they do not have a mortgage.

The total amount that James and Mary can borrow using a reverse mortgage is limited by the Federal Department of Housing and Urban Development (HUD) and is based on the age of the youngest spouse, current mortgage rates, and the value of the home.

Let’s run a hypothetical scenario through the National Reverse Mortgage Lenders Association’s reverse mortgage calculator.

Value of the home $250,000
Loan principal limit $150,000
Closing costs -$7,800
Net principal limit $142,200
Lump sum cash for kitchen remodel -$20,000
Remaining for monthly advance $122,200
Monthly advance $750

James and Mary have been mortgage-free for a year. The current value of their home is $250,000, and they are applying for a $150,000 reverse mortgage. After accounting for closing costs of approximately $7,800, the remaining available principal is $142,200. James and Mary would like to have $20,000 of that up front for the kitchen remodel, leaving $122,200 available for monthly installments. Based on this scenario, the amount James and Mary would receive monthly is approximately $750.

Reverse mortgage requirements

Businesswoman pushing button on touch screen

To qualify for a reverse mortgage, you must:

  • Be age 62 or older
  • Own your home outright or have a small mortgage (meaning the amount you owe on the mortgage is less than the amount you qualify for under the reverse mortgage program)
  • Use the home as your primary residence
  • Not be delinquent on any federal debt, such as back taxes, federally backed student loans, SBA loans, or HUD-insured loans.
  • Have the financial resources to continue to meet obligations such as property taxes, homeowners insurance, association dues, and repairs
  • Participate in an information session with a HUD-approved Home Equity Conversion Mortgages counselor

Meeting these basic requirements doesn’t necessarily mean a reverse mortgage is right for you.

3 questions to ask yourself when considering a reverse mortgage

  • Do you want or need to move? This question should help you understand whether or not your home will continue to meet your needs for the foreseeable future. If your home is physically difficult for you to navigate and maintain, you may be better off selling the home and downsizing to a home that is better suited to your retirement years. A reverse mortgage requires you to continue to reside in and maintain the home. If you are physically or financially unable to do that, you may have to sell the home to pay off the loan balance.
  • Can you afford to continue paying real estate taxes, homeowners insurance, association dues, and maintenance? While a reverse mortgage will boost your monthly income, consider whether that additional cash flow will be enough to continue covering real estate taxes, insurance, association dues, and home maintenance. Keeping up with these obligations is a requirement of a reverse mortgage. If you cannot afford to keep up with these expenses and your other bills, including health care, utilities, and other living expenses, a reverse mortgage may not make sense.
  • Are you planning on leaving your home to your children, grandchildren, or other heirs? When you pass, your heirs may have to sell the home to pay off the reverse mortgage. Other assets, such as investments or life insurance, may be available to pay off the loan balance. If your sole motivation for staying in the home is to pass it on to heirs, consider whether they’ll be able to hold on to it after you are gone.

Robin Faison is a licensed mortgage loan officer specializing in reverse mortgages with Open Mortgage in Scottsdale, Az. Faison also teaches a Reverse Mortgage for Purchase class accredited through the Arizona Department of Real Estate.

Faison says reverse mortgage borrowers typically fall on a spectrum, from those who are facing foreclosure and need a reverse mortgage to keep their homes, to those who are not in any financial difficulty and use a reverse mortgage line of credit strategically as a part of their overall retirement plan.

Reverse mortgage risks

A reverse mortgage is a financial product, and all financial products come with risks. Make sure you understand those risks before signing any paperwork. Those risks may include the following.

Fewer assets for heirs

Some homeowners dream of holding on to the family home and passing it down to their children or grandchildren. If this is part of your estate plan, consider whether your heirs will need to sell the home to pay off the reverse mortgage.

Even if you have life insurance proceeds or other assets that can be tapped to pay off the reverse mortgage after your death, those assets may be depleted, leaving less for your family members. Work with your financial adviser and a reputable reverse mortgage specialist to make sure that a reverse mortgage works with your overall estate plan.

Fees and other costs

Real estate investment. House and coins on table

Just like with a conventional mortgage, you will pay closing costs, mortgage insurance premiums, origination fees, and other costs to close on a reverse mortgage. According to the Consumer Financial Protection Bureau (CFPB), the fees and other costs of a reverse mortgage vary based “on the type of loan you choose, how much money you take out up front, and the lender you choose.”

Faison says lenders also receive a premium for servicing your loan (typically from Fannie Mae or Freddie Mac), which can be used to offset closing costs. However, regulations have made it more difficult for banks to offset costs on a fixed rate loan. Your lender will have more leeway for offsetting closing costs with that premium on an adjustable rate mortgage, but then the borrower bears the risk of rising interest rates.

Will owe more over time

As you receive money from the reverse mortgage, interest is added to the balance you owe each month. The amount you owe grows as interest on the loan balance adds up over time. Faison says many borrowers choose to make some payments on their reverse mortgage in order to keep the loan balance down.

Variable rates

Most reverse mortgages have variable rates. While these loans have more flexibility than fixed rate mortgages, your rate can rise quickly and dramatically.

HUD publishes statistics on all federally backed reverse mortgages each month. For October 2016 (the most recent month for which information is available at the time of this writing), interest rates on adjustable rate reverse mortgages range from 2.507% to 6.045%.

Interest is not tax deductible

Unlike a traditional mortgage, the interest you’ll pay on a reverse mortgage is not tax deductible until the loan is paid partially or in full.

Need to continue paying other obligations

You will still be responsible for paying property taxes, insurance, utilities, fuel, maintenance, and other standard costs of keeping up the home, just as you would with a conventional or no mortgage. If you cannot or do not continue to pay real estate taxes or insurance or to maintain the home, the lender may require repayment of the reverse mortgage.

May require “set-aside” amounts

Lenders are required to conduct a financial assessment to ensure borrowers have the financial capacity to continue paying obligations such as property taxes, homeowners insurance, and maintenance. If the lender determines that the borrower may not be able to keep up with such payments, they may require “set-aside” amounts to cover future obligations.

The set-aside amount is based on a formula that takes into account your current property taxes and homeowners insurance premiums, projected increases to taxes and insurance rates, monthly interest rates, and the life expectancy of the youngest borrower. While set-aside amounts help ensure borrowers can continue to meet loan obligations, those amounts will reduce your payment amounts.

Unscrupulous advice

Some unscrupulous advisers try to pressure borrowers into using proceeds from a reverse mortgage to purchase other financial investments. The Financial Industry Regulatory Authority (FINRA) warns consumers to be skeptical of such advice. If those other investments lose value, you or your heirs may not have the means to pay off the reverse mortgage balance and may have to sell the home.

Primary residence requirement

Faison says she also reminds all of her clients about the obligation to continue using the home as your primary residence. You only need to live in the home for six months and one day out of the year for the home to qualify as a primary residence.

Annually, the lender will mail an affidavit that the borrower needs to complete, sign, and send back to confirm they are still there. Make sure to respond to those notices. Otherwise, the lender may believe you are no longer living in the home and take steps to collect on the loan balance.

How to shop for a reverse mortgage

Reverse mortgages are not one-size-fits-all products. Here are a few things to keep in mind when selecting a reverse mortgage.

Types of reverse mortgages

  • Single-purpose reverse mortgages. These are offered by some state and federal agencies and nonprofit organizations. As the name implies, the loans can be used for only one purpose, such as home repairs or improvements or property taxes.
  • Proprietary reverse mortgages. These are private loans without federal backing. Owners of higher-valued homes may receive bigger advances from a proprietary reverse mortgage.
  • Home Equity Conversion Mortgages (HECMs). HECMs are federally insured and backed by HUD. Proceeds can be used for any purpose. An HECM may be more expensive than a traditional home loan, but they offer more flexibility. Borrowers can choose several payment options, including:
    • Single disbursement
    • Fixed monthly advances over a specified period of time
    • Fixed monthly advances as long as you live in your home
    • A line of credit
    • A combination line of credit and monthly payments

Other considerations for choosing a reverse mortgage

Faison recommends working with a local licensed loan officer who specializes in reverse mortgages or HECMs. “It’s fine to work with companies you hear about on TV,” Faison says, “but I often work with people who heard about reverse mortgages on the television but then decide they want to work with someone local.”

No matter who you work with, make sure you understand all costs involved. Loan expenses, including origination fees, interest rates, closing costs, and servicing fees, can vary among lenders. Make sure you fully understand the total cost of the loan.

How long do reverse mortgages take?

Clock time deadline

Depending on where you live and how busy appraisers are in your area, it could take two months or more just to get an appraisal on your home, which is only the first step in the process.

Faison also recommends asking your loan consultant how long the reverse mortgage process will take. If you are facing foreclosure or need money right away, a reverse mortgage may take more time than you have. Faison says some lenders may take 60 days or more, depending on the appraisal. “The appraisal industry has undergone a lot of change recently, and there are fewer appraisers available,” Faison says.

Alternatives to a reverse mortgage

A reverse mortgage isn’t right for everyone. Faison speaks with many people who ultimately are not good candidates. Credit issues may stand in the way of passing a financial assessment. In other cases, homes haven’t been maintained and are unable to pass the appraisal process. These problems can be resolved. However, if they are impossible to overcome, alternatives to a reverse mortgage include the following.

Refinance existing mortgage

If you have an existing home loan, you may be able to refinance your mortgage to reduce your monthly payments and free up some cash.

Take out a home equity loan or line of credit

If you own your home outright, you may be able to take out a home equity loan or line of credit. You will still be responsible for monthly payments, but the interest on the loan is usually tax deductible up to $100,000.

Sell your home and downsize or rent

If you are willing and able to move, selling your home to downsize or rent will free up the equity in your home, giving you extra cash to save, invest, or spend. You could also sell the home to your kids or another family member. Often, people who sell the home to a family member use a sale leaseback agreement where they rent back the home using proceeds from the sale.

REX agreement

A REX agreement is an alternative to a home equity line of credit. It allows you to access the equity in your home, giving you a cash payment of a percentage of your home’s market value (typically 12% to 17%) in exchange for 50% of the increase in your home’s value when it is sold. For example, if the home is worth $100,000 when the REX agreement is signed, the homeowner may receive a cash payment of $12,000 to $17,000. If the home increases in value by $50,000 over the next 10 years, when the home is sold, the company receives $25,000 (50% of the $50,000 increase).

Rent out part of your home

If you want to stay in your home but need some additional income, you may be able to rent out a part of your home to a roommate. Be sure to screen candidates carefully.

The bottom line

If you are considering a reverse mortgage of any kind, make sure you understand the pros and cons of this complex financial product before you sign. The television commercials may make it look easy, but a reverse mortgage is a serious financial commitment that comes at a cost and may impact potential heirs.

If you do not have the money to continue living in your current home at your current lifestyle, borrowing money against your home equity may not be the best option. Discuss your situation with a trusted adviser and a reputable, licensed loan officer with experience in reverse mortgages and HECMs. If you do decide that a reverse mortgage is right for you, review the different types of reverse mortgages and shop around for the best terms and rates. Do some research to find a counselor or company who will take the time to help you understand the costs and obligations before making any decisions.

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Featured, Mortgage

Mortgage Broker vs. Loan Officer: The Best Way to Shop for a Mortgage

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Senior businessman showing a document to sign to a couple

When you need to take out a loan to buy a home, you generally have two options. You can work with a lender’s loan officer or hire a mortgage broker. Loan officers and mortgage brokers are not the same thing, although the terms are often used interchangeably.

Loan officers work for a bank or a lender and will only be able to show you mortgage options from that financial institution. In contrast, mortgage brokers are individuals or firms that are licensed by a state to act as middlemen between you and multiple banks or mortgage lenders. Because brokers aren’t beholden to a particular lender, they can shop around and try to find you a loan with terms that best fit your circumstances.

Why should you consider working with a mortgage broker?

One of the biggest benefits to working with a mortgage broker is that they take over the job of shopping for a loan. You might be able to do this on your own, and in some cases, you could find a better loan than the broker, but it can be a time-consuming and complicated process.

A broker can help collect and organize the documents you need to apply for a mortgage, such as your proof of employment and income, tax returns, a list of your assets and debts, and credit reports and scores. The broker can then use the information to look for loans, compare rates and terms, and apply for mortgages on your behalf.

Casey Fleming, a mortgage adviser and author of “The Loan Guide: How to Get the Best Possible Mortgage,” says one of the big benefits is that brokers are generally “on your side,” while a loan officer represents the lender’s interest. Brokers are also incentivized to find you a loan that meets your needs and see the deal through closing because they don’t get paid until you close on the home.

Additionally, brokers might have access to lenders that don’t work directly with consumers, meaning you wouldn’t be able to get a loan from the lender even if you tried. And in some cases, brokers can leverage their relationship with a lender to get it to waive fees you’d otherwise have to pay.

Are there risks involved with using a mortgage broker?

While working with a broker could be a good idea, there are potential drawbacks to consider. “Not all brokers are created equal,” says Fleming. “Many have only a few sources for loans, and may not be able to find the best pricing.” There are also some mortgage lenders that don’t work with brokers and will only offer loans directly to consumers (through one of the lender’s loan officers).

Using a mortgage broker can also be expensive. Although you may find the services are worth paying for, consider the costs of using a broker:

Mortgage broker fees

Mortgage brokers are often paid in one of two ways. You may be able to choose how you’d like to pay the broker, or opt for both payment methods.

Some mortgage brokers will charge you a commission based on the loan you take out, often about 1% of the loan. For example, that’s a $3,000 fee on a $300,000 mortgage loan. You’ll pay this fee as part of your closing costs when you close on the home.

Other brokers may offer you a fee-free mortgage. However, what likely happens in this case is that the mortgage broker arranges a loan with a higher interest rate, leaving room for the lender to give the broker a cut. This route could cost you more over the lifetime of the loan but might be the better option if you want to minimize costs now.

Where to find a good mortgage broker

“Word of mouth is very useful when it comes to finding a good [mortgage broker],” according to Professor David Reiss, a real estate law professor at the Brooklyn Law School in Brooklyn, N.Y. You could ask friends or family members who’ve recently bought a home if they used a mortgage broker, as well as your real estate agent if he or she can recommend a broker.

However, don’t settle for the first recommendation you receive. The Federal Trade Commission recommends interviewing several brokers and trying to find one who’ll be a good fit for your home search.

Ask about their experience with buyers like you in the area, the fees they charge, and how many lenders they work with. “You want to know whether the mortgage broker can find competitive mortgage products, is well organized so that loans close in a timely manner, and whether it keeps away from bait-and-switch tactics that can be so difficult to deal with when buying a home,” says Reiss.

You can also look for reviews of the mortgage broker online, and check for complaints against the company with the Better Business Bureau. The National Association of Mortgage Brokers (NAMB) also has a directory of state associations and regulators, which you can use to check the broker’s license and standing.

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Featured, Mortgage

Guide to Getting a Federal Housing Administration (FHA) Mortgage Loan

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Couple Celebrating Moving Into New Home With Champagne

Saving up the traditional 20% for a mortgage down payment is the kind of financial obstacle that can bar first-time homebuyers with minimal savings from becoming homeowners. The government-backed Federal Housing Administration (FHA) mortgage is one solution for those who want to buy a home but can’t pull together a large down payment.

FHA mortgages are home loans funded by FHA-approved lenders and insured by the government.

The government backing protects lenders from loss if borrowers default. Because of this protection, lenders can be more lenient with their qualifying criteria and can accept a significantly lower down payment.

You can get approved for an FHA mortgage with a minimum credit score of 500, and you only need to put 3.5% to 10% down to buy a home.

How much can an FHA mortgage help you?

For a $150,000 home, a 20% down payment would mean you would need to bring $30,000 (along with other closing costs) to the table. That’s no small chunk of change. By comparison, an FHA mortgage would require anywhere from 3.5% to 10% for a down payment, which comes out to $5,250 to $15,000.

In this post, we’ll cover the following topics to explain the FHA mortgage, including:

  • FHA mortgage terms
  • FHA qualifying criteria and restrictions
  • FHA costs and mortgage premiums
  • FHA mortgages vs. conventional mortgages
  • How to shop for an FHA mortgage

FHA mortgage terms

There are both 15- and 30-year fixed-rate and adjustable-rate FHA mortgage options. With a fixed-rate FHA mortgage, your interest rate is consistent through the loan term. However, your monthly mortgage payment may increase based on your homeowners insurance, mortgage insurance premium, and property taxes.

Adjustable-rate FHA mortgages are home loans where the rate stays low and fixed during an introductory period of time such as five years. Once the introductory period ends, the interest rate will adjust, which means your monthly mortgage payments may increase.

A unique situation where signing up for a low, adjustable-rate FHA mortgage could make sense is if you plan to sell or refinance the home before the introductory period ends and the interest rate can change. Otherwise, a fixed-rate FHA mortgage has predictable mortgage payments and may be the way to go.

Qualifying criteria and restrictions

Although the FHA home loan is particularly appealing for first-time homebuyers, it’s not only open to first-time purchasers. Repeat buyers planning to use the home as a primary residence may qualify for an FHA home loan as well.

Besides the low down payment, an undeniable benefit of the FHA mortgage is the low credit score requirement. You may qualify for 3.5% down payment with a credit score of 580 or higher. You can also qualify with a credit score lower than 580, but you’ll have to make a 10% down payment.

Debt-to-income (DTI) ratio is another key metric lenders consider in addition to your credit score to determine whether you can afford a mortgage. DTI measures the amount of debt you have compared to your income, and it’s expressed in a percentage.

Lenders look at two debt-to-income ratios when determining your eligibility — housing ratio or front-end ratio and your total debt ratio or back-end ratio.

Your front-end ratio is what percentage of your income it would take to cover your total monthly mortgage payment. Lenders like to see your front-end ratio below 31% of your gross income.

Your back-end ratio shows how much of your income is needed to pay for your total monthly debts. Lenders prefer a back-end ratio of 43% or less of your gross income.

FHA limits

The FHA mortgage can be used for both single-family and multi-family homes, but there are loan amount maximums that vary by state and county.

For an example, in Fulton County, Atlanta, the maximum loan for a single-family house is $342,700. You can find the loan limits for all states and counties here.

 

FHA mortgage costs and mortgage insurance premium

Just like a traditional mortgage, an FHA home loan has closing costs. Closing costs are the costs necessary to complete your transaction, such as appraisals and home inspections. However, you may be able to negotiate to have some of these costs covered by the seller.

The real expense of the FHA home loan lies in the mortgage insurance premiums.

At first glance, the FHA mortgage probably seems like the ultimate hack to buying a home with minimal savings. The flip side to this is you need to pay mortgage insurance premiums to cover the lender for the lower down payment.

Remember, FHA-approved lenders offer mortgages that require less money down and flexible qualifying criteria because the Federal Housing Administration will cover the loss if you default on the loan. The government doesn’t do this for free.

FHA mortgage borrowers must “put money in the pot” to cover the cost of this backing through upfront and annual mortgage insurance premiums. The upfront insurance premium for the FHA mortgage is currently 1.75% of the loan amount, and it can be rolled into your mortgage balance.

The annual insurance premium is broken into a payment that you make monthly. The annual premium for mortgage insurance can be up to 1.05% based on your loan term length, loan amount, and loan-to-value ratio (LTV).

LTV is a percentage that compares your loan amount to your home’s value. It also represents the equity (or lack of equity) you have in the property.

For example, putting 3.5% down means your LTV would be 96.5%. In other words, you have 3.5% equity in the home, and your loan is covering the remaining 96.5% of the home value.

Here’s the annual mortgage insurance premium on a 30-year FHA mortgage (for loans less than $625,000):

  • LTV over 95% (you initially have less than 5% equity in the home) – 0.85%
  • LTV under 95% (you initially have more than 5% equity in the home) – 0.8%

As you can see, starting off with less equity (or a smaller down payment) will cost you more in insurance premiums. You can expect to pay 0.85% in annual mortgage insurance premiums if your down payment is 3.5% on the 30-year mortgage.

Unfortunately, if your LTV was greater than 90% at time of origination, insurance premiums tag along for the entire loan term or 11 years, whichever comes first. There are exceptions if you have an FHA mortgage that was taken out before June 3, 2013.

How does the FHA home loan compare to conventional home loans?

Government-backed home loans like the FHA mortgage are part of special programs that serve borrowers that can’t qualify for a traditional mortgage.

At the other end of the spectrum is the conventional mortgage or the “Average Joe” of mortgages.

These traditional mortgages are offered by lenders and banks backed by Fannie Mae and Freddie Mac’s mortgage standards. Fannie Mae and Freddie Mac are government-sponsored agencies that buy loans from mortgage lenders and banks that conform to preset requirements.

Since conventional mortgages are loans eligible to be purchased by Fannie Mae and Freddie Mac, the qualifying criteria bar is usually set higher. For instance, you should have at least a 620 credit score to qualify for a fixed-rate conventional loan. Although, credit score minimums vary by lender, and a score above 620 will be necessary for the most competitive interest rates.

A misconception about the conventional mortgage is that borrowers must have 20% for a down payment to qualify. Mortgage lenders may accept less than 20% down for a conventional mortgage if you have a high credit score and pay their version of mortgage insurance premiums, which is called private mortgage insurance (PMI).

PMI is a private insurance policy that protects the lender if you default. Be careful not to confuse the two types of insurance policies.

If you have PMI on a conventional mortgage, you’re able to request a removal of insurance payments when you build up 20% equity in your home.

On the other hand, the mortgage insurance premiums for new FHA mortgages (post 2013) can’t be removed unless you refinance.

When to choose a conventional mortgage instead

Putting down less money with the FHA mortgage can be a shortcut to homeownership if you don’t have much cash saved or the credit history to get approved for a conventional mortgage.

But, the convenience doesn’t come without strings attached and the additional insurance costs can follow you for the entire loan term. This can get costly.

Furthermore, putting a small sum down on a home means that it will take you quite some time to build up equity. A small down payment can also increase your monthly payments. Homebuyers with a strong credit score should consider saving a bit more money and shopping for a conventional home loan first before thinking the FHA home loan is the only answer to a limited down payment.

You may be able to qualify for a conventional home loan with PMI if you have a down payment of 5% to 10%. A conventional home loan with PMI may not require the same upfront insurance payment as the FHA home loan, so you can find some savings there. Plus, you’re capable of getting rid of PMI without refinancing.

How to shop for an FHA mortgage

If your present credit score and savings make you ineligible for a conventional home loan, the FHA home loan is still a viable option to consider for financing. Just make sure you understand the implications of the extra cost.

Like a conventional mortgage, you need to shop around with multiple FHA-approved lenders to find the most competitive rate. If you’re unfamiliar with FHA-approved lenders in your area, you can go to the HUD website to find a few.

Don’t rush to a decision. If you’re not sure which option (FHA or conventional mortgage) will be the most cost effective for you, ask each lender you shop with to break down the costs for a comparison.

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Mortgage

PMI Explained: What It Is and Why You Should Have It

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

PMI Explained: What It Is and Why You Should Have It
There’s a lot to consider when purchasing a home. Location, size, and cost spring to mind as three of the most important factors. Perhaps you’ve budgeted and figured out how much you can afford for a down payment, but have you also considered your total monthly mortgage payments?

If you’re applying for a mortgage and can’t afford to put at least 20% down, you may have to pay for mortgage insurance.

What is mortgage insurance?

Mortgage insurance helps protect the lender’s investment, not the homeowner.

A homeowner’s insurance policy may reimburse you for a variety of expenses, including vandalism, thefts, and environmental damage to your home. Mortgage insurance is a bit different. Although you are responsible for mortgage insurance premiums, the policy protects the lender.

Casey Fleming, mortgage adviser and author of “The Loan Guide: How to Get the Best Possible Mortgage,” explains mortgage insurance “insures the lender against principal loss in the event you default, they foreclose, and the foreclosure sale doesn’t bring in enough money to cover what they’ve lent you.” In short, if you don’t pay your bills, the insurance company will help make the lender whole.

The 20% down payment rule

Mortgage insurance isn’t required for all homebuyers. “Typically, homebuyers looking to get a conventional mortgage must pay PMI if they are making a down payment of less than 20%,” says Josh Brown of the Ark Law Group in Bellevue, Wash., which specializes in bankruptcy and foreclosures. Brown points out PMI serves a valuable function by allowing otherwise qualified homebuyers (with an acceptable debt-to-income ratio and credit score) to be approved for a conventional loan without the need for a large down payment.

How to find mortgage insurance

Mortgage lenders will often find a PMI policy for you and package it with your mortgage. You will have a chance to review your PMI premiums on your Loan Estimate and Closing Disclosure forms before signing paperwork and agreeing to the mortgage.

Types of mortgage insurance

There are two main types of mortgage insurance: Private mortgage insurance (PMI) and mortgage insurance premium (MIP).

PMI helps protect lenders that issue conventional, Fannie Mae and Freddie Mac-backed, mortgages. You’ll often be required to make monthly PMI payments, a large upfront payment at closing, or a combination of the two. These payments are made to a private insurance company and are required unless you have at least 20% equity in your home. You may request to cancel your PMI once you have paid down the principal balance of your home to below 80% of the original value.

Mortgages issued through the Federal Housing Administration (FHA) loan program also require mortgage insurance in the form of a mortgage insurance premium (MIP). You will be required to pay an upfront fee at closing and an MIP every month as part of your monthly mortgage payment. Your MIPs depend on when your mortgage was finalized and your total down payment.

How much mortgage insurance will cost you

How much mortgage insurance will cost you

PMI premiums can vary depending on the insurer, your loan terms, your credit score, and your down payment. The premiums often range from $30 to $70 per month for every $100,000 you have borrowed, according to Zillow.

Many homeowners’ monthly mortgage payments include their PMI premium. Alternatively, you might be able to make a one-time upfront PMI payment. Or, you could make a smaller upfront payment and monthly payments.

As we mentioned earlier, for an FHA loan, you will have to pay upfront mortgage insurance premium (UFMIP) which is generally 1.75% of your loan’s value. You may have the option of rolling this premium payment into your mortgage and pay it off over time. Your MIP depends on your down payment, the base loan amount, and the term of the mortgage and can range from .45% to 1.05% of the loan’s value. The MIPs must be paid monthly.

Mortgage insurance doesn’t have to be forever

There are a few situations when you may be able to stop making mortgage insurance premium payments.

There are two eligibility requirements for conventional mortgages closed after July 29, 1999. As long as you’re current on your payments, PMI will be terminated:

  • On the date when your loan-to-value is scheduled to fall below 78% of the home’s original value.
  • When you’re halfway through your loan’s amortization schedule; 15 years into a 30-year mortgage, for example.

Your home’s original value is often the lower of the purchase price or appraised value. The current value of your home and your current loan-to-value aren’t figured into the above criteria.

You can also submit a written request asking your lender to cancel your PMI:

  • On the date your loan-to-value is scheduled to fall below 80% of the home’s original value.
  • If your current loan-to-value ratio is lower than 80%, perhaps due to rising home prices in your area or renovations you’ve done.
  • After refinancing your mortgage once you have at least 20% equity in the home.

Unlike PMI, if you have an FHA loan, your MIP may not ever be removed. The date your mortgage was finalized and the amount you put down determines your eligibility:

  • The MIP stays for the life of the loan for mortgages closed between July 1991 and December 2000.
  • The MIP will be canceled once your loan-to-value is 78%, if you applied for the mortgage between January 2001 and June 2013, and you’ve owned the home for five or more years.
  • If you applied after June 2013 and put at least 10% down, the MIP will be canceled after 11 years. If you put less than 10% down, the MIP stays for the life of the loan.

Refinancing an FHA loan to a conventional mortgage may provide you with additional options.

The pros and cons

There are a variety of pros and cons to consider when weighing the options of waiting to save a 20% down payment versus paying mortgage insurance.

Melanie Russell, a mortgage loan officer in Henderson, Nev., points out buying now can make sense if you expect home prices to increase or interest rates to climb.

What about waiting? In addition to avoiding mortgage insurance, putting more money down could lead to lower closing costs and a lower interest rate on your mortgage. Also, if you expect prices to drop, you’re saving on all the costs that could come with ownership, including taxes, mortgage, insurance, maintenance, and potential homeowners’ association fees.

In the end, it’s often a situational and personal choice. While Russell shared a few positives to buying early and paying for PMI, she also notes, “Only you can answer this question for yourself.”

When you don’t need mortgage insurance

There are also a few options that don’t require mortgage insurance, even if you can’t afford a 20% down payment.

For example, Veterans Affairs (VA) loans, offered to qualified veterans, don’t require mortgage insurance. You might not have to put any money down either, but these loans usually require an upfront payment at closing.

The Affordable Loan Solution program offered through a partnership between Bank of America, Freddie Mac, and the Self-Help Ventures Fund allows borrowers to put as little as 3% down without taking on PMI. Maximum income and loan amount limit requirements may apply.

You may also find some lenders willing to offer lender-paid mortgage insurance. You’ll pay a higher interest rate on the loan, but in exchange, the lender will make the insurance payments for you. “The math works differently every time,” says Fleming. “If a borrower thinks they won’t be in the property very long, [lender-paid mortgage insurance] might be a good choice, as sometimes the additional amount you pay is lower this way.”

However, if you’re in the home and paying off the mortgage for a long time, it could be more expensive than taking out a conventional loan with PMI. Because the premiums are built into your mortgage, you won’t be able to get rid of the extra payments after building equity in the home.

Another option could be to take out a second loan, called a piggyback mortgage. Although there are potential downsides to this route, you can use the money from the second loan to afford a 20% down payment and avoid PMI. Some people also borrow money from friends or family to afford a 20% down payment, but that could put your relationship in jeopardy if you run into financial trouble.

Finally, you might also discover lenders offering no-mortgage-insurance loans with a 10% to 15% down payment. As with the lender-paid mortgages, it’s important to review the fine print and the potential pros and cons of the arrangement.

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Life Events, Mortgage

What Is Mortgage Amortization?

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The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

What Is Mortgage Amortization?

Owning a home can feel good. But is it a good financial decision?

There’s a lot that goes into answering that question, and one of the biggest factors is something that sounds both incredibly boring and incredibly confusing: mortgage amortization.

It’s not the sexiest financial topic in the world, but it has a big impact on your personal finances. In this post we’ll break it down so that you understand what it is and how it should factor into your decision about whether to buy a house.

What Is Mortgage Amortization?

Each time you make your monthly mortgage payment, that payment is split between paying interest and paying down principal (reducing your loan balance). Amortization is simply the process by which that split is calculated.

See, your payment isn’t split the same way throughout the life of your mortgage. It’s actually different with each payment, with your earliest payments going primarily toward interest.

For example, let’s say you buy a $250,000 house, put 20% down, and take out a 30-year, $200,000 mortgage with a 4% interest rate. That means your monthly payment would be $955.

To calculate how much of that first payment goes toward interest, you simply divide the interest rate by 12 to get a monthly interest rate and multiply that by your outstanding loan. Here’s how it looks in this example:

  • (4% / 12) * $200,000 = $667

That means $667 of your initial mortgage payment is used to pay off interest, while the remaining $288 reduces your mortgage balance to $199,712.

Next month the same calculation is run again, but this time with your slightly lower mortgage balance. That leads to a $666 interest payment and $289 going toward reducing your loan.

And that’s how it works. Your early payments are primarily used to pay interest, but over time it slowly shifts so that more and more of your monthly payment is used to reduce your mortgage balance.

You should receive an amortization schedule when you apply for a mortgage, and you can also run the numbers yourself here: Zillow Amortization Calculator. This will show you exactly how much of each payment goes toward interest, how much goes toward principal, and how much interest you’ll pay over the life of the loan.

What Does That Mean for You?

Okay, great, so you have the technical explanation for how mortgage amortization works. But how is that actually relevant to you? Why should you care?

There are two big implications to keep in mind as you consider whether or not to buy a house.

The first is this is one of the reasons it often requires you to stay in your house for several years before your home purchase pays off versus renting. People often talk about renting as if you’re “throwing money away,” but they forget that you’re doing something very similar in those early years of your mortgage as well.

Remember, those interest payments you’re making, which are the majority of your early mortgage payments, aren’t building equity in your home. That money is going straight to your lender and will never be yours again. It usually takes a while before your home equity really starts to grow.

The second is buying a house costs much more than most people realize. Take the example above. You might think of it as just a $250,000 purchase, but when you include all the interest you pay over the life of that 30-year mortgage, the total cost rises to $393,739.

And that doesn’t even include the cost of homeowners insurance, property taxes, repairs, upgrades, and everything else that comes with owning a home.

The bottom line is buying a house is expensive, and in many cases renting is actually a better financial move, especially if you aren’t committed to staying in the house for an extended period of time. You can run the numbers for yourself here: New York Times buy vs. rent calculator.

How to Combat Amortization

To be clear, mortgage amortization isn’t a bad thing. It’s just how mortgages work, and it’s important to understand so you can evaluate the true cost of buying a house.

But if you’d like more of your money to go toward principal sooner, and therefore decrease the amount of interest you pay, there are a few ways to do it.

The first is to put more money down when you buy the house. That down payment is immediate equity in your home that will not be charged interest.

The second is to make extra payments and make sure they go toward paying down principal. You will have to double-check your mortgage’s specific terms, though, to make sure there aren’t any prepayment penalties or other clauses that would make this a bad idea.

And the third is to take out a 15-year loan (or other shorter term). Using the same example above and changing only the length of the loan from 30 years to 15 years, the monthly payment increases to $1,479, but the total cost of the house over the life of the loan decreases to $316,287. That’s a savings of $77,452 and doesn’t factor in the likelihood of getting a better interest rate in return for the shorter loan period.

Keep in mind all of these strategies can be beneficial in some situations and not in others. In some cases it can make more sense to invest your money elsewhere, so you’ll have to run your own numbers and make the best decision based on your personal situation.

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