IS A 15 YEAR MORTGAGE FOR YOU?

Article courtesy of Realtor.com

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One of the best ways to eliminate your mortgage debt is moving into a 15-year fixed-rate loan. With the average spread a full 1% compared to its 30-year counterpart, a 15-year mortgage can provide an increased rate of acceleration in paying off the biggest obligation of your life.

Can you pull it off?

In most cases, you’re going to need strong income for an approval. How much income? The old 2:1 rule applies. Switching from a 30-year mortgage to a 15-year fixed-rate loan means you’ll pay down the loan in half the amount of time, but it effectively doubles up your payment for each month of the 180-month term. Your income must support all the carrying costs associated with your home including the principal and interest payment, taxes, insurance, (private mortgage insurance, only if applicable) and any other associated carrying cost. In addition, your income will also need to support all the other consumer obligations you might have as well including cars, boats, installment loans, personal loans and any other credit obligations that contain a monthly payment.

The attractiveness of a 15-year mortgage in today’s interest rate environment has mass appeal. The 1% spread in interest rate between the 30-year mortgage and a 15-year mortgage is absolutely real and for many, the thought of being mortgage-free can be very tempting. Consider today’s average 30-year mortgage rate of around 4% on a loan of $400,000—that’s $287,487 in interest paid over 360 months. Comparing that to a 15-year mortgage over 180 months, you’ll pay a mere $97,218 in interest. That’s a shattering savings of $190,268 in interest, but there’s a catch—your monthly mortgage payment is going to be significantly higher.

Here’s how it breaks down. The 30-year mortgage in our case study pencils out to a $1,909 monthly payment covering principal and interest. Weigh that against the 15-year version of that loan, which comes to $2,762 a month in principal and interest, totaling $853 more per month, but going to principal. This is why the income piece makes or breaks the 15-year deal. Independent of your other carrying costs and other credit obligations, you’ll need to be able to show an income of $4,242 a month to offset just a principled interest payment on the 30-year fixed-rate mortgage. Alternatively, to offset the principled interest payment on the 15-year mortgage, you would need an income of $6,137 per month, essentially $1,895 per month more in income, just to be able to pay off your debt faster. As you can see, income is a large driver of debt reduction potential.

What to do if your income isn’t high enough

When your lender looks at your monthly income to qualify you for a 15-year fixed-rate loan, part of the equation is your debt load.

Lenders are going to consider the minimum payments you have on all other credit obligations in the following way. Take your total proposed new 15-year mortgage payment and add that number to the minimum payments on all of your consumer obligations and then take that number and divide it by 0.45. This is the income that you’ll need at minimum to offset a 15-year mortgage. Paying off debt can very easily reduce the amount of income you might need and/or the size of the loan you might need as there would be fewer consumer obligations handcuffing your income that could otherwise be used toward supporting a stable mortgage plan.

Can you borrow less?

Borrowing less money is a guaranteed way to keep a lid on your monthly outflow maintaining a healthy alignment with your income, housing and living expenses. Extra cash in the bank? If you have extra cash in the bank beyond your savings reserves that you don’t need for any immediate purpose, using these funds to reduce your mortgage amount could pencil very nicely in reducing the 15-year mortgage payment and interest expense paid over the life of the loan. The concept of the 15-year mortgage is “I’m going to have to hammer, bite, chew and claw my way through a higher mortgage payment in the short term in order for a brighter future.”

Can you generate cash?

If you can’t borrow less, generating cash to do so may open another door. Can you sell an asset such as stocks, or trade out of a money-market fund in order to generate the cash to rid yourself of debt faster? If yes, this is another avenue to explore.

You may also want to explore getting additional funds via selling another property. If you have another property that you’ve been planning to sell such as a previous home, any additional cash proceeds generated by selling that property (depending upon any indebtedness associated with that property) could allow you to borrow less when moving into a 15-year mortgage.

Are you an ideal match for a 15-year mortgage?

Consumers who are in a financial position to handle a higher loan payment while continuing to save money and grow their savings would be well-suited for a 15-year mortgage. The other school of thought is to refinance into a 30-year mortgage and then simply make a larger payment like you would on a 25-year, 20-year or 15-year mortgage every month. This is another fantastic way to save substantial interest over the term of the loan, since the larger-than-anticipated monthly payment you make to your lender will go to principal and you’ll owe less money in interest over the full life of the loan. As cash flow changes, so could the payments made to the loan servicer, as prepayment penalties are virtually nonexistent on bank loans.

There is an important “catch” to taking out a 15-year mortgage—you also decrease your mortgage interest tax deduction benefit. However, if you don’t need the deduction in 15 years anyway, the additional deduction removal may not be beneficial (depending on your tax situation and future income potential).

If your income is poised to rise in the future and/or your debt is planned to decrease and you want to have comfort in knowing by the time your small kids are teenagers that you’ll be mortgage-free, then a 15-year loan could be a smart move. And when your mortgage is paid off, you’ll have control of all of your income again as well.

Proximity to retirement is another factor borrowers should consider when carrying a mortgage into retirement isn’t ideal. These consumers might opt to move into a faster mortgage payoff plan than someone buying a house for the first time.

Keep in mind that to qualify for the best interest rates on a mortgage (which will have a big impact on your monthly payment), you need a great credit score as well.

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BUYING A HOME WITH LOANS FROM FRIENDS AND FAMILY

Courtesy of Realtor.com

Asking a friend or family member for a home loan can be tricky, considering the large sum of money involved. Entering into a private home loan isn’t a decision to make lightly—after all, you’ll be seeing Aunt Martha at the holidays for years to come—but your loved one might be more likely to make the loan if you explain how it will also work to his or her advantage.

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How to ask for the loan
When you approach your friend or family member for a home loan, have a plan in mind.
Thomas Fox, community outreach director at Cambridge Credit Counseling, told bankrate.com readers that borrowers should approach a private home loan the same way they would a mortgage from a bank.
“Borrowers should be realistic about what a practical repayment plan would be and not try to borrow more than they can repay. You have to treat it the same as any kind of loan and be realistic,” he says.
If this approach seems businesslike, that’s because it is. When you create a legally binding loan contract, even your mother can take you to court for missed payments—and she can win.
How private home loans are similar to traditional ones
Private home loans, also called private mortgages or intrafamily mortgages, aren’t all that different from a loan from a bank or credit union. Like institutional loans, with private home loans:
  • Both lender and borrower sign a promissory note (also known as a mortgage note) stating the terms of the agreement.
  • Your promissory note should establish the amount loaned and the interest rate, as well as the repayment dates and frequency.
  • You will draw up a mortgage (also called a deed of trust). This document gives the lender the right to foreclose on the property if you fail to stick to the repayment plan.
  • The lender holds a lien on the mortgaged property.
The arrangement legally protects the borrower as well. The lender may not foreclose on your house due to a family disagreement and can’t request repayment in full because of other financial needs. So if Aunt Martha wants to go on a cruise, she can’t demand that you foot the bill as long as you’ve been sticking to the agreed-upon repayment schedule.
Private home loans benefit borrowers
When you borrow from a friend or family member, you benefit in several ways:
  • Better interest rates. You can negotiate with your lender to determine the interest rate that works best for you. Even if that rate is lower than what you’d pay for a loan from the bank, it can still work out to the lender’s advantage – more on that below.
  • Setting your own repayment terms. When you and Aunt Martha make a contract, you can determine which repayment schedule works best for you— monthly, semi-weekly or any other. Don’t take advantage of your lender’s generosity, though: You are still legally obligated to make payments as stated in your promissory note.
  • Federal tax deductions. With a private home loan, you can still take the same tax deductions that you would with an institutional loan.
Private home loans benefit lenders
Lenders also receive benefits in a private home loan:
  • Better interest rates. Even if you and Aunt Martha agree on an interest rate that is lower than what is offered through an institutional loan, she can still come out ahead. The rate you determine could still be higher than what she earns through a savings account or other investments.
  • Regular income. With the structure provided by your promissory note’s repayment plan, Aunt Martha will know exactly when to expect your payments and how much they will be.
Missing payments with a family loan
No matter who loans the money, Aunt Martha, a bank or credit union, sometimes unforeseen life twists happen. You might lose your job or have medical bills that pile up. As with any lender, discuss the situation with the family member who loaned you the money. The options are the same as other lenders: loan modification can include lowering payments in exchange for a longer loan term, temporarily freezing payments or maybe letting some payments slide. However, dodging Aunt Martha’s calls aren’t the way to go!
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15 YEAR VS. 30 YEAR MORTGAGE

Article courtesy of Realtor.com

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It’s not always easy to think even a year or two into the future but when it comes time to apply for a mortgage we are often looking at a commitment that spans 30 years. While the 30-year loan is standard in the industry it isn’t the only option for homeowners and there may be some real advantages to having a shorter mortgage.

A 15-year mortgage will have you making higher payments for a shorter period of time as compared to making smaller monthly payments over a longer period of time. Making this decision depends a lot on where you are in your life.

There are some disadvantages for a shorter mortgage. They may also be harder to receive approval for than other mortgages. It may also be difficult to make a larger payment and it is important to continue to save for retirement and for emergencies even as you pay down your mortgage. You don’t want to rely on your home as your sole source of savings.

Below are some of the key benefits of both terms. For this exercise in order to compare apples to apples we will assume that both mortgages are fixed but there are also adjustable rate mortgage products available.

Benefits of a 30-Year Mortgage

  • Allows you to put less down and have more manageable monthly payments.
  • You may be able to buy a more expensive home because you will be paying less per month.
  • You can deduct the interest off your taxes for a longer period of time.
  • Your interest rate may be lower than it would be with a shorter mortgage.
  • Because you are paying less you have more money to devote to other savings and can diversify more easily.

Benefits of a 15-Year Mortgage

  • Your home is paid off in half the time and you end up paying less interest.
  • You accumulate equity in the home more rapidly and pay down the principal faster.
  • You may be able to finish paying before you retire.
  • Because you are gaining equity in the home faster you may be able to obtain a home equity loan if needed.
In order to make a sound choice be sure to discuss all options with your mortgage broker. Consider comparison shopping to find the lowest interest rates and the best terms.
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