Wednesday, September 21, 2022

Should I Take Out A Mortgage

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Many homeowners wonder how long they have to hold their current mortgage before theyre eligible for a cash-out refinance.

If you have a conventional, FHA, or VA mortgage, most lenders require a 6-month waiting period after closing on the first mortgage before taking out a cash-out refinance.

With FHA and VA loan programs, youre also eligible for a Streamline refinance, and youll generally need to wait for 210 days before refinancing. However, these loans do not allow cash back at closing.

A USDA refinance could require a 6-12 month waiting period, and USDA loans never allow cash-out. Read more about refinancing waiting periods.

The Lender Is Your Beneficiary

With a conventional term insurance policy, your beneficiaries are typically loved ones who get to decide what to do with the money. With mortgage protection insurance, however, the lender is typically the beneficiary, and it uses the money to pay off the debt. Theres no flexibility whatsoever.

That means your family doesnt have the option to use the coverage to pay for funeral costs or replace your lost income.

Consider Life Insurance As An Alternative

Fortunately, I didnt need to buy more life insurance to cover our mortgage because Id purchased a big enough policy when I was young and healthy.

But if youre a new homeowner and dont have life insurance, now is a good time to get some.

The best alternative is a simple level term life insurance policy, which offers consistent premiums throughout the life of the policy and no decreases in your coverage.

That means your family members will get more value and the flexibility to use the funds how they see fit. If they want to pay off the mortgage in full, they can. If they want to make monthly payments and use some of the cash for other needs, they can do that instead.

Although mortgage protection insurance letters create a sense of urgency, take a step back and consider the big picture before signing up for a policy. Shop around and compare insurance rates from several life insurance companies.

Also consider what else you want your life insurance policy to cover in case something bad happens to you. By taking into account your whole financial plan, youll know exactly what kind of policy you need to buy so your family has the protection it needs.

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Can I Pay Cash And Get A Mortgage

Most buyers put cash down and take out a mortgage. While its possible to only put 5 percent down on a conventional loan, 20 percent is recommended. This eliminates mortgage insurance and lowers your mortgage interest rate. A few more reasons to pay cash and get a mortgage:

  • Equity investment
  • You can pay off early, with no prepayment penalties
  • You can always pull equity with a cash out refinance

How To Get A Home Equity Loan

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Apply with several lenders and compare their costs, including interest rates. You can get loan estimates from several different sources, including a local loan originator, an online or national broker, or your preferred bank or credit union.

Lenders will check your credit and might require a home appraisal to firmly establish the fair market value of your property and the amount of your equity. Several weeks or more can pass before any money is available to you.

Lenders commonly look for, and base approval decisions on, a few factors. You’ll most likely have to have at least 15% to 20% equity in your property. You should have secure employmentat least as much as possibleand a solid income record even if you’ve changed jobs occasionally. You should have a debt-to-income ratio, also referred to as “housing expense ratio,” of no more than 36%, although some lenders will consider DTI ratios of up to 50%.

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Is A Mortgage Better

On the other hand, obtaining financing also has significant benefits. “Even if a buyer has the ability to pay cash for a home, it might make sense to not tie up a lot of cash to purchase real estate,” says Grabel. Doing so could limit your options if other needs arise down the road. For example, if the home turns out to need major repairs or renovations, it may be tough to obtain a home-equity loan or mortgage, as you don’t know what your will look like in the future, how much the home will then be worth, or other factors that determine approval for financing.

Selling a home bought with cash could also be a problem if the owners stretched a lot financially to buy it. “If cash buyers decide its time to sell, they need to make sure they will have sufficient cash reserves to put down as a deposit on the new home,” says Grabel.

In short, “cash buyers need to be sure to leave to leave themselves plenty of liquidity,” says Grabel. By opting to go with a mortgage, you can give yourself more financial flexibility.

Paying a mortgage can also provide tax benefits for homeowners who itemize deductions versus taking the standard deduction. And while you shouldn’t opt for a mortgage just to get a deduction, a reduced tax obligation never hurts.

Using A Home Equity Loan To Get Cash

Some homeowners choose to use a home equity loan to trade the equity that has built up in their home for cash for home improvements or other expenses. You may be able to get between 90% to 95% of the cash value of the equity by putting up your home as collateral for the second mortgage. However, you will have two mortgage payments, and you create the risk of losing your home if you fail to make payments.

An alternative is a cash-out refinance, which refinances your existing loan into a new loan and allows you to receive the difference in cash. The terms, interest rates, and payment plan for the consolidated loan will be different from the original loan, but you will not have two loans to contend with. A cash-out refinance is particularly attractive if you can secure a lower interest rate on the consolidated loan than on a second mortgage.

Of course, you may wish to forgo both options and instead preserve the equity in your home for when you retire or when you sell the home and move to a new one.

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Second Mortgage Vs Refinance: Whats The Difference

A second mortgage is different from a mortgage refinance. When you take out a second mortgage, you add an entirely new mortgage payment to your list of monthly obligations.

You must pay your original mortgage as well as another payment to the second lender. On the other hand, when you refinance, you pay off your original loan and replace it with a new set of loan terms from your original lender. You only make one payment a month with a refinance.

When your lender refinances a mortgage, they know that theres already a lien on the property, which they can take as collateral if you dont pay your loan. Lenders who take a second mortgage dont have the same guarantee.

In the event of a foreclosure, your second lender only gets paid after the first lender receives their money back. This means that if you fall far behind on your original loan payments, the second lender might not get anything at all. You may have to pay a higher interest rate on a second mortgage than a refinance because the second mortgage lender is taking on increased risk.

This leads many homeowners to choose a cash-out refinance over a second mortgage. Cash-out refinances give you a single lump sum of equity from a lender in exchange for a new, higher principal.

Learn more about the difference between a second mortgage and a refinance.

For Most Americans Including Taxes Favors Paying Down Mortgages

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Our initial analysis above doesn’t factor in the impact of taxes. A common argument about this type of analysis is the different tax treatment of stock returns and mortgage interest. Usually, you get more benefit from stocks, due to a lower tax rate for stock gains. However, recent changes in the tax code actually give an edge to the 30-year fixed for many Americans.

The Tax Cuts and Jobs Act of 2017 reduced the use of itemized deductions, such as mortgage interest, because the standard deduction increased. Now, 82% of homeowners have standard deductions large enough that the mortgage interest deduction isnt providing a tax benefit to them. Those who do benefit from deducting mortgage interest have a tax bracket of 24%.

Stocks held longer than a year are subject to long-term capital gains taxes, which, for the majority of Americans, is 15%. Heres how this might work out. Say that both mortgages and stocks have a rate of return of 10%. Tax affecting the mortgage rate at 24% would create a rate of return of 7.6% while the comparable stock return tax affected at 15% would be 8.5%.

5-YEAR S& P 500 RETURNS VERSUS 30-YEAR FIXED RATES

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  • 50%

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Mortgage Loan Insurance Premiums When You Switch Lenders

You may have to pay a new mortgage loan insurance premium when you switch lenders, if:

  • the amount of your loan increases
  • you extend the amortization period

If you already have mortgage loan insurance on your existing mortgage, tell your new lender. This may help you avoid paying mortgage loan insurance premiums twice. Ask your existing lender for a certificate number. They can provide you with a copy of the insurance certificate when you receive your mortgage contract.

You need to sign the registration documents that are part of your mortgage contract. You may have to meet with your lawyer or notary.

What Goes Into A Loan Application

Remember, you must meet certain financial standards to qualify for a mortgage. Most lenders will want to see that your monthly mortgage payment including taxes, insurance, and all other fees, does not exceed 28% of your gross or before-tax monthly income. Generally, lenders will want you to have your monthly mortgage payment and other debt payments under 36% of your gross monthly income. You may find a lender who will let you exceed this guideline if you have an excellent credit history or can make a large down payment.

Your ability to qualify for a loan will depend on the Four Cs of credit:

  • Capacity to repay the debt.
  • of how much and how often you borrow, whether you pay bills on time, and whether youre living within your means.
  • Capital, or the amount of cash you have for a down payment, settlement costs, and cash reserves.
  • Collateral to protect the lenders investment.

The language of mortgages may seem foreign at first, but you can learn to speak and understand the basic terms that your loan officer will use. Before you meet with a loan officer, refer to the glossary for definitions of these terms:

  • Adjustable rate mortgage
  • Title
  • VA loan
Before you meet with a loan officer, refer to the glossary for definitions of these terms:

Youll be able to complete a loan application quickly when you arrive with the following documents:

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How A Home Equity Line Of Credit Functions

A HELOC is a revolving line of credit that allows you to repeatedly “draw” from or borrow against your home equity.

When you open a HELOC, you will be given a set of checks or a credit card that you can use to draw the money as you need it up to the lender-approved maximum line amount over a “draw period” that lasts for a fixed term, usually 10 years. As you make payments, funds are available again in your HELOC to draw from again. A HELOC is similar to a credit card in this respect because you can continue to access the available balance as long as the line of credit is open.

When the draw period ends, you enter another fixed period of years known as the repayment period, which may last for 20 years. During this period, you must pay the balance you owe in regular payments that include the principal and interest. The interest rate on a HELOC is most often variable, which can result in payments that fluctuate from month to month. Some HELOC lenders and agreements even require you to pay the amount you borrowed in full immediately when the repayment period starts. If you don’t make payments as required, your property could go through foreclosure and your credit score could decrease.

The biggest risk of home equity loans or home equity lines of credit is that you could lose your home because you are using the equity in your home as collateral.

Using A Second Mortgage As A Down Payment

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Some people use a second mortgage to cover a down payment or even closing fees that they can’t otherwise afford. Others take out what is known as a “piggyback” second mortgage to qualify for their main mortgage and avoid paying Private Mortgage Insurance even if they don’t have enough to make a down payment of 20% on their home. For example, instead of paying 10% of the home value with a down payment and 90% of the remaining value with a mortgage that requires PMI, a borrower can qualify for a 10% down payment, 80% of the mortgage, and 10% with a piggyback second mortgage.

But a second mortgage or a piggyback second mortgage both come with higher interest rates. You could also become underwater on your mortgage. Making a down payment of 20% will allow you to avoid paying PMI, qualify for lower interest rates on the first mortgage, and start your home loan on better financial footing. More importantly, you can avoid potentially losing your home.

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Example Of How A Cash

Say the remaining balance on your current mortgage is $100,000 and your home is currently worth $300,000. In this case, you have $200,000 in home equity. Lets assume that refinancing your current mortgage means you can get a lower interest rate, and youll use the cash to renovate your kitchen and bathrooms.

Since lenders generally require you to maintain at least 20 percent equity in your home after a cash-out refinance, youll need to have at least $60,000 in home equity, or be able to borrow up to $140,000 in cash. Keep in mind youll also need to pay for closing costs like the appraisal fee, so the final amount could be less.

Be Wary Of Sales Pitches For A Reverse Mortgage

Is a reverse mortgage right for you? Only you can decide what works for your situation. A counselor from an independent government-approved housing counseling agency can help. But a salesperson isnt likely to be the best guide for what works for you. This is especially true if he or she acts like a reverse mortgage is a solution for all your problems, pushes you to take out a loan, or has ideas on how you can spend the money from a reverse mortgage.

For example, some sellers may try to sell you things like home improvement services but then suggest a reverse mortgage as an easy way to pay for them. If you decide you need home improvements, and you think a reverse mortgage is the way to pay for them, shop around before deciding on a particular seller. Your home improvement costs include not only the price of the work being done but also the costs and fees youll pay to get the reverse mortgage.

Some reverse mortgage salespeople might suggest ways to invest the money from your reverse mortgage even pressuring you to buy other financial products, like an annuity or long-term care insurance. Resist that pressure. If you buy those kinds of financial products, you could lose the money you get from your reverse mortgage. You dont have to buy any financial products, services or investment to get a reverse mortgage. In fact, in some situations, its illegal to require you to buy other products to get a reverse mortgage.

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Whats Behind The Numbers In Our How Much Can I Borrow Mortgage Calculator

When buying a home, the question How much can I borrow? should be the second question you ask. The most important consideration is, How much house can I afford? Thats because, even with all the angst involved in applying for and being approved for a home loan, lenders are often inclined to loan you more money than you expect.

Thats a surprising and important reality.

As much as you want to buy a home, lenders want to loan you money. And the bigger the loan, the happier they are. Youll know why when you see the estimate of the interest youll pay over the life of the loan. Its a really big number.

But if you know how much home you can afford, of course, youll want to learn how much you can borrow. The NerdWallet How much can I borrow? calculator can give you a solid estimate.

The calculator considers standard mortgage payment elements, such as principal and interest. Then, we take things a few steps further, factoring in taxes, insurance even homeowner association dues to help determine a real-life monthly payment.

We also examine your income and debt, just as a lender would, to determine the maximum home loan amount youre likely to qualify for.

Getting ready to buy a home? Well find you a highly rated lender in just a few minutes.

Enter your ZIP code to get started on a personalized lender match.

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