Thinking about buying a house? Before you do, you might want
to work on boosting your credit score.
A new study by
real estate research site Zillow found that a borrower with a fair credit
score (640-679) would pay about $720 more per year in mortgage costs for the
same home than a borrower with an excellent score of above 760.
The analysis found that nationally, a borrower with an
excellent credit score could get a 30-year fixed-rate mortgage of 4.5% for a
median priced U.S. home of $213,100 with a 20% down payment. The borrower with
fair credit would qualify for a 5.1% rate, according to Zillow’s analysis of
quotes offered to borrowers on Zillow Mortgages between March 25-May 5.
Over the lifetime of that 30-year mortgage, the fair credit
borrower would pay $21,000 more for the typical home.
"When you buy a home, your financial history determines
your financial future," said Zillow senior economist Aaron Terrazas in a
The penalty for having a lower credit score grows for
homebuyers in more expensive markets.
For example, a buyer with a fair credit score in San Jose,
where the median home value is $1.3 million, would wind up paying about
$129,000 more over the course of the 30-year loan than a borrower with an
excellent score, according to Zillow's analysis.
The study does note that "these estimates likely
represent the maximum impact of fair versus excellent credit, because credit
scores aren’t set in stone." Borrowers can also secure lower rates with a
larger down payment and few buyers pay out the full 30-year term on a loan.
"Homeowners do have the option to refinance their loan
if their credit improves, but as mortgage rates rise this may be a less
attractive option," Terraza said.
How to boost your credit score
There are ways to raise your credit score in a relatively
The personal finance website Nerd Wallet recommends these 3 steps
to improving your credit score in a short time:
1. Fix errors on your credit reports
2. Stay well below your credit limit
3. Deal with past-due bills
By addressing these issues it’s possible for a borrower with
a low credit score to boost it by as much as 100 points, according to
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The housing market has been going up, and as
a result, a lot of investors and homeowners are finding themselves benefitting
from substantial appreciation on their home values. Investors often approach me
with the problem of too much "lazy" equity in their homes.
investors know the amount of equity they have in their properties and
closely monitor the return on equity of their investment —
that is, the percentage of return in comparison to the amount of deployable
equity, or how much they would net after a liquidation. This is different from
the return on investment, which is the amount the initial capital investment makes
off a down payment.
With the rise in home prices, people are looking to
optimize the equity trapped in their home. In this situation, there are three
options for redeploying the equity: sell the property, cash-out refinance, or
take out a home equity line of credit (HELOC). Consider the strategy known as
mortgage recasting or rate arbitrage on of those options in order to pay down
your current mortgage.
First, let’s talk
about good debt versus bad debt. An 18% interest rate paid on something like a
credit card is bad debt. But taking a 4% HELOC or loan from your life insurance
policy can be good debt. Especially if you are putting the loan proceeds into
private note fund at 10%, an apartment private placement at 15%, a rental
property at 25% or another higher risk/return partnership or development
at 30%. What you do with the liquidity from your mortgage debt is what
really matters — just don’t buy jet skis or other doodads with the money.
You assume when
you buy a house that it will go up in price. Historically this has been true,
but it’s not guaranteed to go up in the future. Mortgage debt is how most
people can afford homeownership, whether or not they are responsible enough to
commit to a 30-year loan or can afford the monthly payment. The unavoidability
of mortgage debt is one of the myths I blindly followed to buy my first primary
residence in 2009. You hear of it often from bankers and lenders, most of whom
are simply acting as salesmen for big banks and get compensated when you
originate a loan. They are not always acting as a fiduciary.
mortgage is where you have a 30-year amortization schedule where you make
payments in the same amount for 30 years and all the interest is paid upfront.
In the first few years, a huge majority of your payment is going toward
interest. When the majority of homeowners move before the end of the 30-year
mortgage, brokers love it because they get compensated with origination fees
when a new loan or refinance happens, and banks love it because the amortization
clock has been extended and the customer is again put into the front-loaded
majority interest portion of an amortized loan.
arbitrage turns the tables on this situation.
Take out a
HELOC — credit borrowed against the equity in your home or any other loan that
is based on simple interest, not amortized interest. This is a liquid line
of credit that you can put money into and out of without penalty. Many people
call these “debt-destruction weapons,” which is illustrated when you take a spreadsheet
and compare simple interest and amortized interest against you.
In this strategy, you are taking money out of your HELOC
(simple interest) to pay off your mortgage (amortized interest). This pushes
down your interest paid every day since the HELOC with simple interest is
calculated with an average daily rate (ADR). If you are paying 5% on your
HELOC, you are paying 5%/365 or 0.0137% per day. Your ADR is 0.0137%. If you
borrowed $100,000, you are paying 0.000137 x $100,000, or $13.70 per day.
On the flip
side, amortized loans are front-loaded with interest and great benefit your
lender, not you.
Mortgage Rate Arbitrage Key Considerations
your low-stress frequency. To reduce the headache of making payments to your
mortgage with amortized interest every day or week, you need to figure out what
is an effective amount to “chunk” these payments to your mortgage from the
HELOC. Most people start out in quarterly to annual increments.
frequency dictates how much you are going to take from your HELOC to apply
to your mortgage payment. Be sure you are maintaining a positive cash flow
status in your personal budget.
3. An advanced
strategy is to put your income into your HELOC and utilize your HELOC as your
4. Before you
begin, evaluate how stable your monthly income and expenses are. Someone in a
stable government job might want to be a little more aggressive and pay off
your mortgage with bigger amounts from your HELOC. If your employment is
unstable or your salary irregular, you might want to calculate a rolling 6- or
12-month average and base your chunking amount on that. Often this
requires a cash flow plan in the form of a spreadsheet and a little
financial guidance from someone who has employed this strategy before.
Though a sound strategy for many, this mortgage rate arbitrage
process is not right for everyone. Avoid if:
• You need to
have positive cash flow in your personal finances due to low income or budget
is too tight.
• You do not
have a credit score of 620 or higher needed to secure a HELOC.
• You do not
have enough equity in your home to obtain a HELOC.
• You are an
incredibly efficient, sophisticated investor already growing your money at
greater than 15% per year. You might be better off investing in what you do
In the end,
mortgage lenders are trying to extract every bit of revenue they can via
amortization of loans. By using simple interest in the form of HELOCs to pay
down your current amortized debt, you can more quickly pay down the principal
on your loans, saving significant money over the lifetime of your loan.
point is essentially prepaid interest: You pay an upfront fee to lower the
interest rate on your mortgage.
When you take out a
mortgage loan, you run into a lot of closing costs, and few are optional. Most
lenders, however, will give you the option to buy mortgage discount points,
which can lower your interest rate. You may also get the chance to receive a
negative point credit, though this will raise your interest rate.
the lowdown on what mortgage points are, how they work and when you should
and shouldn’t use them.
point can be either positive or negative, though positive points are much more
common. Buying a positive, or discount, point or receiving a negative point
changes your mortgage interest rate. Each kind of
point costs 1% of your mortgage loan amount. For example, if you have a
$100,000 mortgage, you’d pay $1,000 for one discount point.
discount point is essentially prepaid interest: You pay an upfront fee to
lower the interest rate on your mortgage. Because purchasing points lowers
your interest rate, buying them is often known as “buying down the rate.”
Discount points may be tax-deductible if the purchase is for your
primary residence. Before buying points, you should have your lender give you
an estimate for both scenarios — your mortgage closing costs if you buy points
and if you don’t — says Ann Thompson, a divisional sales executive at Bank of
America. She recommends then taking these two estimates to your tax
professional to learn if points are tax-deductible for you and how each option
would affect your overall tax situation.
points, sometimes called rebate points, are different: The lender offers to
give you a credit by paying some of your fees in exchange for a higher interest
sometimes called a no-cost mortgage. Negative points can be paid either to a
broker as part of his or her compensation or to the borrower to cover closing
costs. When a lender offers you negative points, it is effectively saying
it’ll cover some of your mortgage fees and charge you a higher interest
rate in return.
from negative points cannot exceed the mortgage closing costs, and these points
can’t be used as part of a down payment. Thompson says points can be used to
cover some nonrecurring closing costs, such as bank and title fees, but they
can’t cover recurring fees like interest or property tax.
Why would you
willingly take a higher interest rate? If you’re short on money needed for
closing costs, “you may want to pay a little bit more in interest over the life
of the loan to have some of that covered,” Thompson says. Another reason might
be if you want to hang onto some cash for improvements before you move in
and can afford a higher monthly payment.
set amount for how much a point will lower or increase your rate, Thompson says.
It varies by the type of loan, the lender and prevailing rates, since mortgage
rates fluctuate daily.
On the day of
the interview with Thompson, buying a point on a fixed-rate loan lowered the
rate by a quarter of a percentage point. On an adjustable-rate mortgage, the
rate would drop three-eighths of a percentage point.
At Guaranteed Rate,
a national lender, the savings are similar: Buying one point will typically
lower your rate a quarter, or perhaps three-eighths, of a percentage point,
says Dan Gjeldum, senior vice president of mortgage lending.
should pay points?
whether to buy mortgage discount points is always a case-by-case decision,
though it typically comes down to two factors: time and money. How long will
you stay in the house, and how much can you afford to pay to close your
The key factor is how long you think you’ll stay in the home.
Then you can calculate at what point you’ll break even on the cost of the
points (use our calculator
here for a personalized recommendation on whether to buy
personally ever encourage paying points simply because of the fact that it does
take so long to make it up, especially for a first-time home buyer,” Gjeldum
says. While it can make financial sense for some, first-time home buyers
generally don’t hold the mortgage long enough to make up the upfront expense,
can make financial sense for some people to buy discount points, first-time
home buyers generally don’t hold the mortgage long enough to make up the
money may be better spent on improvements like paint, landscaping or new
carpets, he adds.
It may make
sense to buy points when you’re purchasing a long-term investment property or a
home you plan to hold for many years, Thompson says, since you’ll reap savings after
example from Thompson to help demonstrate how long it can take to benefit from
buying a point. Say you’re taking out a $400,000 loan. Since one point equals
1% of the loan, buying one discount point would cost you $4,000. So first, decide whether you
can afford to pay that $4,000 on top of your existing closing costs.
mortgage rates the day she was interviewed, Thompson said buying a point would
save you roughly $57 a month on your mortgage bill. By dividing the cost of the
point ($4,000) by the monthly cost ($57), you determine how many months it
would take you to make up the cost of buying the point. In this example, it’s
about 70 months, or almost six years.
That means if
you planned to stay in the home for six years, you’d break even, and any longer
than that, you’d save money. But if you moved out before then, you’d have lost
buying points makes sense if the seller is willing to pay for it. Gjeldum and
Thompson both say that if an employer is relocating you for work and offering
to pay points to buy down your interest rate, it could also be worthwhile since
you’re not the one shelling out money.
The total closing costs you’ll
pay can vary greatly according to your home’s purchase price.
The average homebuyer will pay between about 2% and 5% of the loan
amount in closing fees.
Your lender is required to outline your closing costs in the Loan Estimate and
this Closing Disclosure you
receive before the big settlement day. Take the time to review them
closely and ask questions about things you don’t understand.
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To get the best FHA mortgage rate, check your
credit report, consider making a larger down payment, reduce debt, shop more
than one lender and explore state assistance programs.
loans are backed by the government, so you might think the interest rates are
regulated. But FHA mortgage rates vary by lender — they’re not set by the
Federal Housing Administration. That means you’ll have to do a little work to
get the best interest rate on an FHA mortgage. Here’s how.
It’s important to make sure your credit report and score
properly reflect you. Why? While FHA guidelines say
that borrowers can qualify with a credit score as low as 500, lenders make
their own rules about what they’ll accept. And the higher your credit score,
the better your interest rate will be.
So pull your free
credit report, which the three primary credit agencies are mandated
to provide you once a year without charge. In fact, you can get all
three at once if you’re about to apply for an FHA loan.
you get your report, look for mistakes and omissions. For example, a bad-debt
collection that you don’t recognize. Or a credit account that you’ve paid
perfectly for quite some time but doesn’t show up on the report.
If you find an error in your favor and get it corrected,
it might boost your credit score and earn you a lower interest rate.
FHA mortgages allow down payments as low as 3.5%. But
putting down just a little bit more can improve your interest rate. Lenders
consider loan-to-value when pricing a loan. A larger down payment lowers your
LTV while positioning you as a more-trusted borrower.
You can plug some numbers into the NerdWallet loan-to-value
calculator to consider different scenarios.
Another key measure lenders consider is your debt-to-income ratio,
which is how much you owe, divided by your monthly earnings.
a credit card that still has a balance due? Work to pay it off. There can be
two positive results: You’ll lower your debt-to-income ratio, and quite likely
improve your credit score.
Here’s a DTI calculator that
can help you work the numbers.
“yes” from a lender is a great feeling, and many people stop right there. But
it’s smart to continue shopping for better deals. Think about it: You know you
can qualify, you’ve got an approval in your back pocket, so what’s the
takes time and more paperwork. But finding a lender that offers you a better
FHA mortgage rate reduces the interest you pay over the life of the loan. That
can mean a lower monthly payment and saving thousands of dollars.
Use that as
an incentive to shop around.
We saved it
for last. Perhaps the best tip of all. Explore first-time home buyer assistance
programs offered by your state’s housing authority. Many of these nonprofit
agencies combine FHA mortgages with down payment and closing cost assistance.
We’re talking free money, in the form of grants.
that, but these state-sponsored programs often offer even more favorable FHA
mortgage rates through associated local lenders.
Purchasing your first home is a major
milestone and not a decision to be taken lightly. It’s a huge financial
commitment that can take months of preparation — searching for the right home,
making an offer, going through the mortgage application process and closing on
the home. Then you have the actual business of home ownership, which is a whole
But in order for this to go as smoothly as
possible, it’s a good idea to have your affairs in order before you become a
homeowner. Here are five signs you might be ready.
Financial stability is one of the most
important contributing factors to successful homeownership. You need to have a
steady source of income that can easily cover your mortgage payment — experts
recommend that your home cost no more than 20 to 30% of your monthly income.
You’ll also want to minimize any debt or financial obligations that can reduce
your ability to afford a mortgage. Finally, you’ll need income or savings to
afford home repairs, furniture and other assorted expenses.
If you’re already emptying your bank account
to pay your rent, you may need to reduce your expenses or increase your income
and savings before you’re ready to buy.
“You shouldn’t spend to your limit and end up
with a new home and nothing in the bank,” Chris Taylor, a real estate broker
with Advantage Real Estate, said. “You need to have a plan and a comfortable
buffer so that if the unexpected happens, you have the money to make repairs.”
Want to know more about mortgages? There’s a
lot to learn and our mortgage
learning center can be a good place to start.
Almost all home sales require some sort of
down payment. Depending on loan type, down payments can range from 5 to 20% of
the cost of your home. The more money you can provide for a down payment, the
less you will owe on your mortgage.
Down payments can increase the odds of getting
approved for a loan and help you secure better interest rates, Randy Hopper,
senior vice president of Mortgage Lending at Navy Federal Credit Union, said.
“It is, therefore, critically important to factor into your budget the source
of your down payment.”
Many lenders, agencies and nonprofits provide
assistance programs and financing options that can help potential homeowners
come up with their down payment. Be sure to shop around and research the
available options. And when it comes time to settle on a price? Consider
checking out this guide to help you know the best tactics for negotiating.
Strong credit is essential to securing a mortgage. A good credit score can
help you secure a better interest rate, which can save you thousands over the
life of a loan. The better your credit score, the better your odds of landing
your dream home with a reasonable interest rate.
Building or improving your credit takes time,
and it’s best to start well before you begin touring houses. “Make 100% of your
payments on time,” Hopper said. “You should avoid opening too many accounts at
once. And always check each of your credit reports for errors.”
Not sure where your credit is at? Now is the
time to find out. You can see two
of your credit scores for free on
Credit.com and you can see your full credit reports from the three major credit
bureaus (also free) on AnnualCreditReport.com. If you find that things aren’t
in the best shape, you can focus on repairing your credit yourself or turn to a
professional credit repair expert for help. Either way, if you can wait to
apply for a loan until your credit is in decent shape, your wallet will likely
House hunters are often primarily focused on
the type of home they want. But consider that you’ll be making a long-term
commitment to both your home and the geographic region. Pay attention to the home values in the neighborhood, the quality of schools, recreation options and any other priorities. Building value in your home and putting down roots requires years of commitment, so make sure you're ready.
“There are costs associated with acquiring
your loan, closing on the sale and then moving in — and this is not to mention
the physical items you’ll most likely end up purchasing,” Hopper said. “On
average, it can take about five years to break even on these costs, so I
recommend thinking ahead and asking yourself if you will still be in the home
beyond five years.”
You don’t have to be an expert handyman to own
a home. But if you can’t operate a plunger, you may not be ready. Homes need
maintenance and TLC to retain their function and value, and if you can’t handle
repairs, you’ll at least need to be able to afford someone who can.
“Calling a plumber on a Saturday night is
going to be costly,” Taylor said. “If you have the ability to watch a few
YouTube videos and figure out minor repairs, you’re in good shape. It’s also
important to know when you’re in over your head and need to consult an expert.”
Home buyers are leaving serious money on the
According to new research from
Freddie Mac, the average
borrower could save $1,500 just by getting one extra rate quote when applying
for their mortgage. With five quotes, they could save $3,000 or more.
But Freddie Mac’s report shows buyers just aren’t doing it. In
fact, less than half of today’s borrowers shop around for rates when getting a
mortgage or refinancing. “Worse,”
Freddie Mac reported, “many consumers do not seem to realize that the rates
offered by lending institutions vary widely.”
In fact, according to David Edmondson, senior loan officer at
Flagstar Bank in Boston, interest rates vary from one-eighth percent to a
half-percent from lender to lender. On a $300,000 loan, a half-percent
difference means more than $1,000 in savings per year.
Why Aren't People Shopping?
Most people would jump at the chance to have an extra $1,000 in
their pockets, so what’s holding today’s buyers back? Freddie Mac’s researchers
point to Nobel Prize winner Richard Thaler’s economic theory.
“His research into seemingly irrational economic behaviors finds
that in general consumers search too little, get confused while evaluating
complex alternatives and are slow to switch from past choices, even if it costs
them,” Freddie Mac reported. “These types of behavior apply to more complex
tasks such as taking out a mortgage and can lead to borrowers relying solely on
their existing banking relationship or a single referral from a real estate
agent or a friend.”
But it might be simpler than that. According to Anthony Casa,
president of Garden State Home Loans and chairman of the Association of
Independent Mortgage Experts, home buying is often just overwhelming.
“If you're a home buyer, it's a pretty overwhelming process,” Casa
said. “You have home inspections. Then you have to get the mortgage loan. The
idea of sitting there and talking to three to four different mortgage companies
to get your quotes, it can be a little bit overwhelming to go through that
Not getting started early enough can also prevent buyers from
shopping around, Edmondson said.
“The No. 1 reason for not rate shopping is that buyers wait to the
last minute,” said David Edmondson. “Buyers often don’t think about the terms
of the mortgage until they have signed a purchase agreement. Once that happens,
they are dealing with deadlines and often end up going with whomever their
Realtor recommends. While this can be quick and convenient, it could be costly
Casa agreed that timing has a lot to do with it — especially in a hot market.
“Unfortunately because of the moving parts, lack of familiarity
with the process, and also the pace that you have to get things done, many
buyers will go with that first person they get referred to,” Casa said.
“Unfortunately they're going to pay a very, very high premium over the life of
the loan for doing that.”
Why Rate Shopping Works
Mortgage rates vary greatly — from
day to day and lender to lender. According to Freddie Mac’s data, in a single
week borrowers received rates anywhere from 4.2% to 4.8%.
“If borrowers only search once, some will get lucky and get a low
rate, others will get a high rate, and many will get a rate around 4.5%,” the
On average, buyers who get one extra quote will save anywhere from
$966 to $2,086 over the life of their loan. For five quotes, buyers will save
$2,089 to $3,904. “If you shop
around, you could get as much as a full three-quarters of a percent
difference,” Casa said. “It's a game-changer.”
Rate shopping is especially important in today’s market, as home
prices continue to rise. “Shopping
around and getting the lowest rate is what's going to expand your budget and
allow you to buy more house,” Casa said.
According to Ric Edelman, whose Edelman Financial Services offers
financial and investing advice, the varied nature of the mortgage industry is
also a reason to shop around.
“Some companies, for marketing reasons, choose to emphasize
certain kinds of buyers or certain kinds of loans,” Edelman said. “For that
reason, you need to shop around, just like you would for any other product.”
Veterans United, for example, specializes in loans for military
and former military members, while other mortgage companies focus more on
first-time home buyers, rural home loans or other niche markets. Some lenders
even offer professional loans for buyers with specific jobs, like lawyers,
doctors, teachers or other types of public servants. As Edelman said, shopping
around can help borrowers find better-fit loans — as
well as rates — for their
Pro Tips For Mortgage Shopping
It’s clear that shopping around can help home buyers save. But
what does that rate shopping actually look like? What can buyers do to get the
best deal in today’s competitive market?
From scoping out fees to simply staying consistent, here’s how
industry experts recommend buyers get the best rate in today’s market:
Pay attention to fees.
“Ultimately you need to figure out the monthly payment you are
comfortable making, instead of focusing so much on just the interest rate. A
borrower could be tempted to choose one lender offering a 4.125% interest rate
over another lender offering a 4.25%, but the place with the lower interest
rate could also have the highest closing costs and title fees in the market.” — Mat
Ishbia, president and CEO of United Wholesale Mortgage
Get a full breakdown of fees and
“Origination fees are another cost that will frequently vary from
lender to lender. Lenders will have different names for these fees, such as
underwriter fee, processing fee, origination fee, etc. However, it is important
to compare total lender fees when comparing one lender with another. You can
easily review fees when you have the loan estimates. A buyer may think they are
saving a little on the interest rate, when in reality they are paying a much
higher upfront fee. Ask each lender for an official, written loan estimate of
rates and fees based on your particular situation.” — Edmondson
Consistency is key.
“You just need to make sure you're comparing apples to apples. You
need to ask what the interest rate for 30-year fixed rate is so that you know,
with each mortgage company or bank, they're quoting you for the same kind of
product.” — Edelman
“It is important to think ahead. Before meeting with a Realtor,
shop around with three to four different lenders to find out what they can
offer you.” — Edmondson
Know your scenario.
“What's your credit score? What kind of home are you buying?
What's your purchase price? How big of a loan are you looking at? Define your
scenario, and connect with three to four different loan officers from three to
four different companies and say, ‘Here's my scenario. I don't need you to do a
whole application. I don't need to have you have to pull my credit; I know this
is my situation. Based upon these parameters and what my closing date is, what
can you do for me on a 30-year fixed? What are your options?" — Casa
Lock your rate.
“Once you have a house under contract, double check with each
lender to see if any of their terms have changed. Once you have compared your
options, ask to lock into the best rate that works for you. That way you’ll
avoid the rate or fees from changing while the loan is being underwritten.” — Edmondson
Consider a broker.
“When you go to a mortgage lender, you're only dealing with that
one institution's products. When you go to a mortgage broker, they work with
dozens of lenders and they can shop the loan for you to show you the rates
available from a variety of sources and showing you the best that's available
for your situation.” — Edelman
Think hard about paying points.
“You should be wary of paying points. A point is a prepayment of
the loan interest. So, one way to get the interest rate of the loan down is to
make a big cash payment up front in the form of points. You need to recognize
that by paying points, or prepaying the interest, you need to stay in the house
long enough for that to be of value. Your lender or mortgage broker should be
able to show you how many years you need to stay in the house for paying points
to be worthwhile.” — Edelman
The pros and
cons of home equity loans, including a home equity line of
credit or HELOC, home equity loan and cash-out refinance, are confusing to some
equity line of credit
A HELOC is a
credit line secured by your home. Most HELOCs have an adjustable rate,
interest-only payments for a specified time, and a 10-year “draw” period,
during which the borrower can access the funds.
draw period ends, the outstanding balance must be repaid. Typically, the
repayment period is a 15-year term.
Lenders calculate the
combined loan to value by adding all mortgage debt and dividing the total by
the home’s current appraised value.
Formula: (Amount owed on primary mortgage + second mortgage) /
Example: Morgan owes $60,000 on the primary mortgage and has a
HELOC for up to $15,000. The house is worth $100,000. The CLTV is 75%: ($60,000
+ $15,000) / $100,000 = 0.75
good and bad of a HELOC
a first mortgage, a HELOC can be a good way to borrow a small sum for a short
time, says Justin Lopatin, vice president of residential lending at PERL
Mortgage in Chicago. For example, you might borrow $20,000 that you plan to
repay within three to five years.
One bad thing
about a HELOC is it can be “very tempting” to access it, even if it’s not
necessary, says Alan Moore, CEO of AdvicePay, a payment-processing platform for
A home equity
loan, like a first mortgage, allows you to borrow a specific sum for a set term
at a fixed or variable rate. That’s why these loans are sometimes called second
loans aren’t common, but some banks offer them.
equity loans with fixed rates and terms
alternative is a HELOC that’s structured like a fixed-rate home equity loan.
senior vice president of home equity for Wells Fargo in San
Francisco, says the bank offers a HELOC with a fully amortizing payment, which
means the loan is repaid in full if all the payments are made through the draw
payment you make, you pay down a little bit of principal and a little bit of
interest. So, when you get to the end of your draw period, you don’t have a big
payment shock,” Kockos says.
advance option allows the borrower to lock in a portion of the
credit line at a fixed rate and term. If interest rates change, the advance can
be unlocked to float down to a lower rate, Kockos says.
only one mortgage? Go with a cash-out refi
refinance is an entirely new first mortgage with cash back.
appeals to homeowners who want to refinance and take out cash at the same time.
“It’s a good
way to grab equity and keep it all in one loan,” Moore says.
however, that any loan or cash-out strategy must have a clear purpose. Don’t
take the cash just because you can.
typically limit the cash-out refinance to 80 percent of the home’s value, says
Jay Voorhees, broker and founder of JVM Lending, a mortgage company in Walnut
fees and interest rates
important to compare closing costs and home equity loan rates. Fees might be
higher for a cash-out refinance than they are for a HELOC, but the interest
rate might be lower for a cash-out refinance.
to lock in a low fixed rate is an advantage of a cash-out refinance, Voorhees
says. “Whenever your payback period is going to be relatively slow, it behooves
you to have a fixed rate because it’s much safer,” he says.
current interest rate matters
monthly payment might be higher or lower than your current payment, depending
on your interest rates, loan balances and repayment terms.
if your existing mortgage has a very low rate and you go for a cash-out refi,
you could end up paying a higher rate on your entire loan, not just the
“If you bought
(your home) in 2012 or 2013 and got a rate in the 3s, you may not want to touch
that because it’s such a pristine loan that can’t be beat,” Lopatin says. “If
you purchased (before then) and maybe haven’t refinanced, it may make sense to
roll everything into one loan.”
Even when a
seller and buyer agree on a price for a home, the deal can collapse if the
property appraises for less than that price.
let’s say a seller lists his house for $325,000, the buyer offers $275,000, but
they settle on $300,000. A week before closing, the appraisal comes in at
$265,000. That’s the maximum price for which the lender is willing to offer a mortgage.
to make up the $35,000 difference?
In this case,
the seller has already come down on the price and doesn’t want to lower it
again. And the buyer may not have enough cash to cover the shortfall, or does
not want to pay more for the house than its appraised value.
As a result,
the deal falls through.
causes a low appraisal
appraisals are common in declining housing markets because the lack of recent
comparable home sales in the area, or “comps,” make it hard for appraisers to
determine the current market value of a property.
sales slow down, good comps “age” quickly. Add foreclosures and short sales to the mix
and appraisals can run all over the map.
Valuation Code of Conduct, or HVCC, which went into effect in May 2009,
compounded the problem. The HVCC prohibits Fannie Mae and Freddie Mac lenders
from having direct contact with appraisers.
As a result,
most lenders work through appraisal management companies, or AMCs, whose pool
of residential appraisers includes those with limited training or little
familiarity with the geographic area being appraised.
how to protect yourself
protect yourself from low appraisals. Here are some suggestions for buyers
If you’re a
Learn how you can qualify for an FHA loan with a low down
payment and flexible approval requirements.
For most Americans, the purchase of a home is made possible with
a mortgage. However, saving a 20 percent down payment is an unattainable goal
for many would-be buyers in areas with high home prices. Compounding the
challenge are strict underwriting requirements, including some that were put
into place to protect the housing market from a crash. Underwriting is the
process mortgage lenders use to determine whether to approve a loan, based on
the borrower’s risk profile.
The Federal Housing Administration, or FHA, loan program was
created to help Americans buy homes following the Great Depression, and it
remains a popular choice for people who need an affordable mortgage option. FHA
loans are a popular solution because they allow for smaller down payments,
while also resolving some of the underwriting challenges borrowers face. FHA
mortgages are made by lenders and insured by the Federal Housing
Administration, a U.S. government agency. With a government guarantee, the
lender can offer more flexibility in its underwriting requirements, including
credit guidelines and the size of the down payment.
“If a borrower has good credit but limited cash on hand, other
government-backed loans are available for less money down,” says Stephen Moye,
senior loan officer for Citywide Home Loans. “For a borrower with a bankruptcy,
foreclosure or other credit issue, the FHA loan has a much lower barrier to
This guide explains the FHA loan process and offers
recommendations of lenders that can meet your home buying needs.
How FHA Loans Work
An FHA loan works like any other mortgage in that the lender that
approves your application pays for the home you want to purchase and you repay
that lender, with interest, over time. A mortgage is a secured loan and the
house is the collateral. Your name will appear on the deed, but the lender will
keep a lien against it until the loan is repaid in full. If you default, the
lender has the right to sell the property and recover the balance due.
FHA loans are made by lenders, just like traditional mortgages.
The difference is that FHA loans have a government guarantee. This guarantee
allows lenders to loan to borrowers who might not qualify for a conventional
Traditional conventional mortgage lenders typically expect a 20
percent down payment, but the FHA minimum down payment requirement is 3.5
percent. FHA loans have lower credit score requirements and may allow a higher
debt-to-income, or DTI, ratio.
General FHA loan requirements include:
Waiting period with extenuating circumstances (nonrecurring events beyond your control that result in sudden, significant, prolonged reduction in income or a catastrophic increase in financial obligations)
Chapter 7 or 11 bankruptcy
Chapter 13 bankruptcy
Two years from discharge, or four years from dismissal
Five years if more than one filing in last seven years. Most recent bankruptcy must have been caused by extenuating circumstances.
Three years from most recent discharge or dismissal
Three years, with additional requirements after three years up to seven years: 90 percent maximum loan-to-value purchase, principal residence, limited cash-out refinance
Deed-in-lieu of foreclosure, preforeclosure sale (short-sale), or charge-off of mortgage account
Two DTI ratio figures are calculated when considering an FHA
The front-end DTI ratio is your total monthly housing expense,
which includes the mortgage principal and interest, mortgage insurance,
homeowners insurance, property taxes and applicable homeowners association
fees, divided by your total monthly income. The back-end DTI ratio is your
total monthly debt obligation, including housing, minimum credit card payments,
auto loans, student loans and any other required monthly debt payment, divided
by your total monthly income.
Standard FHA front- and back-end DTI limits are 31 percent and
43 percent, respectively. If you earn $3,500 per month, your front-end DTI
cannot exceed $1,085 and the sum of all your monthly debt obligations cannot
Applications for borrowers with lower salaries and higher DTIs
are manually underwritten. Manual underwriting means that your lender assigns a
person to review your loan application and documents, versus running your
information through an automated underwriting system. Manually underwritten FHA
loans allow for front- and back-end DTI ratios of up to 40 percent and 50
percent, respectively. To qualify for these higher DTI limits, you will need to meet other
FHA Loan Limits for 2018
FHA loan limits are based on median local home values, county by
county. Where the median local home value exceeds the baseline loan limit, the
limit is raised. Most of the U.S. is subject to standard loan limits:
Standard FHA loan limits
Loan limits are higher in high-cost areas including San Francisco, New York
City and Washington, D.C.
High-cost FHA loan limits
Special exception loan limits apply in a select few very high-cost areas, such
as Honolulu, Hawaii.
Max special exception FHA loan limits
You can use HUD’s FHA loan limit lookup tool to find out
the limit in your county.
The loan term is the number of years you will make payments.
Typical mortgage loan terms are 10, 15, 20 or 30 years. FHA loan terms depend
on the lender. One lender may offer only 15- or 30-year loans, while another
may offer a customizable term between eight and 30 years.
Interest Rate Types
The two main types of mortgage interest rates are fixed and
Fixed-rate mortgage: Fixed-rate loans are the most popular type of mortgage.
With a fixed-rate loan, the interest does not change over the life of the
mortgage. The advantage of a fixed-rate loan is a predictable payment set for
the life of the mortgage. The disadvantage is that even if market conditions
cause rates to fall in the future, the rate will not change.
Adjustable-rate mortgage: With an adjustable-rate mortgage,
also called an ARM, the interest rate fluctuates along with a benchmark rate.
The primary advantage of an ARM is that it often starts out at a rate that is
lower than the lowest available rate on a fixed-rate mortgage. Not all FHA
lenders offer ARMs.
With the most popular type of ARM, the hybrid ARM, the rate is
fixed for a few years at the beginning of the loan and then adjusts
periodically according to market conditions. For the early years of the loan,
you might save money on interest. However, when the adjustable rate kicks in,
the rate on an ARM is usually higher than the rate available for a fixed-rate
With an interest-only ARM, you make only interest payments for a
period of time. In this case, the principal balance does not go down during
this time. After this interest-only payment period is over, you have to start
paying on the principal of the loan.
You can save money in the short term with a payment option ARM
by making low payments. However, at some point, the required payment could
spike depending on the payment option you choose. The lender will recalculate,
or recast, the required payment amount at periodic intervals, based on the
remaining loan term and the loan balance. If your balance has grown and the
remaining number of years on the loan has gone down, your required payment will
When comparing loan options, keep in mind that the annual
percentage rate, or APR, on your loan is not the same as the
interest rate. The APR is a measure of the total annual cost of the loan,
including the mortgage interest, points, fees and any additional costs.
Mortgage points are a fee you can pay at the start of the mortgage to lower
your interest rate for the duration of your mortgage.
Each point costs 1
percent of your total loan amount. The interest rate reduction depends on the
lender, but it is common to lower your interest rate by 0.25 percent in
exchange for every point purchased.
Since costs vary from one lender to the next, you should compare
APRs to make a meaningful comparison between similar loans.
Whether your lender requires mortgage insurance hinges on your
loan-to-value ratio, or LTV. This number refers to how much you’re borrowing
compared to the value of the property. Mortgage insurance is typically required
on any mortgage with a loan-to-value ratio of more than 80 percent. It protects
the lender from losses if you default on the loan. If you make a 3.5 percent
down payment, your LTV is 96.5 percent and will be higher if additional costs
are rolled into the loan.
Private mortgage insurance, or PMI, is one of the most important
aspects of FHA loans to understand because it can make FHA loans more costly
than conventional mortgages. FHA lending standards are less stringent than
conventional mortgage lending standards, so FHA borrowers pay two different
mortgage insurance premiums, or MIPs: upfront MIP and annual MIP.
Upfront MIP is 1.75 percent of the loan amount. This may be paid at
closing or rolled into the loan.
Annual MIP depends on the loan size, loan term, LTV ratio and annual
outstanding loan balance (see the chart below).
For example, if the loan is less than $625,500, the term is more
than 15 years and the down payment is lower than 5 percent, the premium is
equal to 0.85 percent of the outstanding balance. Annual MIP is calculated each
year, based on the current outstanding loan balance, and divided into 12 equal
monthly payments (which are added to your regular payments).
term of more than 15 years
Base loan amount
Less than or equal to $625,000
= 90 percent
> 90 percent but = 95 percent
Life of loan
> 95 percent
Greater than $625,000
term of less than or equal to 15 years
> 90 percent
= 78 percent
> 78 percent but = 90 percent
Borrowers who make a down payment of 10 percent or more will pay
annual MIP for 11 years; borrowers who make smaller down payments are obligated
to pay this premium for the entire mortgage term.
Here’s what these costs might look like for a typical borrower:
Home purchase price
Down payment (3.5 percent)
Closing costs (2 percent)
Total amount financed with upfront MIP and closing costs rolled into loan
Annual MIP first year
$1,489, or $124 per month
If this loan has an interest rate of 5 percent, the principal, interest and MIP
monthly payment in year one is $1,065. This figure does not include property
taxes, homeowners insurance or homeowners association fees if required.
Hawaiian Home Lands loans are not subject to either form of MIP,
and Indian Lands are not subject to upfront MIP.
Applying for an FHA Loan
The process of obtaining an FHA loan is largely the same as the
process for obtaining any other mortgage. The main difference is that the search
for a suitable lender is limited to those that offer FHA loans. As with any
borrowing decision, it’s helpful to compare the loan terms you may qualify for
with multiple FHA-approved lenders before committing to a mortgage. You can
then move on to the next steps to get prequalifed or preapproved for a loan.
Prequalification: You’ll supply basic information to the lender about your
debt, income and assets. No verification or credit check are performed. This
allows you to start your home search with a general idea of the loan size and
terms you might qualify for.
Preapproval: You’ll provide more detailed information and documentation to
the lender about your income, assets, debts and regular expenses. The lender
will check your credit and tell you what loan amount and terms you qualify for.
Preapproval does not guarantee loan approval, but can alert you to problems in
your credit report so that you are not surprised during the application
Application: If you are preapproved, the lender will confirm all of the
details you provided and may require up-to-date documentation. If you were not
preapproved, you’ll begin the process. The lender will now require details
about the specific property you want to buy.
Loan estimate: Within three business days after you apply, the lender
will give you a loan estimate. This is a standard three-page document that
explains the terms and details of your loan. If you apply with multiple
lenders, you can compare loan estimates and choose the best one. You must
notify the lender within 10 business days if you intend to proceed.
Processing: After you notify the lender of your desire to proceed, the
lender will verify all your financial information and order a property
appraisal and title report.
Additional documentation: If questions arise during loan
processing, the lender may ask you to submit additional documentation.
Appraisal: An appraisal lets the lender and borrower know the value
of the home. For an FHA loan, the lender will choose a professional
HUD-approved appraiser to evaluate the property you want to buy and give an
opinion of its value. By law, the lender must provide a copy of the appraisal
to you no later than three days before closing.
Underwriting: Once the application and appraisal are complete, a loan
underwriter will evaluate the entire package and determine whether the loan is
acceptable. It must meet guidelines set by the FHA and the lender.
Closing disclosure: The lender will provide a closing disclosure at least
three business days before your loan closes. This is a standard, five-page form
that describes the final details of the loan. You can compare it to your loan
estimate to find out whether any terms or details have changed.
Insurance: Before your loan closes, you will need to purchase
homeowners insurance that is effective no later than your closing date. You
must bring proof of insurance to your closing.
Closing: To close your loan, you’ll meet with your lender’s closing
agent. At this meeting, you’ll show identification and proof of insurance, sign
all the necessary documents and deliver a cashier’s check for the down payment
and closing costs. Then you will receive the keys to the home.
For more information about the mortgage process, including how
interest rates are determined and details about additional costs and fees, see
the U.S. News Mortgage Guide.
Choosing an FHA Lender
To find the best FHA mortgage lender to meet your needs, you
should consider criteria including:
Product offerings include loan terms and loan types. A large
menu of product offerings may mean that the lender is more likely to have the
right loan to meet your needs. Examples of popular product offerings include:
While a 3.5 percent-down FHA loan is technically available if
you have a FICO score as low as 580, lender guidelines vary. You should verify
that you can qualify for each lender’s FHA loan offerings before applying in
order to minimize credit inquiries and save time.
Although the FHA will guarantee the loan, not all lenders will
make loans to borrowers who meet only the minimum requirements. Research the
lender’s minimum credit score and maximum DTI ratio requirements.
Compare APRs from one lender to the next. Since this figure
includes the interest rate, points and other fees, the APR will be higher than
the interest rate and is a more accurate measure of the true cost of the loan.
Even a few tenths of a percent can equate to thousands of dollars saved over
the life of a loan.
While fixed rates don’t tend to be widely different from one
lender to the next, you may find a broader range of options on adjustable-rate
mortgages, so if you’re shopping for an ARM, pay special attention to the APR.
Virtually all FHA lenders offer fixed-rate loans, but not all
offer adjustable-rate loans.
You might find detailed closing costs on a lender’s website, or
you may need to talk to the lender’s representative or apply for a loan in
order to get a more clear picture of the lender’s costs. Since an application
does not obligate you to a loan, you may wish to apply with multiple lenders
before making a choice. Some lenders are willing to negotiate or waive certain
costs in order to gain your business.
Evaluate closing costs along with the interest rate to determine
the total cost of the loan over time. Low closing costs and a high interest
rate could cost more over time than higher closing costs and a lower interest
rate. Remember, if you roll closing costs into your loan, you will pay interest
on those costs.
Each factor is rated on a scale of zero to five. A lender with
an overall score of five is rated “among the best.” A score of four means its
rating is “better than most.” A three means “about average,” and a two means
Not every lender is included in the J.D. Power report. You
should review these and other lenders with the Better Business Bureau.
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Did you think that when you stopped renting and started owning
your, you'd finally be done with deposits? Think again. When you buy a
residence with a down payment of less than 20%, your lender may require you to
make a deposit on your homeowners insurance, private mortgage
insurance, any required additional insurance (like flood insurance) and your
An impound account (also called an escrow account,
depending on where you live) is simply an account maintained by the mortgage
company to collect insurance and tax payments that are necessary for you to
keep your home, but are not technically part of the mortgage. The lender
divides the annual cost of each type of insurance into a monthly amount and
adds it to your mortgage payment.
who make low down payments are considered to be a higher risk (smaller down
payment equals less personal stake in the property; plus, they often have less income, as well), lenders
want some level of assurance that the state will not foreclose because of non-payment of property taxes, and
that borrowers won't be without homeowners insurance in the event that the
property is damaged. An impound account ensures that the only person who will
become owner of the house in case of default will be the lender.
Even if an
impound account is not required, one can be elected at the loan signing. But is
that a good idea?
On the down
side, it's locking up money that might be better used elsewhere. Not all states
require lenders to pay interest on the funds held in impound accounts, and
those that do may not pay as much as individuals could earn by investing the
money on their own. Not surprisingly, some consumers would rather set
money aside in a high-interest savings account, or some other investment.
Further, if the mortgage
company does not pay bills – like property taxes and homeowners
insurance – when they are due, the homeowner will still be on
the hook. Therefore, homeowners should be aware of the due dates for these
payments and monitor their impound accounts carefully.
On the other
hand: Although the impound account is designed to protect the lender, it can
also be beneficial for the borrower. By paying for big-ticket housing expenses
gradually throughout the year, borrowers avoid the sticker shock of paying
large bills once or twice a year and are assured that the money to pay
those bills will be there when they need it.
Your monthly mortgage statement will probably show the balance in your
impound account, making it easy for you to keep a close eye on it. Federal
regulations also help borrowers out in this area by requiring lenders to review
borrowers' impound accounts annually to ensure that the correct amount of money
is being collected. If too little is being collected, the lender will start
asking you for more; if too much money is accumulating in the account, the
excess funds are legally required to be refunded to the borrower.
The cash amount
that fixed-rate borrowers
think of as their monthly payment is still subject to change – this is one of
the biggest issues with impound accounts. Since homeowners insurance and
property taxes can vary, monthly payment amounts can fluctuate, affecting
monthly cash flow with little
(Read "Understanding the Mortgage Payment Structure" for more
impound accounts also decrease the amount of money borrowers can place in an emergency fund.
The lender keeps a little extra in your impound account, in order to ensure the
extra cushion needed in order to keep making insurance and tax payments if you
stop making your monthly mortgage payments. This cushion is collected when you
acquire the loan. Thus, the startup costs associated with impound accounts can
increase the amount of cash buyers need in order to purchase a residence in the
need to maintain impound accounts forever, though. Once sufficient equity (often 20%) in the residence is achieved, lenders
can often be convinced to ditch the impound account.
homeowners, mortgage impounds are a necessary evil. Without them, lenders might
not be willing to give mortgages to borrowers who can afford only low down payments. The
best way to deal with impound accounts is to understand how they work, monitor
them carefully – and get rid of them when you can.