Mortgage Management For Dummies book cover

Mortgage Management For Dummies

By: Eric Tyson and Robert S. Griswold Published: 06-26-2017

Quickly make sense of mortgages

Taking out a mortgage to purchase real estate is a huge decision, one that could affect your family's finances for years to come. This easy-to-follow guide explains how to secure the best and lowest-cost mortgage for your unique situation. Whether you select a 15- or 30-year mortgage, you'll get all the tips and tricks you need to pay it off faster—shortening your payment schedule and saving your hard-earned cash.

  • Fine-tune your finances
  • Qualify for a mortgage
  • Secure the best loan
  • Find your best lender
  • Refinance your mortgage
  • Pay down your loan quicker
  • Must-knows about foreclosure
  • Top mortgage no-nos

Articles From Mortgage Management For Dummies

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38 results
38 results
Paying Off a Mortgage Early vs. Investing

Article / Updated 05-12-2022

If you talk with others or read articles or books about prepaying your mortgage, you’ll come across those who think that paying off your mortgage early is the world’s greatest money-saving device. You’ll also find that some people consider it the most colossal mistake a mortgage holder can make. The reality is often somewhere between these two extremes. Everyone has pros and cons to weigh when they decide whether prepaying a mortgage makes sense. In some cases, the pros stand head and shoulders over the cons. For other people, the drawbacks tower over the advantages. At the crux of the decision is the fact that you’re paying interest on the borrowed mortgage money, but if you use your savings to pay down the loan balance, you won’t then have that money working for you earning an investment return. More importantly, what happens if that rainy day comes along and you need those handy cash reserves? Interest savings: The benefit of paying off your mortgage early Mortgage prepayment advocates focus on how much interest you won’t be charged. On a $100,000, 30-year mortgage at 7.5 percent interest, if you pay just an extra $100 of principal per month, you shorten the loan’s term significantly. Prepayment cheerleaders argue that you’ll save approximately $56,000 over the life of the loan. It’s true that by making larger-than-required payments each month, you avoid paying some interest to the lender. In the preceding example, in fact, you’ll pay off your loan nearly ten years faster than required. But that’s only part of the story. Read on for more. Quantifying the missed opportunity to invest those extra payments When you mail an additional $100 monthly to your lender, you miss the opportunity to invest that money into something that could provide you with a return greater than the cost of the mortgage interest. Have you heard of the stock market, for example? Over the past two centuries, the U.S. stock market has produced an annual rate of return of about 9 percent. Thus, if instead of prepaying your mortgage, you put that $100 into some good stocks and earn 9 percent per year, you end up with more money over the long term than if you had prepaid your mortgage (assuming that your mortgage interest rate is below 9 percent). Conversely, if instead of paying down your mortgage more rapidly, you put your extra cash in your bank savings account, you earn little interest. Because you’re surely paying more interest on your mortgage, you lose money with this investment strategy, although you make bankers happy. If you’re contemplating paying down your mortgage more aggressively than required or investing your extra cash, consider what rate of return you can reasonably expect from investing your money and compare that expected return to the interest rate you’re paying on your mortgage. As a first step, this simple comparison can help you begin to understand whether you’re better off paying down your mortgage or investing the money elsewhere. Over the long term, growth investments, such as stocks, investment real estate, and investing in small business, have provided higher returns than the current cost of mortgage money. Taxes matter but less than you think In most cases, all of your mortgage interest is deductible on both your federal and state income tax returns. Thus, if you’re paying, say, a 6 percent annual interest rate on your mortgage, after deducting that interest cost on your federal and state income tax returns, perhaps the mortgage is really costing you only about 4 percent on an after-tax basis. For most people, approximately one-third of the total interest cost of a mortgage is offset by their reduced income tax from writing off the mortgage interest on their federal and state income tax returns. However, don’t think that you can simply compare this relatively low after-tax mortgage cost of, say, 4 percent to the expected return on most investments. The flaw with that logic is that the return on most investments, such as stocks, is ultimately taxable. So, to be fair, if you’re going to examine the after-tax cost of your mortgage, you should be comparing that with the after-tax return on your investments. Alternatively, you could simplify matters for yourself and get a ballpark answer just by comparing the pretax mortgage cost to your expected pretax investment return. (Technically speaking, this comparison isn’t as precise as the after-tax analysis because income tax considerations generally don’t exactly equally reduce the cost of the mortgage and the investment return.)

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How to Improve Your Fico Score

Article / Updated 05-08-2020

The FICO score evaluates five main categories of information. Some, as you’d expect, are more important than others. It’s important to note the following about your fico score: A score considers all these categories of information, not just one or two. The importance of any factor depends on the overall information in your credit report. Your FICO score looks only at information in your credit report. Your score considers both positive and negative information in your credit report. Raising your score is a bit like getting in shape. The percentages are based on the importance of the five categories for the general population. For particular groups — for example, people who haven’t been using credit for very long — the importance of these categories may be different. Your loan repayment history One of the most important factors in a credit score is your payment history; it affects roughly 35 percent of your score. In the area of payments, your score takes the following into account: Payment information on many types of accounts: These types of accounts include credit cards such as Visa, MasterCard, American Express, PayPal Credit, and Discover, credit cards from stores or online merchants where you do business, installment loans (loans such as a mortgage on which you make regular payments), and finance company accounts. Public record and collection items: These items include reports of events such as bankruptcies, foreclosures, suits, wage attachments, liens, and judgments. Details on late or missed payments (delinquencies) and public record and collection items: The FICO score considers how late such payments were, how much you owed, how recently they occurred, and how many you have. How many accounts show no late payments: A good track record on most of your credit accounts increases your credit score. So how do you improve your FICO score? Consider the possibilities: Pay your bills on time. Delinquent payments and collections can have a major negative impact on your score. If you’ve missed payments, get current and stay current. The longer you pay your bills on time, the better your score. Paying off or closing an account doesn’t remove it from your credit report. The score still considers this information, because it reflects your past credit pattern. But closing accounts that you never use can help because the number of lines of credit and the total dollar amount of available credit are factors in the credit scoring algorithms. If you’re having trouble making ends meet, get help. This step doesn’t improve your score immediately, but if you can begin to manage your credit and pay on time, your score gets better over time. Amount you owe About 30 percent of your score is based on your current debt. In the area of debts, your score takes into account the following information: The amount owed on all accounts: Note that even if you pay off your credit cards in full every month, your credit report may show a balance on those cards. The total balance on your last statement is generally the amount that will show in your credit report. The amount owed on all accounts and on different types of accounts: In addition to the overall amount you owe, the score considers the amount you owe on specific types of accounts, such as credit cards and installment loans. Whether you show a balance on certain types of accounts: In some cases, having a small balance without missing a payment shows that you’ve managed credit responsibly. But keep open only the credit accounts that you intend to use because having a bunch of open credit accounts with no activity can be a negative. How many accounts have balances: A large number can indicate higher risk of overextension. Although many stores and online retailers want to lure you into having their specific branded or affinity credit card, it’s better to consolidate all your credit to just a few of the major credit cards that are widely accepted. How much of the total credit line you’re using on credit cards and other revolving credit accounts. Someone closer to “maxing out” on many credit cards may have trouble making payments in the future. How much of installment loan accounts is still owed, compared with the original loan amounts. For example, if you borrowed $10,000 to buy a car and you’ve paid back $2,000, you owe (with interest) more than 80 percent of the original loan. Paying down installment loans is a good sign that you’re able and willing to manage and repay debt. How to improve your FICO score: Keep balances low on credit cards and other revolving credit. High outstanding debt can adversely affect a score. Pay off debt. The most effective way to improve your score in this area is by paying down your revolving credit. Don’t close unused credit accounts that you still may use as a short-term strategy to raise your score. Generally, this tactic doesn’t work. In fact, it may lower your score. Late payments associated with old accounts won’t disappear from your credit report if you close the account. Long-established accounts show you have a longer history of managing credit, which is a good thing. Don’t open new credit cards that you don’t need, just to increase your available credit. This approach can backfire and actually lower your score. Again, although it’s tempting when your local retailer makes that great offer of an extra 10, 20, or even 50 percent savings on today’s purchases if you just open a credit account with them, don’t do it — unless you’re buying an extremely expensive item (although most of these deals have limits or caps) and you’re able to immediately make full payment for all your monthly expenditures, plus you actually intend to use the card regularly. Length of credit history About 15 percent of your score is based on this area. In this area, your score takes into account How long your credit accounts have been established, in general: The score considers both the age of your oldest account and an average age of all your accounts. How long specific credit accounts have been established: Extended responsible use of credit accounts with major credit cards and/or major retailers can have a positive effect on your credit score. This is much better than having a lot of accounts that are open for only a short period of time. How long it’s been since you used certain accounts: Not using all your available credit shows self-control and responsible use of credit. If you’ve been managing credit for a short time, don’t open a lot of new accounts too rapidly. New accounts lower your average account age, which will have a larger (negative) effect on your score if you don’t have a lot of other credit information. New credit Taking on a lot of new debt affects your score, too. About 10 percent of your score is based on new credit and credit applications. In the area of new credit, your score takes into account How many new accounts you have: The score looks at how many new accounts you have by type of account. It also may look at how many of your accounts are new accounts. How long it’s been since you opened a new account: Again, the score looks at this info by type of account. How many recent requests for credit you’ve made: This is indicated by inquiries to the credit reporting agencies. Inquiries remain on your credit report for two years, although FICO scores consider inquiries only from the last 12 months. The scores have been carefully designed to count only those hard inquiries that truly impact credit risk. Inquiries for insurance or employment are soft inquiries and don’t negatively affect your credit score. Length of time since lenders made credit report inquiries: The older the lender inquiries, the better. Inquiries more than a year old are ignored. In this case, being ignored is good. Whether you have a good recent credit history, following past payment problems: Reestablishing credit and making payments on time after a period of late payment behavior helps to raise a score over time, so can disputing any incorrect entries or even providing a letter of explanation. Here are some ways to improve your FICO score: Do your rate shopping for a specific loan within a focused period of time. FICO scores distinguish between a search for a single loan and a search for many new credit lines, in part by the length of time over which inquiries occur. Reestablish your credit history if you’ve had problems. Opening a select number of new credit accounts responsibly and paying them off on time will raise your score in the long term. Request and check your own credit report and FICO score. It’s okay to do this and it doesn’t affect your score because it’s a “soft inquiry” — as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers. Types of credit in use About 10 percent of your score is based on this category. In this area, your score takes into account the following factors: What kinds of credit accounts you have: Your score considers your mix of credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. Don’t feel obligated to have one of each. How many of each type of credit account you have: The score looks at the total number of accounts you have. Think quality, not quantity. Apply only for credit accounts that you know you’ll really need, and always use all types of credit judiciously and responsibly. How to improve your FICO score: Apply for and open new credit accounts only as needed. Don’t open accounts just to have a better credit mix or fall for the trap of thinking that more accounts is better. Years ago, common advice was that to build up your credit history, you must go out and buy something you really don’t need just to establish that you can show a good payment history— our advice is to buy only what you have to buy on credit and pay it off as promised. Have credit cards — but manage them responsibly. In general, having two to three major widely accepted credit cards and installment loans (and making timely payments) raises your score. Note that closing an account doesn’t make it go away. A closed account still shows up on your credit report and may be included in the score. Adding up inquiries A search for new credit can mean greater credit risk. This is why the FICO score counts inquiries — those requests a lender makes for your credit report or score when you apply for credit. FICO scores consider inquiries very carefully because not all inquiries are related to credit risk. You should note three things about credit inquiries: Inquiries don’t affect scores very much. For most people, one additional hard credit inquiry takes less than 5 points off their FICO score. However, inquiries can have a greater impact if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk: People with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports. Many kinds of inquiries aren’t counted at all. Ordering your own credit report or credit score from a credit reporting agency has no impact on your score because it’s a soft inquiry. Also, the score doesn’t count requests a lender makes for your credit report or score to make you a preapproved credit offer, or to review your account with them, even though you may see these inquiries on your credit report. The score looks for rate shopping. Looking for a mortgage or an auto loan may cause multiple lenders to request your credit report, even though you’re looking for only one loan. To compensate for this reality, the score counts multiple inquiries in any 14-day period as just one inquiry.

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How Does A Reverse Mortgage Work?

Article / Updated 04-04-2018

What is a reverse mortgage? A reverse mortgage is a loan against your home that you don’t have to repay as long as you live there. In a regular, or so-called forward mortgage, your monthly loan repayments make your debt go down over time until you’ve paid it all off. Meanwhile, your equity is rising as you repay your mortgage and as your property value appreciates. With a reverse mortgage, by contrast, the lender sends you money, and your debt grows larger and larger as you keep getting cash advances (usually monthly), make no repayment, and interest is added to the loan balance (the amount you owe). That’s why reverse mortgages are called rising debt, falling equity loans. As your debt (the amount you owe) grows larger, your equity (that is, your home’s value minus any debt against it) generally gets smaller. However, your equity could increase if you’re in a strong housing market where home values are rising nicely. If your financial goal is to preserve the equity in your home, you may be able to conservatively structure your reverse mortgage so you limit the amount of equity you pull out of your property to the estimated increase in home values anticipated over future years. Now predicting future real estate appreciation is definitely an inexact science. But real estate values do generally rise over time, and you may find that if you’re modest in the amount of money you receive from the lender, you haven’t eroded your home equity as much as you thought. Reverse mortgages are different from regular home mortgages in two important respects: To qualify for most loans, the lender checks your income to see how much you can afford to pay back each month. But with a reverse mortgage, you don’t have to make monthly repayments. Thus, your income generally has nothing to do with getting a reverse mortgage or determining the amount of the loan. With a regular mortgage, you can lose your home if you fail to make your monthly repayments. With a reverse mortgage, however, you can’t lose your home by failing to make monthly loan payments — because you don’t have any to make! A reverse mortgage merits your consideration if it fits your circumstances. Reverse mortgages may allow you to cost-effectively tap your home’s equity and enhance your retirement income. If you have bills to pay, want to buy some new carpeting, need to paint your home, or simply feel like eating out and traveling more, a good reverse mortgage may be your salvation. Keep reading to discover reverse mortgage pros and cons. Who can get a reverse mortgage? Of course, reverse mortgages aren’t for everyone. Alternatives may better accomplish your goal. Also, not everyone qualifies to take out a reverse mortgage. Specifically, to be eligible for a reverse mortgage: You must own your home. In the early years of reverse mortgages, as a rule, all the owners had to be at least 62 years old. Now, in a couple, you may qualify for a reverse mortgage if one person is at least 62 years of age and the other person is younger than that. However, such a couple will qualify for lower reverse mortgage money due to the younger spouse because “life expectancy” is part of the calculation. Your home generally must be your principal residence — which means you must live in it more than half the year. For the federally insured Home Equity Conversion Mortgage (HECM), your home must be a single-family property, a two- to four-unit building, or a federally approved condominium or planned-unit development (PUD). Reverse mortgage programs will lend on mobile homes with foundations that meet the U.S. Department of Housing and Urban Development (HUD) guidelines but won’t lend on cooperative apartments. If you have any debt against your home, you must either pay it off before getting a reverse mortgage or, as most borrowers do, use an immediate cash advance from the reverse mortgage to pay it off. If you don’t pay off the debt beforehand or don’t qualify for a large enough immediate cash advance to do so, you can’t get a reverse mortgage. One final and important point about qualifying for a reverse mortgage: Lenders are now required to perform a financial assessment analyzing the prospective borrower’s financial situation, including credit history and monthly income and expenses. Lenders pay particular attention to whether borrowers have enough cash flow to pay their property tax and home insurance bills. How much money can you get and when? The whole point of taking out a reverse mortgage on your home is to get money from the equity in your home. How much can you tap? That amount depends mostly on your home’s worth, your age, and the interest and other fees a given lender charges. The more your home is worth, the older you are, and the lower the interest rate and other fees your lender charges, the more money you should realize from a reverse mortgage. For all but the most expensive homes, the federally insured Home Equity Conversion Mortgage (HECM) generally provides the most cash and is available in every state. In general, the most cash is available for the oldest borrowers living in the homes of greatest value over current debt (net equity) at a time when interest rates are low. On the other hand, the least cash generally goes to the youngest borrowers living in the homes of lowest value (or with high current debt) at a time when interest rates are high. The total amount of cash you actually end up getting from a reverse mortgage depends on how it’s paid to you plus other factors. You can choose among the following options to receive your reverse mortgage money: Monthly: Most people need monthly income to live on. Thus, a commonly selected reverse mortgage option is monthly payments. However, not all monthly payment options are created equal. Some reverse mortgage programs commit to a particular monthly payment for a preset number of years. Other programs make payments as long as you continue living in your home or for life. Not surprisingly, if you select a reverse mortgage program that pays you over a longer period of time, you generally receive less monthly — probably a good deal less — than from a program that pays you for a fixed number of years. Line of credit: Instead of receiving a monthly check, you can simply create a line of credit from which you draw money by writing a check whenever you need income. Because interest doesn’t start accumulating on a loan until you actually borrow money, the advantage of a credit line is that you pay only for the money you need and use. If you have fluctuating and irregular needs for additional money, a line of credit may be for you. This is also the preferred way to access funds if your financial goal is to limit the equity you pull from your home to its increase in value. The size of the line of credit is either set at the time you close on your reverse mortgage loan or may increase over time. Generally, during the first 12 months, you can receive up to but no more than 60 percent of the maximum loan allowed. Lump sum: The third, and generally least beneficial, type of reverse mortgage is the lump-sum option. When you close on this type of reverse mortgage, you receive a check for the entire amount that you were approved to borrow. Lump-sum payouts usually make sense only when you have an immediate need for a substantial amount of cash for a specific purpose, such as making a major purchase or paying off an existing or delinquent mortgage debt to keep from losing your home to foreclosure. Ironically, but also a blessing, when your financial troubles are caused by falling behind on your mortgage payments, you can get a reverse mortgage to tap the remaining equity in your home to assist in resolving your immediate pending foreclosure. Mix and match: Perhaps you need a large chunk of money for some purchases you’ve been putting off, but you also want the security of a regular monthly income. You can usually put together combinations of the preceding three programs. Some reverse mortgage lenders even allow you to alter the payment structure as time goes on. Not all reverse mortgage programs offer all the combinations, so shop around even more if you’re interested in mixing and matching your payment options. When do you pay the money back? Some reverse mortgage borrowers worry about having to repay their loan balance. Here are the conditions under which you generally have to repay a reverse mortgage: When the last surviving borrower dies, sells the home, or permanently moves away. “Permanently” generally means that the borrower hasn’t lived in the home for 12 consecutive months. Possibly, if you do any of the following: Fail to pay your property taxes Fail to keep up your homeowners insurance Let your home fall into disrepair If you fail to properly maintain your home and it falls into disrepair, the lender may be able to make extra cash advances to cover these repair expenses. Just remember that reverse mortgage borrowers are still homeowners and therefore are still responsible for taxes, insurance, and upkeep. What do you owe? The total amount you will owe at the end of the loan (your loan balance) equals All the cash advances you’ve received (including any used to pay loan costs) Plus all the interest on them — up to the loan’s nonrecourse limit (the value of the home) If you get an adjustable-rate reverse mortgage, the interest rate can vary based on changes in published indexes. The greater a loan’s permissible interest rate adjustment, the lower its interest rate initially. As a result, you get a larger cash advance with this type of loan than you do with loans that have higher initial interest rates. You can never owe more than the value of the home at the time the loan is repaid. True reverse mortgages are nonrecourse loans, which means that in seeking repayment the lender doesn’t have recourse to anything other than your home — not your income, your other assets, or your heirs’ finances. How do reverse mortgages affect your government-sponsored benefits? Social Security and Medicare benefits aren’t affected by reverse mortgages. But Supplemental Security Income (SSI) and Medicaid are different. Reverse mortgages will affect these and other public benefit programs under certain circumstances: Because they don’t count as income, loan advances on a reverse mortgage generally don’t affect your benefits if you spend them during the calendar month in which you get them. But if you keep an advance past the end of the calendar month (in a checking or savings account, for example), it counts as a liquid asset. If your total liquid assets at the end of any month are greater than $2,000 for a single person or $3,000 for a couple, you could lose your eligibility. If anyone in the business of selling annuities has tried to sell you on the idea of using proceeds from a reverse mortgage to purchase an annuity, you need to know that annuity advances reduce SSI benefits dollar for dollar and can make you ineligible for Medicaid. So if you’re considering an annuity and if you’re now receiving — or expect that someday you may qualify for — SSI or Medicaid, check with the SSI, Medicaid, and other program offices in your community. Get specific details on how annuity income affects these benefits.

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How to Pay Off Mortgage Faster

Article / Updated 04-04-2018

If you believe you want to choose mortgage payoff faster than is required, this information is for you. If you’re certain that you want to pay down your mortgage balance quicker, it can be as simple. Here’s a few tips that show how to pay off your mortgage faster: Making an extra mortgage payment: If the stars align or you find yourself with extra funds, you can make an extra mortgage payment. This will go towards your principal balance and can help lower the amount of interest significantly. Sending in a regular additional amount: You can choose to add a certain amount of money on to the top of your payment to speed up your mortgage payoff (such as $100 more). Escalating your mortgage payoff in this fashion can cut down the length of the loan and the amount of interest you’ll pay. Sending in extra money less regularly: If you have a variable income, you might consider paying extra when you have extra cash (like when you receive that quarterly or annual bonus). Paying the mortgage in full: If you have enough money to do so, you can always pay the remaining mortgage in full to eliminate monthly mortgage payments. You can mix and match these practices. Just remember, though, that once you send in extra money or pay off the loan in full, you can’t take it back! If it’s important to you to understand how much sooner your mortgage will be paid off because of the extra payments you’re making or plan to make, you can contact your loan officer (who should be able to do those calculations), contact your mortgage service company and ask it to do some calculations on your behalf, or use an online amortization calculator.

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Not All Mortgage Insurance is Tax Deductible

Article / Updated 04-04-2018

Is mortgage insurance tax deductible? If you’re a high-income earner, are subject to the Federal Alternative Minimum Tax (AMT), or have low levels of itemized deductions, be warned that some of the itemized deductions from your mortgage interest may not effectively be tax deductible and may result in less tax savings than you think. For tax year 2017, for example, if your income exceeds $287,650 (for married couples filing jointly, it’s $313,800), you lose some of your Schedule A itemized deductions (which includes mortgage interest and property taxes, too). Also, be aware of the following standard mortgage tax deductions: $12,700 for married couples and $6,350 for singles for tax year 2017. Ignoring your mortgage interest deductions, if your itemized deductions total less than these threshold amounts, some of your mortgage interest is effectively not tax deductible. For example, if you’re married and your itemized deductions, excluding mortgage interest, total to $10,000, then $2,600 of the mortgage interest you pay is essentially not tax deductible because you automatically qualify for the standard $12,600 deduction if you elect not to itemize. Last but not least, IRS tax laws limit the amount of mortgage interest on your primary and a secondary residence that’s tax deductible to no more than the interest on up to $1 million of mortgage debt. Also, the interest is allowed to be deducted only on debt equal to the amount you borrowed when you originally bought your home plus $100,000.

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Cash Out Refinance Basics

Article / Updated 04-04-2018

A cash-out refinance differs from the cost-cutting and the restructuring refinances in one important aspect — instead of replacing your current loan with another one for the same amount of money, you pull extra cash out of the property when you refinance it. You can do a cash-out refinance in two ways: Get a new first mortgage. If you’re going to refinance your existing mortgage (because you want to cut costs or must restructure your financing), this situation could be an ideal opportunity to free up some of that equity you’ve accumulated. As long as getting extra cash won’t jack up your new mortgage’s interest rate and you have a good use for the money (such as investing in a profitable business or paying off a pile of high-interest-rate consumer debts), go for it. However, be sure you can afford to borrow all this extra money. Get a home equity loan. Don’t disturb your existing loan if you’re happy with your present first mortgage, if you want to tap only a small amount of your equity, if you won’t need all the cash at once, or if you don’t need the money for very long. Pulling cash out of your property may jack up your refi mortgage’s interest rate. Why? Lenders have gathered statistical proof over the years that taking cash out of property for nonmortgage purposes (versus pouring the money right back into the home by adding a bathroom or modernizing the kitchen, for instance) increases the probability of a future loan default. Due to a huge increase in foreclosures between 2007 and 2012, lenders started putting cash-out refinances under a microscope. Lenders now impose extremely stringent loan restrictions on any market they consider risky because home prices in the area are declining. Be sure to ask your lender whether your property is located in what it considers a declining market. Lenders believe that the lower your property’s loan-to-value (LTV) ratio, the lower the odds that you’ll eventually default on your loan — and vice versa. Lenders generally charge higher interest rates and loan fees or make you pay mortgage insurance for purchase loans if the LTV ratio exceeds 80 percent. For cash-out refinances, on the other hand, many lenders jack up rates and fees when the LTV ratio exceeds 75 percent of appraised value. To see the difference this policy makes: Suppose you put $30,000 cash down and got a $120,000 first mortgage with an 8 percent interest rate ten years ago when you bought your dream home for $150,000. The LTV ratio then was a nice, safe 80 percent (your $120,000 loan divided by the $150,000 appraised value). Fast forward to today. You’re ecstatic. Your home just appraised for $225,000. You intend to replace the faithful old loan you’ve had all these years with a new $180,000 first mortgage, which is 80 percent of the current appraised value . After paying off the $105,000 remaining principal balance of your old loan and $5,000 of refi expenses, you believe you’ll get a check for $70,000 ( cash out of the refi). “Wow!” you think to yourself. “I’ll have my $30,000 out of the house and another $40,000 to boot. And I’ll still have $45,000 equity left in the property . I can buy that red convertible I’ve been dreaming about, take a first-class cruise around the world, and still have cash in the bank when I get home. Life is good — and so is home ownership.” Not so fast, dear reader. Before you mentally spend all that cash, see whether your lender is one of those that increases interest rates 0.25 to 0.5 percent on 80 percent LTV cash-out refinances. If so, either reduce your refinance’s LTV ratio to 75 percent or shop around to see whether you can find a lender with equally competitive rates on 80 percent LTV cash-out refinances. Some lenders won’t even offer cash-out refinancing. The cash-out refinance may seem like found money. It isn’t. You probably worked pretty darn hard for the cash you used to buy your home. You’re working just as hard to pay off your loan. The equity you’re accumulating in your property can be transformed into retirement income someday or used for another worthwhile purpose unless, of course, you squander it. Never borrow money needlessly. Your home isn’t a piggy bank and if you’re a “serial refinancer” always seeking to have the latest depreciable technology or consumer item, then you’re asking for trouble and will miss out on one of your best sources of retirement funds — a home that you own “free and clear.”

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Adjustable Rate Mortgage (ARM)

Article / Updated 04-04-2018

What is an adjustable rate mortgage? Adjustable-rate mortgages (ARMs) have an interest rate that varies over time. On a typical ARM, the interest rate adjusts every 6 or 12 months, but it may change as frequently as monthly. Popular ARMs include hybrid loans where the initial interest rate is locked in for the first three, five, seven, or ten years and then adjusts after that (see the sidebar “Fixed-rate periods on hybrid-ARMs”). The interest rate on an ARM is primarily determined by what’s happening to interest rates in general. Remember that interest rates are the “price” for the commodity or product known as cash money. If the price of borrowing money is increasing, then most interest rates are on the rise. In this scenario, the odds are that your ARM will also experience increasing rates, thus increasing the size of your mortgage payment. Conversely, when interest rates fall (as the price of money becomes cheaper usually due to less demand and more capital available in the market), ARM interest rates and payments eventually follow suit. If the interest rate on your mortgage fluctuates, so will your monthly payment sooner or later. And therein lies the risk: Because a mortgage payment is probably one of your biggest monthly expenses (if not the biggest), an adjustable-rate mortgage that’s adjusting upward can wreak havoc with your budget. You may be attracted to an ARM or hybrid loan because it starts out at a lower interest rate than a fixed-rate loan and thus may enable you to qualify to borrow more. However, just because you can qualify to borrow more doesn’t mean you can afford to borrow that much, given your other financial goals and needs. The right reason to consider an ARM is because you may save money on interest charges and you can afford the risk of higher payments if interest rates rise. Because you accept the risk of an increase in interest rates, mortgage lenders cut you a little slack. The initial interest rate (also known as the teaser rate) should be significantly less than the interest rate on a comparable fixed-rate loan. In fact, even with subsequent rate adjustments, an ARM’s interest rate for the first year or two of the loan is generally lower than a fixed-rate mortgage. Another important advantage of an ARM is that, if you purchase your home during a time of high interest rates, you can start paying your mortgage with the artificially depressed initial interest rate. If overall interest rates then decline, you can capture the benefits of lower rates without refinancing as your ARM adjusts lower. Here’s another situation when adjustable-rate loans have an advantage over their fixed-rate brethren: If, for whatever reason, you don’t qualify to refinance your mortgage when interest rates decline, you can still reap the advantage of lower rates. The good news for homeowners who can’t refinance and who have an ARM is that they’ll receive many of the benefits of the lower rates as their ARM’s interest rate and payments adjust downward with declining rates. With a fixed-rate loan, by contrast, you must refinance to realize the benefits of a decline in interest rates. The downside to an adjustable-rate loan is that if interest rates in general rise, your loan’s interest and monthly payment will likely rise, too. During most time periods, if rates rise more than 1 to 2 percent and stay elevated, the adjustable-rate loan is likely to cost you more than a fixed-rate loan. How an ARM’s interest rate is determined Most ARMs start at an artificially low interest rate. Don’t select an ARM based on this rate because you’ll probably be paying this low rate for no more than 6 to 12 months, and perhaps for as little as 1 month. Like other salespeople, lenders promote the most attractive features of their product and ignore the negatives. The low starting rate on an ARM is what some lenders are most likely to tell you about because profit-hungry mortgage lenders know that inexperienced, financially constrained borrowers focus on this low advertised initial rate. The starting rate on an ARM isn’t anywhere near as important as what the future interest rate is going to be on the loan. How the future interest rate on an ARM is determined is the most important issue for you to understand when evaluating an ARM — if you plan on holding onto your loan for more than a few months. To establish what the interest rate on an ARM will be in the future, you need to know the loan’s index and margin, the two of which are added together. So ignore, for now, an ARM’s starting rate and begin your evaluation of an ARM by understanding what index it is tied to and what margin it has. What are the index and margin? So glad you asked! Start with the index The index on an ARM is a measure of general interest rate trends that the lender uses to determine changes in the mortgage’s interest rate. For example, the one-year Treasury constant maturity index is a common index used for many ARMs. Suppose that the going rate on this index is approximately 2 percent. The indexes used on various ARMs theoretically indicates how much it costs the bank to take in money, for example, from people and companies investing in the bank’s various accounts, which the bank can then lend to you, the mortgage borrower. The following sections explain the most common ARM indexes. Don’t worry about lenders playing games with the indexes to unfairly raise your ARM’s interest rate. Lenders don’t control any of the indexes discussed here. Furthermore, they’re easy to verify. If you want to check the figures, you can usually find these indexes in publications such as The Wall Street Journal for online sources for this information. TREASURY SECURITIES The U.S. federal government is the largest borrower in the world. So it should come as no surprise that some ARM indexes are based on the interest rate that the government pays on some of its pile of debt. The most commonly used government interest rate indexes for ARMs are for one, three, five, and ten-year Treasuries. The Treasury security indexes are volatile; they tend to be among the faster-moving ones around. In other words, they respond quickly to market changes in interest rates. Treasury indexes are good when interest rates are falling and lousy when rates head higher. THE LONDON INTERBANK OFFERED RATE INDEX (LIBOR) The London Interbank Offered Rate Index (LIBOR) is an average of the interest rates that major international banks charge each other to borrow U.S. dollars in the London money market. Like the U.S. Treasury indexes, LIBOR tends to move and adjust quite rapidly to changes in interest rates. This international interest-rate index became increasingly popular as more foreign investors bought American mortgages as investments. Not surprisingly, these investors like ARMs tied to an index that they understand and are familiar with. Be sure to ask your lender how the index tied to the ARM you’re considering has changed in the last five to ten years. Add the margin The margin, or spread as it’s also known, on an ARM is the lenders’ profit, or markup, on the money that they lend. Most ARM loans have margins of around 2.5 percent, but the exact margin depends on the lender and the index that lender is using. When you compare several loans that are tied to the same index and are otherwise the same, the loan with the lowest margin is better (cheaper) for you. All good things end sooner or later. After the initial interest rate period expires, an ARM’s future interest rate is determined, subject to the loan’s interest rate cap limitations,by adding together the loan’s current index value and the margin. The following formula applies every time the ARM’s interest rate is adjusted: For example, suppose that your loan is tied to the one-year Treasury security index, which is currently at 2.5 percent plus a margin of 2.25 percent. Thus, your loan’s interest rate is This figure is known as the fully indexed rate. If a loan is advertised with an initial interest rate of, say, 3.5 percent, the fully indexed rate (in this case, 4.75 percent) tells you what interest rate this ARM would rise to if the market level of interest rates, as measured by the one-year Treasury security index, stays at the same level. Always be sure to understand the fully indexed rate on an ARM you’re considering. To avoid any surprises, you also should know what the payment will be for various potentially higher interest rates during the life of your loan, including the maximum rate, so you fully understand what the maximum possible monthly payment is. Ask the lender and/or your mortgage broker to provide this payment information. How often does the interest rate adjust? Although some ARMs have an interest rate adjustment monthly, most adjust every 6 or 12 months, using the mortgage-rate determination formula discussed previously. In advance of each adjustment, the mortgage lender should mail you a notice, explaining how the new rate is calculated according to the agreed-upon terms of your ARM. The less frequently your loan adjusts, the less financial risk you’re accepting. In exchange for taking less risk, the mortgage lender normally expects you to pay more — such as a higher initial interest rate and/or higher ongoing margin.

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Fixed Rated Mortgage (FRM)

Article / Updated 04-04-2018

What is a fixed mortgage? As you may have surmised from the name, fixed-rate mortgages have interest rates that are fixed (that is, the rate doesn’t change) for the entire life of the loan, which is typically 15 or 30 years. With a fixed-rate mortgage, the interest rate stays the same, and the amount of your monthly mortgage payment doesn’t change. Thus, you have no surprises, no uncertainty, and no anxiety over possible changes in your monthly payment as you have with an adjustable-rate mortgage. This image illustrates how 30-year fixed-rate mortgage interest rates have fluctuated over the years. You can bet with 100 percent certainty that they’ll continue to bounce up and down due to ever-changing economic conditions. However, once you have your very own 30-year fixed-rate loan, its interest rate won’t ever change. Because the interest rate doesn’t vary with a fixed-rate mortgage, the advantage of a fixed-rate mortgage is that you always know what your monthly payment is going to be. Thus, budgeting and planning the rest of your personal finances is easier. That’s the good news. The bad news is that with a fixed-rate mortgage, you pay a premium, in the form of a higher interest rate, to get a lender to commit to lending you money at a fixed rate over the full term of the mortgage. The longer the term for which a mortgage lender agrees to accept a fixed interest rate, the more risk that lender is taking. In addition to paying a premium interest rate when you originally get a fixed-rate loan, another potential drawback to fixed-rate loans is that, if interest rates fall significantly after you have your mortgage, you face the risk of being stuck with your costly mortgage. That could happen if, for example, due to problems with your personal financial situation or a decline in the value of your property, you don’t qualify to refinance. Even if you do qualify to refinance, doing so takes time and costs money (appraisal, loan fees, and title insurance). Here are a couple of other possible drawbacks to be aware of with some fixed-rate mortgages: Fixed-rate mortgages aren’t generally assumable, so if you sell during a period of high interest rates, your buyers must obtain their own financing. Finding assumable ARMs, however, is difficult. As with some adjustable-rate mortgages, some fixed-rate mortgages have prepayment penalties.

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A Guide to Refinancing Your Mortgage

Article / Updated 04-04-2018

You’re probably not going to refinance the mortgage on your house because you suddenly developed an insatiable urge to generate enormous loan fees for your friendly neighborhood lending institution. Here are three far more sensible reasons to refinance your mortgage: To cut costs: “A penny saved is a penny earned,” is every bit as true today as it was in Ben Franklin’s time, but why stop with a few lousy pennies? Think big. Lowering your monthly loan payment by replacing your present mortgage with a new one that offers a lower interest rate could save you tens of thousands of dollars over your new loan’s term. To restructure your financing: Slashing your monthly mortgage payment isn’t the only reason to refinance. In fact, you may need to refinance even if the new loan won’t save you one red cent. For instance, suppose you have a short-term balloon loan coming due soon that you must replace with long-term financing. Or maybe you want to trade in that volatile adjustable-rate mortgage (ARM) used to finance your home purchase for a more pedestrian (or predictable) fixed-rate loan so you can hit the sack each night without worrying yourself sick about the possibility of your loan’s interest rate skyrocketing. To pull cash out: If you’ve owned your home a long time, you’ve probably built up quite a bit of equity in it, thanks to the combined effect of paying down a small percentage of your loan’s outstanding balance every month through an amortizing loan and property appreciation. Instead of simply replacing the old mortgage with a new one of the same amount, some folks pull out additional cash, which they use for such purposes as starting a new business, helping pay for the kids’ college expenses, or planning that dream trip to Antarctica to see male penguins dutifully play Mr. Mom. You could probably come up with a couple of more ways to use some extra money if you really put your mind to it. Refinancing a mortgage isn’t like ordering dinner in a Chinese restaurant where you select one item from column A and one from column B. What the heck. It’s your refi. You can do whatever you want. If you plan carefully, you may be able to accomplish all three objectives when you refinance. Is refinancing a mortgage a good idea? At times it may actually be a more prudent strategy to not refinance because there can be advantages to keeping the existing loan and seeking additional sources of funds in a different manner. If you’ve had your loan for several years, remember that with all loans, you pay more interest in the beginning of the loan and more principal later in the loan. Ask yourself this hypothetical question: If your loan had only one year left on it (12 payments), but it carried a 10 percent interest rate and a monthly payment of $1,000, would you start a new 30-year loan (360 payments) at 5 percent with a $65 payment? Of course not! That’s why the age of your current loan matters when considering refinancing. One smart idea is to look at the new monthly payments (principal + interest only) for the refinance based on the time period remaining on your current loan. For example, if your current loan has 12 years left on it (144 payments), then analyze the prospective refinance with payments over 12 years, too. Does refinancing the loan still make sense? Even if the refinancing does not make sense over time, you may still go with the refinance if you really need the new lower monthly payments to survive your current financial situation. You’ll be helping yourself in the short term (with the lower payments), but you’ll be hurting yourself long term (by adding many years to the life of your loan), but sometimes this is the only solution. How does refinancing a mortgage work? The sole distinction between a purchase loan and a refinance mortgage is whether a change of property ownership occurs during the financial transaction. When you purchased your dream home, ownership of the house transferred from the seller to you. On the other hand, no change of ownership occurs when you subsequently opt to replace your existing mortgage with a new one. Essentially, you will undergo the same process for a refinancing a mortgage as you do when applying for a mortgage for a home purchase.

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Mortgage Loan Application Process & Paperwork

Article / Updated 04-04-2018

The mortgage application process is complicated. For a mortgage lender to make a proper assessment of your current financial situation and process your mortgage application, the lender needs details. Lots of them! Thus, mortgage lenders or brokers ask you to sign a form authorizing and permitting them to make inquiries of your employer, the financial institutions that you do business with, the Internal Revenue Service, and so on. Mortgage lenders provide you with an incredibly lengthy list of documents that they require with mortgage applications. Here is a mortgage loan documents checklist to help you gather what you need: Pay stubs, typically for the most recent 30 consecutive days Two most recent years’ W-2 forms Two most recent years’ federal income tax returns Signed IRS Form 4506-T Request for Transcript of Tax Return Year-to-date profit-and-loss statement and current balance sheet if you’re self-employed Copies of past two months’ bank, money market, and investment account statements Recent statements for all outstanding mortgages Copy of current declarations pages for homeowners insurance policies in force Home purchase contract (if you’re financing to buy a home) Rental agreements for all rental properties Divorce decrees Federal corporate tax returns for the past two years Partnership federal tax returns for the past two years Partnership K-1s for the last two years Condo or homeowners association documentation — such as CC&Rs, (covenants, conditions, and restrictions) bylaws, articles of incorporation, budget, reserve study, current regular assessment amount owed, if any, special assessments due now or approved for the future, if any, contact name, address, and phone number Title report, abstract, and survey Property inspection report and pest control inspection report (if you’re buying a home) Gift letter — the source of any funds being used toward your down payment must sign indicating that these funds are a “gift” and are not required to be repaid Receipts for deposits (if you’re buying a home) Don’t despair at the length of the list. This list covers all possible situations, so some of the items won’t apply to you. Still, you may rightfully ask, “Why do lenders require so much information?” Most of the items on this laundry list are required to prove and substantiate your current financial status to the mortgage lender and, subsequently, to other organizations that may buy your loan in the future in the secondary mortgage market. Pay stubs, tax returns, and bank- and investment-account statements help to document your income and assets. Lenders assess the risk of lending you money and determine how much they can lend you based on these items. If you’re wondering why lenders can’t take your word about the personal and confidential financial facts and figures, remember that some people don’t tell the truth. Lenders have no way of knowing who is honest and who isn’t. The unfortunate reality is that lenders have to assume that all their loan applicants may lie given the opportunity. Even though lenders require all this myriad documentation, some buyers still falsify information. And some mortgage brokers, in their quest to close more loans and earn more commissions, even coach buyers to lie to qualify for a loan. One example of the way people cheat: Some self-employed people create bogus tax returns with inflated incomes. Although a few people have gotten away with such deception, this wayward path isn’t recommended. Also, lenders have become smarter, too, and now typically rely only on tax returns that they receive directly from the IRS or the state taxing authority. If you can’t qualify for a mortgage without resorting to trickery, getting turned down is for your own good. Lenders have criteria to ensure that you’ll be able to repay the money you borrow and that you don’t get in over your head. Falsifying loan documents is committing perjury — and fraud is not in your best interests, even if you won’t get impeached for it. Mortgage lenders can catch you in your lies. How? Well, some mortgage lenders have you sign IRS Form 4506-T (Request for Transcript of Tax Return) — typically at the time you submit your loan application — that allows them to request directly from the IRS copies of the actual tax returns that you filed with the IRS. Besides the obvious legal objections, lying on your mortgage application can lead to your having more mortgage debt than you can really afford. If you’re short on a down payment, for example, alternatives are available. If the down payment isn’t a problem but you lack the income to qualify for the loan, check out loans known as “No Doc” or NIVs (no income verification) or stated income loans that don’t require documentation of income.

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