IS A 15 YEAR MORTGAGE FOR YOU?

Article courtesy of Realtor.com

mortgage3

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.

Facebooktwittergoogle_plusredditpinterestlinkedinmail

TEN QUESTIONS YOUR MORTGAGE LENDER WILL ASK YOU

Article courtesy of Realtor.com

Your lender won’t put you in an interview room and demand answers, but completing a loan application can feel like an interrogation. But you’ll sweat only if you don’t know the answers to these 10 key questions:

Mortgage Application Approved Stamp Shows Home Loan Agreed

1. Where’s your proof of income?

You should have proof of about two years’ worth of income at the ready. Come prepared with pay stubs, copies of checks, paid independent contractor invoices, and other documents that verify your employment. Be sure to disclose any other sources of income, including child support or alimony.

2. What are your assets?

Your lender wants to know about any cash reserves you have. A balanced investment portfolio demonstrates that your investment planning and goals aren’t solely pinned on a home value appreciation. They’re also resources that can be tapped in an emergency in case you need money for a mortgage payment.

3. What are your outstanding debts?

In general, the more debt you have the less likely you are to get a mortgage. More debt also means you’ll likely have to pay a higher interest rate on the money you borrow. The debt-to-income ratio limit on most mortgages is 43%.

The debt-to-income ratio measures how much of your gross (before taxes) income is used to pay housing costs, including principal, interest, taxes, insurance, mortgage insurance (if applicable), and homeowners association fees (if applicable).

Other debt, including credit cards, student loans, and car loans, will also affect your debt-to-income ratio.

4. What’s your credit score?

You should already know this, because you should have already pulled your credit report and checked it. Before you approach a lender, get your credit score in the best shape possible by paying off debts and disputing any discrepancies on your report. Even if it takes extra time, it can save you thousands of dollars over the life of a loan. Get your free credit reports from AnnualCreditReport.com.

5. Now that you are about to close, how’s your credit again?

When it’s time to close, your lender will ensure you haven’t mucked up your credit or debt-to-income ratio. Your credit report will be pulled again to make sure you haven’t opened any new credit or added new debt.

From the moment you apply for a mortgage right up until closing, don’t take on any new debt.

6. How much do you have for a down payment?

The larger your down payment, the more you will convince a lender that you take homeownership seriously and won’t walk away when times get tough. Your down payment will also determine if you can qualify for a mortgage, how much money the lender will give you, and what interest rate you’ll receive.

7. How will you use this property?

Owning a home as the occupant comes with a different set of regulations, qualifying requirements, rates, terms, and risks. If you’re buying an investment property, let your lender know up front. To get you the right loan, your lender needs to know what you plan to do with the property.

8. Are you involved in a lawsuit?

A lawsuit involving a financial judgment could affect your financial position. If you’re in this boat, you’ll have to prove why the judgment won’t harm you financially.

9. What are the details of your divorce?

If you are recently divorced, your lender will want to know about it. The lender doesn’t need to know about any of the drama that led to a divorce, only how it affected you financially.

10. What is your ethnic background?

This question isn’t discriminatory. It’s in place for federal oversight, so the government can crack down on discriminatory lenders.

Facebooktwittergoogle_plusredditpinterestlinkedinmail

HOW TO CALCULATE HOW MUCH MORTGAGE YOU CAN AFFORD

Article courtesy of Trulia.com

calculatorHow much home can I afford? It’s a funny question. Unlike buying a measured amount of rice at the market or a length of chain at Home Depot, home-buying doesn’t lend itself to measure-and-cut precision. You can specify an exact amount of lumber, glass, and carpet. You can specify bedrooms and baths. But 3BR, 2BA home in one neighborhood may be half the price of a similar home elsewhere in town.

What you can do—and must do, if you borrow from a conventional lender—is determine the maximum amount of money you’ll be able to borrow. That, combined with your down payment, will determine the highest home value you’ll be able to handle.

Lenders will look at your income compared to your debt (“debt to income ratios”). There are two ratios that are important, the front-end ratio and the backend ratio. The front end ratio is your income compared to your mortgage payment. The back-end ratio is your income compared to your total debt, that is, your mortgage, automobile payments, student loans, and other debt. Conventional loans generally use a 28/36 ratio, that is, your mortgage payment should not exceed 28% of your monthly income and your total monthly debt should not exceed 36% of your monthly income. FHA loans use a 31/43 ratio. If you get lost in the math, a good rule of thumb is that your total gross monthly income should be about three times your total monthly debt to qualify for a loan.

The best way to take into account your entire financial picture is to use one of the many good mortgage calculators available online. You can find a good home-affordability mortgage rate calculator at Trulia.

Like all good, sensible things, the limits on borrow-ability have been pushed and abused. Particularly during the real estate boom ending around 2005, some lenders would approve home loans based on ratios beyond 30 and even 40 percent. That’s how so many people got in over their heads and lost their homes.

Other factors, beyond the scope of this article, will influence loan affordability big time. Adjustable Rate Mortgages, for example, usually offer lower payments in the early years, followed by a bump upward later. ARMs represent another good idea that has been frequently abused in the recent past.

Your max loan amount is one thing. The highest home purchase amount is another. How much cash will you need to put down? That’s for your lender to decide, and it’s wise to talk to several lenders—or visit a finance site such as LendingTree.com. The answer depends on many factors. Some lenders may demand a full 20 percent down. If so, that 233,000 loan amount would have to be accompanied by more than $58,000 in cash, just to purchase a $291,000 home. It may sound scary, but prevailing standards vary a lot—between banks and with the times. Extraneous factors such as federal tax credits have at times reduced down payment demands for some borrowers to as little as 3.5 percent, and have offered $8,000 of down payment assistance

This approach to the affordability question began with your income, and adjusted for personal life circumstances such as other debts. Another way is to start with the home value and work backwards. If the price is $300,000, what sort of down payment will I need? What size loan will make the deal possible? How much income will I need to service that debt?

Facebooktwittergoogle_plusredditpinterestlinkedinmail

EXPLAINING ANNUAL PERCENTAGE RATES

Article courtesy of Trulia.com

Humans have a natural tendency to portray themselves in the best possible light. When the neighborhood kid who mows the lawn wants more money, he says his rate is lower than what the other kids are charging. When he gets together with the other kids, he brags about getting paid 20 percent more for the same amount of work.

percent

Consumer credit companies, including mortgage lenders, are no different. When they’re lending you money, they like to talk about their low APR, which stands for Annual Percentage Rate. When they’re “borrowing” your money (by selling you a CD at the bank, for instance) they advertise their generous APY, which stands for Average Percentage Yield.

APR is the term relevant to mortgage borrowers. But it’s useful to understand both, as well as a third concept—compounding.

When you’re paying a simple interest loan at a rate of, say, 12 percent per year, it’s easy to calculate its effect per month. It’s 1 percent. At that rate, a $10,000 debt balance increases by $100 each month or $1,200 each year.

Enter the “magic” of compounding. Einstein called it “the most powerful force in the universe.”

For the lender, the magic works this way. After one month, your new balance is $10,100. At that point, the lender starts charging interest not on $10,000 but on the new balance of $10,100. After a year (if you’ve made no payments) your balance is $12,268. Your simple interest rate was 12 percent but your APR worked out to 12.68 percent.

In fact, for the borrower, it’s worse than that. Lenders don’t compound monthly—most do it daily. That’s the significance of the “daily periodic rate” you see listed at the bottom of your statement. The above 12.68 percent APR becomes something like 12.74 percent. (In a periodic rate, more “periods” means more interest.)

There is more you should know about APR. InvestorWords.com defines it as “the yearly cost of a mortgage, including interest, mortgage insurance, and the origination fee (points), expressed as a percentage.”

The add-ons are man-made, not mathematical constructs. But clearly, they’re of interest to borrowers when cross-shopping loan rates between banks. Just be sure the same number of points is factored into both figures, or you’re comparing an apple to an orange.

Hey, what about APY? Again, that’s more relevant when you’re the lender. Buy a 12-month CD and the bank will advertise its great Annual Percentage Yield of 1.4 percent – which sounds a little better to you than the APR, which is 1.3-something. Hence, the magic works in your favor for once.

Facebooktwittergoogle_plusredditpinterestlinkedinmail

15 YEAR VS. 30 YEAR MORTGAGE

Article courtesy of Realtor.com

housemoneyseesaw

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.
Facebooktwittergoogle_plusredditpinterestlinkedinmail