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How to Qualify for a HELOC

November 8, 2018 By JMcHood

In order to qualify for a HELOC you’ll need to meet certain qualifications. Lenders are looking for applicants with low debt-to-income ratios, solid employment histories, and other indicators of financial stability. This article will show you what it takes to qualify for a HELOC.

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HELOC Application Process

The HELOC application process is not as time-consuming as a traditional mortgage application. However, there is still a bit of paperwork to complete. You’ll need to fill out forms with the following information: your name and other personal information, the name and number of your current employer, your monthly income, and your debts.

You will need to provide documentation proving your current employment (generally a paystub and two years of W-2 forms). Your employer will receive a phone call verifying that you work where you specified. The lender will also send a professional to appraise your home – you must be available during the specified time to unlock the residence.

HELOC Underwriter Checklist – What Lenders Want from You

The underwriter reviews and evaluates your HELOC paperwork and decides whether or not to award you a loan. You cannot talk to the underwriter directly. However, your mortgage broker can answer any questions you have about your qualifications and the application requirements. In general, HELOC writers are looking for four benchmarks:

Significant Home Equity

The underwriter will compare your home’s current appraisal with the amount of money you owe on your first mortgage. Since the credit limit is based on the amount of equity in the property, most underwriters want borrowers to have at least 80% loan-to-value on their home (i.e. you have either paid off 20% of your mortgage or your home’s value has increased 20% since the time of purchase).

Low debt-to-income ratio

To make sure you will be able to afford the payments on your HELOC, the underwriter will compare your monthly debts to your monthly income. When you add your mortgage payment, potential HELOC payment, loan interest payment, property taxes, homeowner’s insurance, and mortgage insurance, the monthly total should not be more than 28% of your pre-tax income. When you add all these housing-related expenses to your other financial obligations such as credit card payments, car loans, student loans, child support, and alimony, the total should not be more than 36%.

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Solid Employment History

The underwriter wants to make sure you will continue to be employed through the life of the loan. He will look over your W-2 forms, double-check your pay stub, and will verify your current employment. If you have been employed in your industry for less than 2 years, you may be asked to provide additional employment information.

How High Will Your HELOC Credit Limit Be?

Because HELOC loans use property as collateral, your credit limit will be determined by the equity in your home. The limit is set by subtracting the balance you owe on your first mortgage by a percentage of the appraised value of your home (generally about 80%).

HELOC Fees: Application Fees and Other Costs

Many lenders will give you a HELOC with no upfront cost. If they do charge an application fee, make sure that it is refundable at the close of the loan. It is common for lenders to charge a HELOC cancellation fee of several hundred dollars if the line is closed early. You may want to ask for this fee to be waived – especially if you plan on moving or refinancing the loan.

Can’t Qualify for a HELOC?

Keep in mind that the above qualifications are only guidelines. You may still be able to take out a HELOC, even if you do not meet the qualifications to a “T.”

Check with your lender. Even if you cannot qualify for a traditional HELOC, you may be able to take out a no-income-no-asset or hard money home equity loan.

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What is a HELOC Account?

August 23, 2018 By JMcHood

A HELOC account, or Home Equity Line of Credit account, is where your money from your second mortgage sits. The HELOC is unique because it does not give you a lump sum of money. For example, let’s say you took out $50,000 as a HELOC. You do not receive that $50,000 at one time. It sits in an account that you can withdraw from. Think of it like a checking account with the rights of a credit card. You can write a check or use a designated ATM card to retrieve the funds, like a checking account. But, you can reuse the funds as you can on a credit card. Once you use funds and pay the back, they are available again. This goes on until your draw period ends.

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Paying the Funds Back

Unlike a standard second mortgage, you only have to pay interest on the funds you borrow. This is the case throughout the draw period. Typically, home equity loans allow you to draw funds for the first 10 years. At the end of those 10 years, you enter the repayment period. At this point, the account closes and you cannot draw funds anymore. The payments you make during the repayment period cover the principal and interest amortized over the rest of the term. This usually means for the next 20 years.

The Interest Rate

The interest rate on a HELOC account also works differently than a standard loan. More often than not, it is a variable interest rate. There are several indexes the rate may coincide with and each loan has its own margin. The lender will tell you the index for your rate as well as the specific margin. The most common index used is the prime rate. This rate can change from month to month. What does not change is your index, though. For example, if your margin is 2%, it remains 2% for the entire draw period. The lender then adds 2% to the prime rate each month to calculate your interest rate.

You should always know the caps on your interest rate. Every lender sets a cap before you close on the loan. This helps limit the amount your interest rate changes. There is a periodic and lifetime cap. The periodic cap limits how much the rate can change each month. For example, if the cap is 1%, your rate cannot increase or decrease more than 1% any given month. The lifetime cap determines how much the interest rate can increase or decrease over the life of the loan. This cap is usually much higher than the periodic cap.

How to Use a HELOC Account

People use a HELOC account many different ways. The most common is for home improvements. It just makes sense to tap into the equity of your home in order to improve it. You see an instant return on your investment this way. Borrowers who use the funds to fix up their home draw the funds out as they need them. Whether they do the work themselves and need the funds to purchase the supplies or they hire contractors, the money is there to use as they need.

Other uses for HELOC funds include:

  • Emergency fund for car, medical, or house emergencies
  • College tuition
  • Weddings
  • Dream vacations
  • Large purchases

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Some people prefer using a HELOC for purchasing a car or paying for a wedding because the rates are often low. Plus, you might be able to write off a portion of the interest you pay on the loan on your taxes. Keep in mind, though, you will not see any return on your investment when you use the funds for something other than your home.

Making Sure you can Afford a HELOC

A HELOC account might seem like a great idea at first. You have funds at your disposal, as you need them. You only need to secure approval once and you can reuse the funds over the next 10 years. However, you should keep in mind that the payments change. If you have fixed income or cannot deal with fluctuating bills, this might not be the right account for you. Look at the worst-case scenario – the highest your rate can go. Can you afford the payment that coincides with that rate? If you cannot see yourself affording that payment, do not take the HELOC as that payment could become reality – there is no way to predict it.

Applying for a HELOC

There are many lenders you can apply for a HELOC with, but starting with your current lender or bank may help. They often provide current customers with a discounted rate in order to keep them coming back. You should also shop around with different lenders, though, so you can see what is available out there. Many lenders have a maximum amount you can borrow as well as a maximum loan-to-value they allow. In most cases, this equals 85% of the value of your home. Make sure you have the equity and that your credit is in good condition before you apply. A second loan is risky for any lender as it is in second lien position. If you default on your loan in the future, the second lienholder is the last to get paid. They usually do not get paid at all in this case.

If you want a HELOC account, make sure you shop for the most favorable terms. Interest rates are often low to start, but increase over time. Make sure you can afford the payments and that you need the money. If it is for frivolous purchases, rethink your decision. If, however, you want to reinvest in your home in order to make a profit, this can be a very profitable way to make the changes you need. Talk to your lender about your options and apply for your HELOC today.

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What to Do if You’re Rejected for a Home Loan

July 26, 2018 By JMcHood

Applying for and being rejected for a home loan isn’t a good feeling, but it doesn’t have to be the end of the road for your potential home-ownership. If you take the right steps, you can try again in the near future.

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Follow these steps if you find yourself in this situation.

Get Information

If a bank or lender turns you down for a loan, they have to give you a reason. If you don’t understand the reason provided, ask for more specifics. If it has anything to do with your credit, they have to send you a letter stating the reasons for the denial. If it was to do with anything besides your credit, most loan officers will happily walk you through the reasons that you were denied.

Once you have the reasons, it’s time to take action. You are armed with information on what is wrong with your application, now you can take the steps to fix those issues.

Fix Your Credit for Your Home Loan Application

Did your loan officer tell you that your credit was the issue? Following are the most common credit issues:

  • Low credit score – If your credit score is too low, it’s time to pull your credit report and found out why. The letter your lender sends you will explain how you can receive a free copy of your credit report because you were turned down for a home loan due to a credit issue. Get a copy of your report and look for the reason for the low credit score. Was it late payments? Did you charge too much on your credit cards? Do you have too many inquiries?
  • Not enough credit – If you only have a few trade lines and they aren’t currently active, a lender may not be able to make a lending decision. You’ll need to build your credit up by applying for a few credit cards and using them. Don’t take this as permission to go out and go on a spending spree, though. Instead, charge what you normally purchase and pay cash for, then pay the bill off in full each month. This will establish good spending patterns and help you build up your credit.
  • Too many inquiries – Inquiries are a red flag for lenders because they could indicate that you have new credit out there that hasn’t reported yet. You may just have to wait it out a few months to prove that you don’t have any new credit lines (if you don’t) or let the new credit lines report on your credit report for the lender to get an accurate credit score and debt ratio calculation.
  • Negative economic events – If you recently had a bankruptcy or foreclosure, you may not have let enough time pass. Each loan program has a specific waiting period. Ask the lender how long you need to wait. In the meantime, keep improving your credit score to enhance your chances of approval the next time you apply.

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Deal With Low Income

If the lender decided you don’t make enough money, they could turn down your application. While you might think there’s no way to fix this issue, there are a few simple ways.

  • Take a side gig – Do you have a skill that you could turn into a side job? Whether you offer physical services, such as electrician work, plumbing, or painting or you do something on the internet, such as writing, crafting, or a virtual assistant, there are many ways to make money on the side. You’ll have to have the job for at least 2 years before you can use the income for qualification purposes. If that’s too long, you can use the extra money to pay down your debts and lower your debt ratio to help your chances of approval sooner.
  • Get a cosigner – If you have a willing cosigner that has good credit, they can help you get approved for a home loan. Make sure it’s someone that is willing to take the obligation of paying the mortgage should you stop paying it. This is a large risk on the cosigner’s part, so make sure there is a clear understanding between both of you.

Deal With Your Debts

Did the lender tell you that you are straddled with too many debts? It’s time to work on them before you apply for another mortgage.

  • Pay the debts down – It’s time to set up a strict budget to get your debts paid down. If you don’t have extra money lying around, take a second job or side gig to boost your income. Then use that extra money to pay your debts down.
  • Apply for a lesser loan amount – If it was the housing ratio that was the issue, it might be time to look for a less expensive home. If your credit score was fine and your income is stable, consider a lower sales price, which means a lower monthly payment.

Increase Your Down Payment on the Home Loan

Sometimes it’s just about the amount of collateral you give the lender. If you borrow a large percentage of the sales price, the lender may see it as too high of a risk. Increasing your down payment can minimize that risk. This could take time though, since you’ll have to save money. Using some of the above strategies, such as paying down your debt or taking on extra work can help you save money faster. In some cases, you may even be able to secure gift money for the down payment from family or your employer. Most loan programs allow the use of gift funds to help boost the equity you have in the home and the collateral the bank has to rely on if you default.

Getting turned down for a home loan isn’t fun, but there are ways to overcome it. Use these tips to improve your chances of approval and get the loan that you want to buy your next home.

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How Does a Lender Credit Help You?

March 6, 2018 By JMcHood

You’ve found your dream house and have just enough money to put down on it. After you apply for the mortgage, though, you find out you have closing costs that go beyond the money you have saved. Do you lose your dream house now?

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Luckily, there is an answer. It’s called the lender credit. It’s the lender’s way of helping you pay the closing costs. Is there a catch? Kind of, but it’s not a big deal.

We’ll discuss how the process works below.

What is a Lender Credit?

First, let’s look at the lender credit. It’s a credit the lender gives you as a line item on your Settlement Statement. Let’s say your closing costs, including all lender and 3rd party charges total $5,000. The lender may issue you a $5,000 credit. This lowers your bottom line and what you must bring to the closing.

What’s the Catch?

Of course, there’s a catch. Lenders are in business to make money. They aren’t just going to give the mortgage away. If you opt for a lender credit, they will increase your interest rate. The good news is that it usually isn’t by very much. On average, lenders increase your rate 0.25%. Of course, this varies by lender. You may find some that increase it as much as 0.5%.

But, let’s look at how much of a difference this makes in your payment. Let’s say you need a $200,000 loan. A 4% rate would give you a $955 principal and interest payment. If you opted for the lender credit and took a 4.5% rate, your principal and interest would equal $1,013. That’s a difference of $58 per month. This means $696 per year. It would take 7 years before you would pay $5,000.

Does it Make Sense?

No, we need to determine if it makes sense to take the lender credit and pay the higher rate. In our above example, it would take 7 years before you started paying more than the $5,000. If you know you’ll move before 7 years passes, you’ll benefit from the lender credit. You don’t pay the closing costs and you’ll get away paying less in the long run because you’ll move.

Even if you won’t move, you might refinance. If you do so within 7 years, you’ll make out on the deal. You won’t pay as much as $5,000. Of course, if you refinance, you are looking at paying closing costs on the new loan, so you’ll have a new decision to make.

What happens if you plan to stay in the home for the next 30 years, though? At that point, the higher interest rate may not make sense. But, you have to look at the big picture. Just how much will a 4% rate cost you in interest over the life of the loan?

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Over 30 years, you would pay $143,739 in interest. On the 4.5% rate, you would pay $164,813 in interest. Over the life of the loan, you would pay $21,074 more in interest with the higher rate. This goes to show that if this is your long-term home, you may want to come up with the money for the closing costs.

Paying for Closing Costs Without a Lender credit

What if you don’t have the money for the closing costs? Are you stuck paying the thousands of dollars in interest for the next 30 years? The good news is that you have options. Many loan programs including conventional, FHA, VA, and USDA allow you to accept gift money. This is money you receive from a relative, employer, or charitable organization.

The key word here, however, is gift. This money cannot be a loan. A friend cannot loan you the $5,000 for the closing costs and expect repayment in 2 years, for example. The lender will ask for proof that it is not a loan. This is usually done with a Gift Letter. This letter must state the reason for the gift (purchasing a home), the amount, the date, and that repayment is not expected.

The lender doesn’t stop there, though. They will also want to source the funds. In other words, they will track where the money originates. They’ll need to see proof that the donor took the funds out of their own account and that you deposited them in your account. The lender may ask for proof of where the donor got the funds if there is a large deposit in their bank account in the last few months. The lender just needs to confirm that the money truly is a gift and that a loan doesn’t exist somewhere.

If the money is a loan, the lender would have to include it in your debt ratio. This could ruin your chances of mortgage approval if you are close to the maximum.

Negotiating the Lender Credit

Of course, you don’t have to take the lender’s offer at face value. Let’s say they offer you a ‘no closing cost loan’ in exchange for a 0.5% higher rate. If that’s not acceptable to you, try negotiating. You can also shop around. This gives you more negotiating power. If you tell the lender you are shopping around, they may lower your rate just to keep your business. A lower rate is better than no business.

If a lender won’t lower your rate, see what other lenders have to offer. Don’t accept a rate you are not sure you can afford, especially if you don’t think you’ll refinance in the future.

A lender credit can be very helpful, but you must determine your total cost for the loan. Don’t assume because the lender pays your closing costs that it’s the best deal available. Sometimes paying the closing costs is the cheaper option in the long run. Once you determine the best choice for you, you’ll have a loan you can afford and lower your risk of default.

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Are Tax Returns and Tax Transcripts Necessary?

February 27, 2018 By JMcHood

 

Requesting transcripts of your tax returns was a common policy for self-employed borrowers before the housing crisis. Today, however, lenders almost always request a transcript to verify your taxes, whether you are self-employed or not.

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Why Lenders Request Transcripts of your Tax Returns

Requesting the transcripts of your tax returns helps lenders verify the information you provided them. It shows that the returns you provided were not altered in any way. In other words, the information you gave the lender is exactly what you gave the IRS.

What is a Tax Transcript?

The tax transcript is not an identical print of your tax returns. Instead, it’s a line item document that shows the same (hopefully) numbers you provided on your tax return. The transcripts do not contain all of the schedules you have on your tax returns, but it will provide the numbers on those schedules. This is what the lender needs.

How Lenders Get Your Tax Transcript

In order for the lender to order your tax transcript, you must sign Form 4506-T. This allows the lender access to your tax transcript. They send the signed document to the IRS who then sends the lender your tax returns within a few weeks. It’s customary to sign the transcript form right away after accepting a lender’s offer so the transcript does not hold up your loan’s processing.

Why Tax Returns Matter

You might wonder why a lender even needs your tax returns. Isn’t paystubs or a P&L from your business enough? Tax returns just provide lenders with more proof of your income. It shows that what you say you claimed on your taxes is truly what you claimed. However, there’s another reason.

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Lenders often request tax returns from borrowers that own their own business or work on commission. These borrowers often claim many expenses on their taxes. These expenses take away from their gross income. The lender can only use the net income you claim on your taxes. So your tax return income may not match the income on your paystubs or P&L. The lender can only use the income on your taxes, though, which may hurt you.

As far as a layer of protection, though, the lender matches the tax returns with your other proof of income. If there is some type of inaccuracy, the lender will start investing the reason. They may come directly to you for an explanation or they may do some verifying on their own. It could greatly delay the underwriting process, so it pays to make sure everything matches before applying for a loan.

If you own your own business, the lender will need to verify that there isn’t a business loss that you tried hiding with your income documents. This is why they use the net income from your tax returns, rather than the documents you provide. If there is a net loss, the lender must use this for qualifying purposes, which could harm your chances of approval. They do add back certain expenses, though, such as depreciation.

One last reason lenders care about your tax returns is to see if you owe the IRS money. This isn’t a deal breaker if you do; however, there are rules. If you owe money, you either have to pay it in full or have a payment arrangement set up. If you have the payment arrangement, you’ll also have to prove that you make your payments on time. There isn’t a specific amount of time you must have the arrangement, but the longer history you can show, the better off you’ll be.

Your tax returns play an important role in your ability to secure a loan. Make sure you provide the ‘real’ returns along with a signed 4506T so that the lender can get the process rolling right away.

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Reserves and Mortgages: How Much Do You Need to Qualify for a Loan?

February 8, 2018 By Justin

What happens after closing? You start making your mortgage payments, pay your property charges, and so on. Do you have enough funds to cover these expenses in case something unexpected happens? These “leftover funds” are called financial reserves.

Lenders will look into these funds to determine if you have enough set aside before they approve your mortgage. As to the minimum level of reserves required, that will depend primarily on your loan type, property, and borrower profile.

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What Are Reserves?

Reserves are assets that are available to you post-mortgage closing. By available, these assets must be readily convertible to cash for your use, per Fannie Mae, who together with Freddie Mac, is the largest purchaser of mortgages in the secondary market.

To make them more relatable, think of these funds as x months’ worth of your total housing expenses as represented by PITI or PITIA:

  • Principal
  • Interest
  • Taxes
  • Insurance (homeowners insurance, mortgage insurance)
  • Homeowners association dues, other assessments

While they are not as popularly discussed as down payment and closing costs, reserves are an important aspect of your mortgage that you should prepare for, save up if you must.

Eligible or Not Eligible Assets for Reserves

Not all assets are eligible to be considered as reserves. Aside from being liquid assets, they must be redeemed/vested, taken from personal bank accounts, or derived from the sale of an asset.

Aside from cash, these are acceptable sources of reserve funds:

(i) savings/checking accounts, (ii) stocks, bonds, certificates of deposits, trust accounts, or any investments, (iii) the portion of the retirement savings account that has vested, and (iv) the cash value of a vested life insurance policy.

As to retirement accounts, not all of the whole vested amount will be considered, e.g. 70% of 401(k), IRA and other related accounts’ vested value.

Stock units become unacceptable if they are from a company or corporation not listed with the SEC. This applies to stock options and restricted stock units that have not vested.

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You can’t also use personal unsecured loans or proceeds from cash-out refinance for your reserve funds.

This is why lenders verify assets for reserve requirements (although this asset verification applies to down payment and closing costs) to ensure that the borrower has funds safely tucked in and that these funds are not illegally sourced or additionally burdensome to the borrower.

How Much Do You Need for Your Reserves?

Your minimum reserve requirement rests on a combination of various factors. But a good starting point would be the property type, i.e. its occupancy status and the number of units.

From there, you can look up what each loan type’s reserve requirement is:

  • FHA loans: This loan program does not have a reserve requirement on one-to-two properties. But for borrowers with non-traditional credit or those requiring manual underwriting, one month of reserves is required. On three-to-four unit properties, reserves worth three months of PITI are required.
  • VA loans: Just like FHA loans, these loans for military personnel require (i) no reserves on one-to-two unit properties and (ii) six months’ reserves on three-to-four unit properties. The borrower also pays additional three months of reserves for every rental property he or she owns.
  • USDA loans: Although these government-guaranteed loans don’t really require cash reserves after closing, having two months of reserves can be a compensating factor.
  • Conforming Loans: The reserve requirements for Fannie Mae take into account the transaction type, the property’s number of units, the borrower’s credit score and LTV, and debt-to-income ratio, the type of underwriting (DU or manual). This is an example of Freddie Mac’s reserve requirements matrix.
  • Jumbo Loans: Reserves on those loans can be equal to three months, although they can go higher depending on the size of the loan.

Indeed, buying a home goes beyond closing. There’s your house to take care of after the transaction closes. Despite reserves being a requirement, it’s wise to have funds set aside for your home.

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What Is a Mortgage Rate Lock, Today’s Mortgage Borrowers Ask

October 17, 2017 By Justin

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Interest rate

Before finding out when’s the best time to lock, you might want to understand what a mortgage rate lock is all about. It’s a practice among mortgage borrowers, be it refinancers or homebuyers, ensuring they’ll get their desired rate even when mortgage rates head higher.

If you are keen on keeping your mortgage costs at realistic levels by keeping your rate low, getting a mortgage rate lock might be your best option. So, let’s unlock the important points surrounding the mortgage rate lock.

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A Mortgage Rate Lock Is

Mortgage rate locks protect borrowers against one of the most variable, ever-changing elements in the world of mortgages: interest rates.

By doing a rate lock, you get a guarantee from a lender that it will give you a certain interest rate and corresponding points for a certain period. This stipulated period, or rate lock period, can be as short as 30 days or as long as 60 days.

In exchange for “reserving” this combination of rate and points, you pay the lender a fee. The rule of thumb is for you to hold onto your rate until such time as you close the loan.

Do remember that the longer the rate lock period, the higher the fee. When you extend this period or when it expires, you have to pay an extension fee.

More recently, Wells Fargo was in the news over extension fees that it charged clients, totaling $98 million. The bank apparently charged mortgage borrowers when it was not their fault that the rate lock expired because of delays from their end, according to CNN Money.

Wells Fargo did promise to refund the mortgage rate lock extension fees it collected from September 2013 to February 2017 as per the report.

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Lock or Float

Rates move many times in a day. No one can predict rates but projections and preparations can be made.

That’s why mortgage experts advise their clients to lock (or float) their rate pending important events that could influence rates to go higher. Examples of these events are meetings of the Federal Reserve’s Federal Open Market Committee that could herald rate hikes, and economic indicators such as job reports and consumer price index.

Locking in on a rate is basically for your peace of mind, especially if rates are trending upward. But if you think rates are bound to go lower, as they are historically now, and are savvy about markets, you can choose to float your rate.

Is It Now or Later

Before you lock in on a rate, be sure you have gone around and compared a number of lenders’ offers. If you have found your desired rate, lock it and time it with your estimated closing date.

Just what if rates will drop tomorrow? Well, you can probably do a let’s-wait-and-see stance. But this could be complicated if you are moving along a mortgage schedule and rates are fluctuating by the day.

You can also consider paying discount points to lower your rate. A point is equivalent to one percent of your loan amount. While you can get a lower rate, your mortgage costs will go up.

Mortgage rates are volatile creatures, nothing can change that. But you can pin one down while you wait for your mortgage to close. Just make sure it makes sense, number-wise.

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Should You Pay Points on Your Mortgage?

September 4, 2017 By JMcHood

Handing house keys

Most people think paying points is bad. While it does add to your closing costs, there are times it is warranted. Understanding how the fees work and why you would pay them can help you make the right decision.

Some borrowers do not have a choice – without an origination fee, they would not get a loan. It’s the lender’s way of making sure they make money.

Sometimes, though, lenders charge discount points. This fee helps lower your interest rate. Not every borrower should pay it. Let’s look at when and how you should make this decision.

Paying Discount Points May Help you Save Money

It sounds counterintuitive. You pay higher fees to save money. But it works. The more you pay the lender now, the less you will pay in interest over the life of the loan.

Think of it as a one-time fee versus a 30-year fee. Of course, you will still pay interest. It just will not be as much.

If you plan on living in your home for a long time, it may make sense to get the lower interest rate. If you are unsure, look at the total interest costs over the life of the loan for both rates. You will likely see a several thousand-dollar difference.

You May Save on Refinancing Fees

Refinancing costs money. The closing costs you are about to pay on your mortgage you will pay again.

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Does paying another 3-5% of your loan amount sound good? If not, consider buying the rate down now. Discount points can help you secure an interest rate you will keep.

Without the need to refinance, you save more money down the road. An exception, of course, is if you need to tap into the equity of your home.

You Can Lower Your Debt Ratio

Borrowers who have a borderline debt ratio often benefit from paying points. Imagine your debt ratio is 44%. You are applying for an FHA loan. The maximum allowed is 43%. That measly 1% could leave you without a mortgage approval.

If you have extra cash lying around, though, you may be able to pay points and bring your rate down. This brings your mortgage payment down. Like a domino effect, your debt ratio decreases too. Suddenly, you may have a mortgage approval.

Discount Points Provide a Tax Deduction

Do not forget when you file your taxes, you may be able to deduct the points you paid. You are only eligible to do this during the year you pay the points, though.

In other words, you can’t carry the deduction over into future years. Talk to your tax advisor before paying the points to see if you would be eligible. Every deduction can help you lower your tax liability.

When It’s not Smart to Pay Discount Points

This doesn’t mean it’s always the right idea to pay points on a mortgage. The following situations usually don’t warrant the extra fee:

  • You know you will live in the house for a short period. Paying the higher interest rate for a short amount of time usually costs less. Of course, you should do the math to make sure you come out ahead.
  • You don’t have the extra money after making your down payment. Stretching yourself thin before you move into your home isn’t a good idea. If you have just enough for the down payment and basic closing costs, take the higher rate. You’ll need extra money for moving costs and getting established in your new home.
  • The cost savings isn’t worth it. Every lender charges their own points and decides the appropriate rate reduction. If you do not feel like prepaying the interest upfront with discount points is worth it, don’t do it. You can always make extra payments down the road. This may knock a few years off your payments and thousands of dollars off your interest paid.

The bottom line is paying points is a personal decision. No two borrowers will have the same decision. Take into consideration the money you have saved, your debt ratio, and your plans for the home.

Ask lenders to provide you with quotes for both loans with a discount point or two and without.

Once you have both quotes, you can look at the big picture. Compare the amortization tables and the total amount of interest paid. Also, look at the APR. This will give you a better idea of the full cost of the loan over its entirety. Only then can you make the right decision for yourself.

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What Makes a Jumbo Loan Different From Other Loans?

June 26, 2017 By JMcHood

A jumbo loan is any mortgage with a balance higher than the standard conforming amount. Today, this means any loan higher than $424,100. That’s the maximum loan amount for a standard, conforming loan. It’s also the maximum for many government-backed loans. Anything beyond that requires a different loan program. Generally, it means a private lender must fund the loan. If you are in this situation, you should know what to expect.

Tougher Underwriting Guidelines

It makes sense – you borrow more, you undergo more scrutiny. There’s more to the story, though. Fannie Mae probably won’t buy the jumbo loan. Instead, a private lender sells it to individual investors in the market. Sometimes investors can be hard to find, especially if the loan is risky. Rather than take a chance, lenders tighten the guidelines for loans over $424,100.

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Higher Credit Scores

Your credit score plays a large role in the jumbo loan process. If you have a score lower than 740, expect some level of resistance. A score of 740 or higher shows lenders you are financially responsible. You probably don’t have any late payments in the last few years. You also probably manage your credit with ease. You don’t overextend yourself and you make your payments on time. These habits get you further with lenders. They see you are able to handle your finances and are more likely to loan you a large mortgage loan.

Lower Debt Ratio

There aren’t maximum debt ratios set in stone for the jumbo mortgage. Again, it’s up to each lender. Usually, lower debt ratios mean a higher chance of approval, though. Don’t assume your low debt ratio is enough, though. Lenders also like to see ample discretionary income. This means you have money left after you pay your monthly bills. This allows you to live comfortably. It may also allow you to build up an emergency fund. You can then rely on these funds during a financial emergency or if you lost your income.

Higher Amount of Reserves

Reserves are money set aside to pay your mortgage should your income stop. Lenders count the reserves based on how many months of payments they cover. Here’s an example:

  • Monthly mortgage payment with taxes and insurance = $2,500
  • Amount of savings = $10,000

You have 4 months of reserves on hand because $10,000 covers 4 months’ worth of payments. The more reserves you have, the higher your chances of approval on a jumbo loan.

Higher Down Payment

It’s not enough to have reserves, though. You also need a high down payment. You probably won’t find lenders willing to loan 95% of the value of a home on a jumbo loan. Instead, you should aim for a down payment of at least 20%. This gives you a significant investment in the home. For example, let’s say you purchase a $500,000 home. If you put down 20%, it equals $100,000. That’s a lot of money. Chances are you will do what you can to make sure you stay on time with your mortgage payments.

Lenders call this “skin in the game.” The more of your own money you have invested, the better chances you have of approval. It shows the lender that you are invested in the real estate. You aren’t just taking out a large loan only to walk away from the investment shortly thereafter. Expensive homes are often harder for banks to sell off in foreclosure. They use the higher down payment as “insurance.”

More Scrutiny of Your Income

You’ll need a solid 2-year employment/income history for a jumbo loan. Lenders will need plenty of documentation regarding your income. For example, if you are self-employed, you’ll need at least 2 years of tax returns. The returns should show not only a profit, but a steady increase from the previous year. If your income declined from one year to the next, qualifying may be difficult. It could show the lender a downward trend, which they don’t want to risk with such a large loan.

Your income should be straightforward too. Income that you can’t fully verify with the exception of your bank statements won’t suffice. Lenders need to see that you receive the income consistently and that it will continue. Just looking at bank statements doesn’t show lenders any details of your income. The more details you can provide, the better.

Alternatives to the Jumbo Loan

There is a way to get around the need for a jumbo loan. If your loan amount is slightly higher than the conforming limit, you can take out 2 loans. The first mortgage would maximize the conforming limit of $424,100. The 2nd would be a home equity loan for the remainder of the amount you need. Of course, this only works if you aren’t buying a home worth millions. This method helps reduce the scrutiny on your loan. It may also help you secure a lower interest rate because conforming rates are often lower than jumbo rates. Even adding a slightly higher home equity rate often averages lower than the jumbo rates.

If you need a jumbo loan, take time to prepare your financial situation. Save as much as you can for the down payment as well as for reserves. Make sure your income is consistent and verifiable as possible. Also pay down your debts as much as you can.

Preparing for a jumbo loan may take more time than it would for a conforming loan. It pays off in the end, though. These loans are much riskier for lenders. They need low-risk borrowers for these loans. It’s especially important if they sell them on the secondary market. While the real estate market has improved, there’s still a sense of worry. This causes lenders/investors to tighten restrictions. You increase your chances of approval with every compensating factor.

As always, shop around with different lenders too. Because this is not a program any government agency purchases or guarantees, each lender has their own program. You may find lenders with completely different options for you. Find the deal that works the best for you not only today, but well into the future as well.

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How to Trim Your Mortgage Closing Costs

June 5, 2017 By JMcHood

Closing costs can keep families away from a mortgage. They cost anywhere from 2-5% of your loan amount. On a $200,000 loan, this means between $4,000 and $10,000! This is in addition to your down payment. There are ways you can lower these costs, though. Below we provide simple tips to make this possible.

Know What You Pay

You must know what you pay. Don’t take a lender’s word for it. Read the Loan Estimate closely. Any lender processing your application must provide this document within 3 business days. It shows you the breakdown of the costs of the loan. Read them carefully. If you don’t understand a cost, ask the lender.

Keep in mind, some lenders lump closing costs into one fee. For example, a loan origination fee could be 2% of your loan amount. On a $200,000 loan, this means $4,000. This usually doesn’t include third-party charges, such as title fees, attorney fees, and appraisal costs. Ask for a breakdown of the fees before assuming you can afford any loan. There may be additional fees you don’t realize.

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Shop Around

Shopping around for the best mortgage is completely acceptable. You won’t ruin your credit by doing so. Just make sure you do it within a 2 to 3-week period. This way you can compare several loan estimates. This gives you a better idea of the normal costs for the area. If one lender has extraordinary costs while another doesn’t, something is off. Look at the big picture and determine which loan is right for you.

Know What Closing Costs You Can Negotiate

Certain closing costs are non-negotiable. Third parties provide the services and have fixed costs. A few examples include appraisal, title, and credit reporting fees. But, you can often negotiate lender fees. A few examples include:

  • Origination fees
  • Discount points
  • Underwriting
  • Document prep fees
  • Processing fees

In rare cases, you can negotiate your title fees or appraisal costs. You must provide your own title company or appraiser, though. If the fees the companies the lender uses are too high, consider negotiating the use of your own provider. Not all lenders allow this, though.

Take a Higher Interest Rate

This option doesn’t eliminate closing costs, but it eliminates the cash you need. Some lenders offer a no-closing-cost loan. In name, it sounds like you don’t pay closing costs. However, you pay them with a higher interest rate. Let’s say a lender offers a 0.5% higher interest rate in exchange for no closing costs. You then pay a higher payment every month. The lender still makes the same amount of money; it’s just spread over the life of the loan.

This situation may or may not make sense for you. Let’s look at an example:

Let’s say you borrow $200,000. With Lender A, you pay the closing costs yourself. It costs you $4,000 out of your own pocket, plus the money you put down on the home. The lender quotes you a 4% interest rate. This gives you a monthly payment of $955 for principal and interest.

Lender B quotes you a 4.75% interest rate with no closing costs. The only money you need at the closing is your down payment. Your monthly payment equals $1,043 for principal and interest.

This is a difference of $88 per month, $1,056 per year, and $31,680 over the life of the loan. That’s a big difference! The $4,000 in closing costs suddenly doesn’t seem too high.

When this might make a difference, though, is for borrowers buying for the short-term. If you move within 3 years, you make out on the deal. In this case, you only pay $3,168 extra in interest. This is less than the $4,000 closing costs. Plus, you didn’t have to come up with a large sum of money at the closing.

Every situation is different. It depends on your plans and what you can afford.

Ask the Seller to Pay

In some cases, sellers will pay closing costs. They probably won’t pay 100% of the costs, but every little bit helps. As a part of your sales contract, try negotiating a seller contribution. The seller can pay specific costs or a percentage of the sales price. It’s up to you and the seller. Some sellers are more than willing to contribute if it means they can sell their home. However, in a hot market, many sellers won’t pay the closing costs. Let’s say there are three bids on the home for the same amount. The seller will likely pick the bidder that doesn’t want their closing costs paid for them. It just makes sense. You can gauge the market and demand for a certain home before taking this avenue.

Wrap the Costs Into the Loan

A final strategy, which should be a last resort, is wrapping the closing costs into the loan. There are two ways to do this.

  • Some loan programs allow you to wrap the closing costs into the loan, such as FHA loans. If the agreed upon sales price is lower than the home’s value, you may add the closing costs into the loan. You can’t exceed 96.5% of the value of the home, though.
  • Ask the seller to pay the closing costs in exchange for a higher sales price. As long as the value of the home supports the price, this can work. Rather than paying the closing costs out of pocket, you wrap them into the loan.

Keep in mind, wrapping closing costs into a loan can get more expensive. The longer you borrow the money, the more interest you pay. If you know this is a short-term purchase, this option can work. If this is your “forever home” though, you may consider other options.

Trimming your closing costs down isn’t impossible, but it does take some work. Make sure you fully understand closing costs and what you pay. Shop around with various lenders and see what options you have. Once you know your options, you can then decide which process works the best for you. Talk to your lender to see what help they may offer as well. Seeing your options all in one place can help you make the right decision.

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