Should I rent or own my home?
Before you even begin the shopping process, the first question you may ask yourself is, on the surface, quite basic: Does it make sense for you to buy your home?
- A place to hang your hat…and own the hook it hangs from. Let’s start with the basics. Owning your own place gives you peace of mind. If you are ready to settle down in your community, you’ll enjoy the established feeling of ownership.
- Establishing Equity. When you own your home, each payment you make establishes ‘equity’ in your house. This is an ownership interest in the property that you can convert into cash when you sell the house. These are also funds which you can borrow against when you refinance or open a home equity loan in the future. As a renter, you do not have this option.
- Static monthly payments. While your rent payment has a tendency to climb each year, a mortgage payment usually stays the same year after year, depending on your home loan. Inflation, for the most part, does not affect your mortgage payment. This assumes of course that your home loan is a fixed rate – an Adjustable Rate Mortgage could mean a fluctuating payment 3, 5 or 7 years down the road.
- A home is generally an appreciating asset. Houses typically increase in value over time. A home you purchase for $75,000 today could be worth a lot more in 10 years. That extra money you realize through the sale of a house is yours.
- Tax benefits. The interest paid on a home loan is usually tax-deductible. That’s a significant savings, particularly in the early years of ownership, when the bulk of your payment is comprised of interest.
- The costs. The increased costs of home ownership can take a big bite out of your budget. While you may be surprised to find out that your mortgage payment is actually less than what you were paying in rent, you need to remember the additional costs of property taxes, homeowner’s insurance, utilities, and general upkeep expenses. And while your mortgage payment is primarily static (as described above) these additional costs have a tendency to go up over time.
- Less mobility. As a renter, you are able to move on relatively short notice. As a homeowner, it’s your responsibility to put your home on the market to sell it. This process can take months, and sometimes years depending on the market. If you anticipate a move in the next couple years, buying a home may not be a wise investment.
- Repairs and maintenance. No more calling the landlord when something breaks. As a homeowner, it’s your responsibility to fix it. For many people, the thought of maintaining a home and the yard that surrounds is not appealing. But don’t forget – condominiums are an option! Condos give you the power of ownership, while leaving the maintenance to a condo association.
Getting Your Home Ready for the Market
Any marketing or sales professional will tell you that the packaging is just as important as the product you are selling. Any marketing or sales professional will tell you that the packaging is just as important as the product you are selling. As you get ready to put your home on the market, you may want to spruce a few things up to attract potential buyers. Remember that no touch is too little. After all, you may be selling the steak, but you’re also selling the sizzle.
A home that’s visually appealing has a better chance of attracting buyers. Now that you have the home listed in a few newspapers and real estate publications, and the sign is in the yard, you have to be ready for the buyers that drive by your place for a look. Here are a few simple things that you can do to cosmetically enhance your property:
- Keep the lawn mowed, the trees clipped, and the shrubs maintained. Pull the weeds and trim the hedges.
- How do the driveway, walkways, and foundation look? If there are cracks, you may want to repair them. If the driveway is in bad shape with cracks and deep oil stains, resurfacing or sealing may be in order.
- Don’t do windows? Well, you may want to now. Wash the windows and check the casings and shutters for a possible touch-up. It’s amazing what a quick paint job can do to your home’s appearance.
- Clean up those gutters!
- Keep the yard clear of any tools, toys, or equipment. You never know when the buyer will be driving by.
- Take advantage of the spring or summer season by planting or hanging a few flowers out front. It adds a little color to the picture.
Now stand by the curb and take a look at all that you have done. Try to look at your home through the eyes of the shopper. How does it look? If you’re happy with what you see, there is a good chance the potential buyer will be enticed. …And that means you have to get the inside ready.
Now that you’ve successfully lured the buyer into your home, you’ll need to impress them with a clean and orderly house. You don’t need to spend a bundle of money, either. Doing a little cleaning of the tiles, windows, floors, and bathroom will go a long way. Make sure you have clean filters for your air conditioner. Consider cleaning the carpets or perhaps doing a little painting, especially if you’re a smoker or have pets.
Removing some of the clutter inside is another consideration to make. If you have a lot of furniture or personal items around, you may want to consider putting a few things in storage for a while. This will give the interior of the house a newer and more spacious look.
Just before potential buyers arrive to look at your house, consider these final touches for icing on the cake. Fresh flowers and scented potpourri will appeal to their senses. Some soft music is a good idea as well. There’s also a lot of truth to the old adage that baking bread or cinnamon rolls will give the house a welcoming aroma.
You will find that a little elbow grease (and not necessarily a lot of money) will go a long way in selling your home. After all, a home is the biggest investment most people will ever make. They’ll want to be sure that the previous owners took care of their investment.
It Pays to Ask Questions when Shopping for a Home
Home Buyers often look at dozens of homes before finding the one that fits the bill. In order to avoid unpleasant surprises after you’ve moved in, you’ll need to get answers to some direct questions.
How? The Financing Question
First and foremost is financing. It’s always wise to have already visited your credit union for pre-qualification on your home loan. This way you will have a good idea of the costs associated with buying a house, and you’ll have a price range in mind that will fit your budget. Call your credit union’s loan department and set up an interview. It is the logical first step.
Where? The Neighborhood Question
It’s on to shopping. For each home you consider, you should take a good look at the neighborhood. Think of your needs and whether or not they will be easily met. Is the home convenient to shopping, public transportation, schools, parks or recreational facilities? Now look closer. Are many homes in the area for sale? If so, why? Are there any rezoning plans in the near future that may affect the value of the home? And don’t overlook the obvious resources – If you know someone that already lives in the neighborhood, be sure to ask them what they like and dislike about living there.
What? The Exterior and Interior Question
There are a lot of things to look at, and since you will be visiting a lot of homes in the shopping phase, you may want to take some notes. What is the size and age of the house? Consider the size of the lot, the landscaping, and the structural condition. Does the roof leak, or does the basement flood? On the inside, you may want to make some crude sketches of the floor plan. How many rooms, bathrooms, and bedrooms are there? Is there adequate storage space? Is the kitchen functional? What appliances are built in? Is the basement finished? Is there central air conditioning? What is the quality level of the building materials? You should also check insulation and whether or not there are storm windows. Many sellers will have information sheets on their house, but that shouldn’t dissuade you from asking these questions anyway.
What else? Some Remaining Questions
Not everything you’ll want to know about a house will be in plain view. How old is the home? How many previous owners have there been? How long has the home been on the market? Are the heating and cooling, electrical, and plumbing systems in operating order? What is the fuel used to heat the house? What are the average utility costs? Once you have the house inspected, you will get many of these answered by a professional. But it’s always good to get these answers up-front on homes that are serious contenders for your money.
Knowing Your Rights as a Borrower
Several federal laws provide you with protection during the processing of your loan. Several federal laws provide you with protection during the processing of your loan. These laws prohibit discrimination and provide you with rights to certain information. Here are some of your basic rights.
The Equal Credit Opportunities Act (ECOA) prohibits lenders from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, martial status, or age. The Act also prevents discrimination resulting from the applicants income source, if said income comes from any public assistance program. Finally, ECOA prevents discrimination based on the fact that the applicant has exercised any right under any federal consumer protection law.
It’s important however to note the following distinction – This does not mean that the lender won’t ask for certain information such as race, sex, age, and marital status when taking your application. In fact, they frequently must do so in order to help government agencies monitor ECOA compliance.
Your local or state government will likely also have laws in place prohibiting discrimination. While overall very similar, these laws can and do vary from state to state.
Prompt Action / Notification of Action
Once you have submitted your completed application, your lender or mortgage broker must act on it and inform you of the action taken no later than 30 days after it is received. Note: your application will not be considered “complete” until you have submitted all of the material and information requested.
Statement of Reason for Denial
If your application is denied, the lender must give you a statement of specific reasons why you were denied, or at the very least tell you how you can acquire such a statement. If it was due to information obtained on your credit report, the Fair Credit Reporting Act (FCRA) requires the lender to give you information on how you can obtain a free copy of your credit report. You always have the right to dispute the accuracy or completeness of any information found on your credit report, but such disputes typically happen begin with you and the credit reporting agency that provided the report. The agency will provide you with the steps you’ll need to take to clean up your report. The three major credit reporting agencies are:
- Experian 1-800-682-7654
- Equifax 1-800-685-1111
- Trans Union 1-800-916-8800
Obtaining Your Appraisal
The lender needs to know the value of your home to determine if it is enough to secure the loan. To do this, the lender typically hires a professional appraiser to give their opinion on the value of the home. ECOA requires the lender to tell you that you have a right to get a copy of the appraisal report, as well as how and when you can obtain it.
If you feel that you have been discriminated against by a lender or anyone else in the home buying process, you may want to talk to an attorney; or ask the federal agency that enforces ECOA (the Board of Governors of the Federal Reserve System) or the Fair Housing Act (HUD). For more information or to download a complaint form, visit http://www.hud.gov/fhe/fheact.htm.
Shopping for a Mortgage: All loans are NOT created equal
Never before has there been such a wide range of sources for home mortgages.Never before has there been such a wide range of sources for home mortgages. Though many alternatives exist, traditional lenders such as community banks, savings and loan companies and credit unions may very well be your first and best choice for a mortgage.
Where do I look?
You probably already have a relationship with your credit union for your checking account. You might also have a savings account or a credit card or a car loan. Odds are, you have chosen to do business with your financial institution for a good reason – competitive rates, superior service, convenience, etc.
Following that logic, it just makes sense that this should be your first stop when shopping for a mortgage. You may be surprised to discover your credit union has the best terms but you don’t know about it, simply because they don’t cram your mailbox full of solicitations and fill the airwaves with commercials.
What questions do I ask?
What a mortgage is going to cost will depend only in part on the interest rate, so make sure your inquiry goes beyond just “What’s your rate?” Take notes when you visit with lenders about terms. Try to build a basis of comparison of lenders by asking for the same information from each. Here are the basics…
- Do you do originate first mortgages on homes? You can’t use a service if they don’t offer it.
- What types of mortgages do you offer? Fixed rates loans? Adjustable rate Mortgages? Balloons? One size does not fit all.
- What are the current rates for each? Are rates lower with an up-front fee? Depending how long you’ll have the mortgage, buying down the rate by paying a discount fee or “points” can save you money in the long run.
- How much are closing costs? What other charges or prepaid items are required?
- What are the requirements for down payments? Will private mortgage insurance be required?
- What are your underwriting requirements for debt ratios, time on job, and credit scores?
- What programs are offered for first time homebuyers?
- Can I get pre-approved ahead of finding a house?
- How long will the process take? What can an applicant do to speed it up?
- How do I apply?
How do I compare?
Look for terms you can live with. You have no use for a lender with the lowest interest rate if the minimum down payment exceeds the amount you’ll have available. Look for the combination of down payment, closing costs and prepaid expenses. Combined, these make up your up-front costs. Next look at the monthly payments for the total for principle and interest on your loan and private mortgage insurance (if necessary).
Choosing a lender with a higher interest rate might be the best move if the closing costs are hundreds of dollars less in a situation where you are only going to be in the house a couple years. Higher rate and higher closing costs might be the best deal in a situation where the lender doesn’t require the borrower to pay private mortgage insurance premiums.
For the first time home buyer, this may seem overwhelming, and it may be difficult to absorb every last detail. That’s why you need to work with a mortgage lender you can trust. After all, you likely don’t want to get bogged down in an exhaustive analysis of your options. Check out the likely lenders, ask questions, make a sensible choice and get on with the application!
The Application Process: What’s the lender doing with all my information?
Before you receive a loan, the lender will require that an application be completed.Before you receive a loan, the lender will require that an application be completed. Basically the application is account of who you are, where you live, where you work, what you earn, what you own and what you owe. A mortgage is very likely the largest loan you may ever receive, and terms will span decades. It shouldn’t be a surprise that the mortgage application process is far more in-depth.
What information does the lender need?
In addition to the basic loan application questions, the mortgage lender will likely require additional documentation in the form of payroll records and W-2 forms. Statements for savings and checking accounts as well as investments and retirement funds are used to document your ability to pay your down payment and closing costs.
The lender will verify the information contained in the application, check credit references and evaluate the property that will collateralize the loan. They’ll also determine if the payments are within your means. It would be a disservice to a borrower for a lender to grant a loan that the borrower cannot afford. If everything checks out within the lender’s underwriting guidelines, the loan is approved. If not, the lender may request additional information from the borrower, offer alternate terms for the loan, or may deny the request.
Do I need perfect credit references?
Not necessarily, but the better your credit history is the more likely that your loan will be approved. Most lenders will ask for a written explanation of any derogatory items or recent inquiries. Remember, to your lender, your credit history is a pretty good indicator whether you’ll make timely payments on your mortgage loan. Some lenders will offer alternate terms for borrowers with bad credit history. Such terms might require a higher down payment, a higher interest rate or a cosigner to guarantee the loan.
How is the property evaluated?
Most lenders will have the property appraised. An appraisal is the determination of the market value of a property. The lender wants to know what the property is worth and that it can be sold if necessary in a foreclosure. Most lenders use independent certified appraisers. You can reserve your right to see the appraisal by signing a special section of the standard mortgage application.
How does the lender know what I can afford?
Most lenders will calculate the affordability of a house payment in two ways. First, by finding the relationship between the total house payment and your gross monthly income. Second, by looking at the relationship between all your debts (including the house payment) and your gross monthly income. The more income that is committed to servicing debt, the harder it is for borrowers to make payments.
How long does all this take?
The length of time involved from application to approval will vary. You should expect any lender to be able to give you an idea ahead of time how long the processing will take. The better you understand what the lender’s process involves, the better position you are in to secure financing for your home loan.
How will I know if I’m approved?
The lender will provide an approval letter as written commitment to fund your loan. It will state any conditions for the approval. It is important that you meet all the conditions as stated. Read all correspondence from your lender relating to your loan. And if you have questions, ASK.
There’s more than one type of Home Loan
Different borrowers have different needs. For that reason, lenders offer an array of home loan products.ifferent borrowers have different needs. For that reason, lenders offer an array of home loan products. What are you looking for? Knowing the benefits of each type may help you answer that all-important question.
Lenders generally offer three types of home loan products: Fixed Rate Mortgages, Adjustable Rate Mortgages (ARMs) and Balloon Mortgages. Which one will be right for you? Let’s look at the advantages of each.
Fixed Rate Home Loans
A fixed-rate mortgage has both a fixed rate and a fixed monthly payment. Terms usually vary from 15 to 30 years. The shorter the term, the lower your interest rate may be. With a shorter term you can also count on building equity in your home at a much faster pace. If you plan to live in the home for a long time, a fixed rate home loan may be the route to take.
Advantages of a Fixed Rate Home Loan
The biggest advantage of a fixed rate home loan is that it is predictable. While your property taxes and insurance may increase, your loan payment will remain unaffected by interest rate changes. So as costs of living and inflation increase, mortgage payments become a smaller part of your overall expenses. In addition, if you suspect interest rates will be rising, it may be best to lock in to a fixed low rate.
With an ARM, monthly payments can increase or decrease on a regular schedule depending on changes in interest rates. These adjustment periods are usually 1, 3, 5 or 7 years. The interest rate changes are usually in relation to an Index. Since ARM loans offer a lower interest rate risk to lenders, they can generally be offered at a lower initial rate than a long-term fixed rate loan. This reduced rate can be an excellent choice of financing under certain conditions; such as high interest rates, rising income expectations, or short-term ownership.
Advantages of ARMs
ARM loans usually offer a lower interest rate than long term fixed rate loans. This can translate to a lower monthly house payment or can qualify you for a larger loan amount.
Balloon Mortgages are a bit of a hybrid of fixed and variable rate loans. They are amortized for 25 or 30 years, but have a fixed rate for a shorter period, usually 3, 5, 7 or 10 years. At the end of that 3, 5 7, or 10-year term, the borrower either pays the loan off or refinances the loan into a new balloon note or a fixed rate loan at the then current interest rate. Since this refinance is not automatic (as with an ARM), the borrower may have to pay for closing costs if you choose to refinance the balloon loan. Again, this is a popular choice for those who have plans for short-term ownership.
Advantages of a Balloon Mortgage
As with an ARM, Balloon mortgages can save you interest expense in the short run and qualify you for a bigger loan.
This is by no means a complete menu of loan options. Typically, there are a host of products within each of these major categories, with varying options to meet varying needs. Understanding these categories is an important first-step in determining which loan will ultimately work for you. You credit union mortgage staff will become a valuable asset as you make this decision, so be sure to use their knowledge and expertise to the fullest!
Buying Down the Rate: Paying now or paying later
Many lenders will offer a lower interest rate for your loan when the borrower pays a fee up front. Many lenders will offer a lower interest rate for your loan when the borrower pays a fee up front. The fee is normally paid at closing, but sometimes collected at the time of application or when the rate is locked. The fee is part of how the lender prices mortgage loans to borrowers.
Is this what they call “points”?
Yes. Loan discount points are charged to adjust what the lender earns on the loan. Points typically depend on the general interest rate environment, as well as market conditions in the geographic area in which the lender operates. The fee is based on a percentage of the loan amount. This percentage can change as often as interest rates change. One point equals one percent of the loan amount.
Is paying the discount fee a good deal?
It depends on the amount of the fee in relationship to the how much the rate is discounted. It also depends on how long you plan on being in the house and having the loan. Plus, you’ve got to be able to afford the fee and determine that it isn’t better spent on a larger down payment, or to pay off some other debt. One might even prefer to save the money for a future purchase, like furniture or improvements for your new house.
How are these things calculated?
Lets look at an example for a $100,000 30-year fixed rate mortgage:
Lender A Note Rate Points Payment (P+I)
8.375 0.000 $760.07
8.250 0.125 $751.27
8.125 0.500 $742.50
8.000 1.500 $733.76
This lender has priced the first .125% rate reduction as only .125% of the loan amount fee. The next reduction costs .375% and jumping to the final reduction will cost an additional 1.00% of the loan amount.
In the first reduction the borrower could save $8.80 a month on a principal and interest payment by selecting the 8.250% rate and paying .125% of the loan amount up front as the discount fee. The fee is calculated by taking the loan amount ($100,000) times the “point” (.125%) which equals $125. One can determine how long it takes to recoup the fee by dividing the fee by the monthly savings ($125.00 / $8.80 = 14.2). Thus it takes just over fourteen months in lower payments to save back in lower payments what was spent up-front in the discount fee. “Buying down the rate” might make sense for the borrower who plans on being in the house and having the loan for more than fourteen months.
Now look at the payment for the 8.000% loan. It’s $26.31 per month lower than the 8.375% payment. The discount fee is 1.500% of the loan amount, which equals $1,500. Working the same calculation as before, $1,500.00 / $26.31 = 57. In this case, a borrower would want to be reasonably sure they will be staying in the house for almost five years in order to recoup the points they bought up-front.
How is the information obtained and when do I lock in a rate?
Though lenders are required to disclose rate and fee information at the time of application, most lenders will answer a potential borrower’s questions about rates and discount points for lower rates.
As far as locking in a rate, lenders vary on policy. Many lenders do not require you to lock in a rate at the time of application. However, know your risks when you do not lock in a rate right away. Rates can go up as well as down. Many borrowers save themselves days of anxiety by locking in early and focusing on other details of their purchase.
Buying a Home: The Cast of Characters
Buying a home is an involved process, and you likely won’t do it alone.Buying a home is an involved process, and you likely won’t do it alone. While it’s not quite a cast of thousands, the purchase process will put you in contact with many professionals along the way. Here are just a few of the people you might meet.
Generally, the first meeting on your list should be with the mortgage representative at your credit union. After all, why go shopping without knowing how much you can spend? Typically, a brief visit with the friendly folk at your credit union can put you on the road to mortgage pre-approval. At the very least, you’ll know what you can and cannot afford before looking at homes.
Banks, Savings and Loans, and Mortgage Companies will, of course, also lend money to homebuyers. As with any loan decision, it’s always wise to shop around for the best rates and most favorable terms. But don’t forget the value of good old-fashioned service. After all, this is a loan you will be likely making payments on for thirty years or more. Your relationship with the lender is thus an important consideration.
Finally, keep in mind that many financial institutions sell their home loans to mortgage investors, commonly referred to as the Secondary Market. If your mortgage is sold, you could very well have one, two, or more lenders over the life of your loan.
Real Estate Broker / Agent
While you can shop for a home without one, a real estate agent can do much of the legwork for you – He or she will help find homes available in your market, keeping your price range and desired specifications in mind. The agent will often refer you to many of the other characters in this cast, so it’s naturally a good idea to find a hardworking agent you can trust. Ask friends or family who they might recommend. If this won’t work, interview several agents in order to find one that you feel comfortable with.
The Property/Mechanical Inspector thoroughly examines the home you are going to buy. This means the plumbing, appliances, electrical wiring, furnace and/or air conditioners, insulation, and overall structure. The lender you choose may require an inspector’s services. Either way, it is a wise decision to have this third party go over the house. They won’t be swayed by emotions, and will provide you with ‘just the facts.’ Their inspection could save you thousands in future expenses and help you negotiate a better price on the house.
While an inspector’s job is to search for defects, an appraiser determines the fair market value of the house. This is based on a variety of factors including the home’s condition and the selling prices of comparable homes in the area.
Attorney / Closing Agent
An attorney is usually present at the closing of a home purchase. They are responsible for ensuring that all documents have been completed properly and signed. This agent will explain each document and collect the transaction fees to be given to the appropriate parties. Many credit unions will have an attorney available for use at the closing.
The Mortgage Insurer comes into the picture if you plan to have a small down payment on the home. A smaller down payment means a greater risk for the lender, therefore they may require Private Mortgage Insurance be purchased by the borrower. If for some reason you cannot make the payments on the house, the mortgage insurance helps cover the lender’s losses.
I’ll take it!
Now that you’ve done your homework, pre-approved your mortgage, and zeroed in on the home you’d like to buy, it is time to make an offer.
The Realtor’s Role
If you’re using the professional services of a real estate agent, it’s a good idea to explain to them how you arrived at the dollar amount in your offer. For example, if there are certain flaws in the house that you feel should reduce the purchase price. The real estate agent may also advise you on how much you should offer. A good realtor should let you know if your first offer is too low, or too high. While the realtor is an expert, never forget that the ultimate decision is always yours.
Contents of the Offer
Your offer is submitted to the present owners usually through the real estate professional. This document is called a “purchase and sale agreement”. The agent is required by law to deliver your offer to the sellers. Your offer should include:
- A legal description of the property
- The price you are offering
- The earnest money amount (see below)
- The size of your down payment and how the remainder of the amount will be financed
- Items of personal property that the seller says will stay with the house or that you wish to be included in the sale
- A closing occupancy date
- Length of time that the offer is valid (usually 3 to 5 days)
- The stipulation that your obligation to buy depends on the negotiation of a satisfactory contract
What is earnest money?
This is a “good faith” payment held by the brokerage firm of the real estate agent. This money shows the seller that you are a serious buyer. It should be held in escrow and returned to you if the seller does not accept your offer within a specified time frame. You forfeit the money if the seller accepts your offer and then you back out of the purchase. There is no set amount and what is customary usually depends on where you live in the United States. A real estate agent should be able to help you determine what is fair.
Negotiating the final price
The real estate agent will usually present your offer to the seller and relay the seller’s response back to you. The response can be acceptance, rejection, or a counteroffer. A counteroffer usually indicates that you are close to an agreement. The seller may have a few suggestions or alterations to make it work. A rejection isn’t necessarily the end. If you get this response, and you have room to negotiate, you may want to draw up another offer.
Once the seller has signed the dotted line, detailed negotiations to write up a formal sales contract begin. Remember that your offer to buy is reliant upon the negotiation of a satisfactory contract. Along with the basic terms of the sale, there may be contingencies that must be met in order for the contract to take effect.
The Nuts and Bolts of Private Mortgage Insurance (PMI)
If you plan on having less than a 20% down payment on your home, you may have to budget a little extra for Private Mortgage Insurance (PMI). There’s a lot you should know about this coverage – though it is required for some, it is also quite possible you’re paying premiums that may no longer be necessary.
What PMI is…
Mortgage Insurance is a policy that protects lenders against some or most of the losses that may result from a default on the home loan. It is required of borrowers that plan to make a down payment of less than 20%. These days, many first-time homebuyers are putting far less than 20% down, making this coverage increasingly popular. The lower your equity, the greater the LTV (Loan-to-Value) ratio on the mortgage. And the greater the LTV, the greater the risk of the loan to the lender. The goal of PMI, therefore, is to reduce the default risk for the lender, which in turn allows the borrower to use less money on a down payment.
What PMI is not…
PMI should not be confused with homeowners insurance. Homeowners insurance protects your assets; including the home, the property, and its contents (depending on your policy). PMI also should not be confused with mortgage life, credit life or disability insurance. These are designed to pay off a mortgage loan in the event of the borrower’s death or disability. The key difference is that these coverages are designed to protect you and your family. PMI is a tool designed to protect the lender.
How does it work?
Like other typical insurance policies, PMI requires payment of a premium. You may be billed monthly, annually, or by an initial lump sum for your premium. In many cases, the lender will package this premium payment in with your other tax and insurance escrow payments. Your premium is usually based on the balance of your mortgage loan, so as the balance is paid down, the premium may decrease. If the borrower can’t repay the insured loan, the lender may foreclose on the property and file a claim with the mortgage insurer for any loss incurred by the lender.
LPMI is Lender Paid Mortgage Insurance. As the name suggests, this program has the lender purchase the mortgage insurance and pay the premiums. The lender will increase your interest rates to pay for the premium, but LPMI may reduce your settlement costs.
Do I always pay PMI?
Private mortgage insurance was designed to protect the lender from loss and allow the borrower to put less money down. As time goes on, the loan gets paid down while the value of the property may be increasing. That means the homeowners are building more equity in the home. So what happens after the homeowners build their equity up greater than 20% of the home’s value? Depending on when you purchased the home, PMI may be canceled by the lender or applied for cancellation by the borrower. (LPMI or government mortgage insurance can not be cancelled during the life of the loan). Before you commit to paying mortgage insurance, find out the requirements for cancellation.
Finally, it is important to note that PMI premiums may become unnecessary sooner than you think. If property values are increasingly rapidly in your neighborhood, you may achieve 20% home equity faster than you initially predicted. If you feel the value of your home has risen substantially, and that PMI is no longer required, visit with your credit union’s mortgage department. It is possible that they’ll recommend a re-appraisal of your home.
Understanding Payments & Escrows
A mortgage payment is comprised of much more than a traditional consumer loan.Principal, Interest, Insurance, and Taxes may all be built into your payment. Eventually you’re going to ask the obvious question, “How is this all going to be paid, and what is this going to cost?”
Payments on your mortgage will be divided into different “parts”. All lenders will collect for accrued interest on a periodic basis and most will provide for principal reduction as well. Some lenders will also collect for the escrow of property taxes and hazard insurance premiums.
How much goes to principal and interest?
First of all, let’s define some terms. Principal is the amount you borrowed, or the balance remaining after payments begin. Interest is the amount the lender charges you for loaning you the money. Interest is accrued on the unpaid balance and is collected by the lender before any remaining portion is applied to principal.
On a loan with a thirty-year repayment schedule, most of the principal and interest payment goes to interest in the early years. As an example, on a loan with a fixed rate of 8.250%, monthly payments (the combination of principal and interest) would be $702.04. Even after a year of payments, only $20.00 is actually applied to principal. It takes over twenty-two years before the monthly payment is evenly distributed between principal and interest. Using a thirty-year term will thus keep payments as low as possible, but total interest paid over the life of the loan is high. Naturally, a shorter term loan would mean less interest, but would also yield a higher monthly payment.
Escrow… what’s that?
An escrow account is balance held by the lender for payment of property taxes, hazard insurance premiums and private mortgage insurance premiums (if necessary). Most lenders will require escrow accounts for borrowers with less than a twenty percent down payment. There is greater risk to the lender when borrowers make lower down payments. To make sure that taxes and insurance premiums are being paid, the lender automatically makes those payments for the borrower from this escrow account.
The account will start with a balance the borrower pays at closing. Consider this your “head start” toward the funds that will ultimately be needed when taxes and insurance premiums are due. Additional funds are collected with monthly payments. The monthly amount for escrows is usually one twelfth of the estimated annual property taxes and annual insurance premiums. The nice thing about escrowing for tax and insurance is that a borrower doesn’t have to worry about where the funds are going to come from when the taxes and insurance premiums are due. Further, most states require lenders to pay interest on escrow accounts.
If your lender doesn’t require you to escrow for taxes and insurance, you may want to do this on your own, by simply making a monthly deposit in a savings account. Transfer from this account to pay taxes and insurance premiums. Most financial institutions can automate a monthly deposit to a special savings account from your checking. Some institutions, particularly credit unions, can set up such deposits through payroll deduction with your employer.
Ways to save money on interest
Beyond shopping for a good rate, there are ways of saving on mortgage interest. Providing there are no prepayment penalties, borrowers can save on interest by applying additional funds to principal. This might be done either by increasing your monthly payment or by applying a lump sum to the loan. Policies pertaining to accelerating payments vary from lender to lender. Check with your lender how this might be handled in your case.
Note: As attractive as such savings may seem, don’t apply additional funds to your mortgage without considering a number of factors – Do you have adequate savings or emergency reserves? Are you saving enough for retirement or education expenses? Do you have other outstanding loans at higher interest rates? Does this make sense tax-wise?
Home Equity Loans
Understanding the Second Mortgage: Home Equity Loans
If you’re a homeowner with equity in your residence, you may be in for some good news. What is home equity?
Your home equity is your home’s market value (what you can sell it for) minus what you still owe on it. Perhaps you don’t realize what a large financial reserve this can be. One good thing about inflation – it usually increases the value of your home. For example, say you bought your home 10 years ago for $100,000; its value today may exceed $150,000, increasing your home’s equity by $50,000. If your first mortgage has a $70,000 balance, the total equity in your home is $80,000.
What is a home equity loan?
A home equity loan allows you to take advantage of the increased value of your home, without having to sell it. Why would you want access to these funds? There are three primary reasons:
- Tax advantages – Most homeowners can deduct interest paid on a home equity loan. This can result in considerable savings over the long run. Consult your tax advisor to see if you would qualify for such deductions.
- Low rates – Since your home is being used as collateral, the loan is considered to have less risk to the lender. This means that the interest rates charged on home equity loans are usually quite low.
- Flexibility – The money you borrow does not necessarily have to be used for the house itself. On the contrary – Equity funds can be used for virtually any reason – to purchase a car, pay tuition expenses, finance a vacation, to purchase investments, or for any other reason you can imagine.
How much can I borrow?
Ask your credit union how much of the home’s value you can borrow against. Often lenders have different percentages that they will loan up to. For example, lets say the lender will provide home equity funds for up to 90% of the home’s value. Now lets assume that your home’s market value is $100,000 and you owe $60,000 on your first mortgage. 90% of $100,000 is $90,000, minus the $60,000 you owe, leaves you with a $30,000 maximum loan. As stated, some lenders will allow you to borrow higher or lower than 90%, so it’s a good idea to ask.
Popular Home Equity Products
There are three primary forms of home equity loans on the market.
- Home Equity Loan – This product carries a fixed rate loan for a fixed term. With this loan, you borrow a lump sum and pay it back in equal installments.
- Home Equity Line of Credit – As a line-of-credit, this product allows for a bit more flexibility. Once the credit line is established, you can advance yourself funds as you need them. That means you can borrow more money in the future without having to re-apply. Since Home Equity Credit Lines are open-ended, they usually carry a variable interest rate. Check with your lender.
- Home Equity Credit Cards – A relatively new concept, this combines the tax advantages of a home equity loan with the convenience and worldwide acceptance of a credit card