Finding the Perfect Mortgage the First Time 

The following is a guest post. Enjoy! 

Every year, millions of first-time homebuyers set out on a search for the perfect piece of property. They scour advertisements; they search through real estate apps; they go on countless tours and stop by untold open houses. Then, when they finally find the home of their dreams, they are utterly unprepared to make an offer.

Buying a home is more than comparing cabinet styles and deciding whether a pool is worthwhile. You must understand your mortgage options before you even consider whether you need or want granite countertops. This guide will help you determine what features you need from your home loan, so you can find and afford your dream home in no time.

Fixed vs. Adjustable

Mortgages last a long time ― typically between 15 and 30 years. Since that is such a significant amount of time for a loan, most lenders offer two options to help you manage your interest rate: fixed or adjustable. Which option you choose depends on your current income, your credit score, and a few other factors.

Fixed Rate

Fixed-rate mortgages are the most common. With these, you can expect the same interest rate for the entire duration of the mortgage loan. The primary benefit of having a fixed rate is knowing exactly what your mortgage payment will be each and every month; your home payment will never be a financial surprise. However, fixed-rate mortgages tend to have a higher interest rate ― at least initially.

Adjustable Rate

Adjustable-rate mortgages are less common but more accessible if you have poor credit. The opposite of fixed rates, adjustable rates will change over time. Most often, adjustable-rate mortgages (ARMs) are actually a hybrid product, as lenders will promise a brief fixed period before adjusting your rate.

Some buyers find ARMs preferable because they seem to have lower interest rates. However, over time, those interest rates will rise, and you likely won’t be able to predict when or how much. Therefore, you can expect financial irregularity for the duration of your loan.

Jumbo vs. Conforming

The cost of your home will also determine the type of mortgage you can obtain. Though you might not realize it, most home loans have a size cap, and not all lenders offer conforming loans, which are the standard size, and jumbo loans, which are substantially larger.

Conforming loans earn their name because they conform to the guidelines of the appropriate government-sponsored enterprise (GSE), Fanny Mae and Freddy Mac.

In 2013, these enterprises determined that the size of home loans should be limited to $417,000 for a single-family home in the United States. The GSE can do this because it purchases and sells mortgage-backed securities, which form the foundation of the housing market. In 2007, the unreliability of these securities incited the Great Recession, so adhering to the size cap for home loans should keep the economy more stable.

Conversely, jumbo loans are available from some lenders for those looking to purchase a home worth more than $417,000. However, such sizeable loans represent a marked increase in a lender’s risk, which means you must have impeccable credit, high income, and a large down payment to qualify. As long as you are prepared for the financial responsibilities of a more expensive home, a jumbo loan is an excellent mortgage option.

Conventional vs. Government-Insured

Finally, not all potential homebuyers have the credit history or liquid assets to purchase a home. Fortunately, the government offers unconventional, government-insured loan programs to help less-advantaged citizens buy property.

The benefit of having a government-insured home loan is that the government promises to pay your mortgage if you default, so lenders see the loan as no-risk. There are three main types of government-insured mortgages:

VA Loans

Typically available only to veterans or their partners, VA loans require no down payment, offer competitively low interest rates, and do not require mortgage insurance. These loans do conform to GSE guidelines, but they are incredibly easy to qualify if you or your spouse served in the Armed Forces.

FHA Loans

The Federal Housing Administration (FHA) also offers a mortgage program to low-income, low-credit homebuyers. Unlike VA loans, FHA loans require a down payment ― though it can be as low as 3.5 percent ― and mortgage insurance. However, interest rates are low.

USDA Loans

If you are willing to move to a rural community, the United States Department of Agriculture will help you secure a mortgage. Your qualification for this program depends on your income; it can be no more than 115 percent of the regional average. However, by participating, you earn exceedingly low interest rates and the opportunity to bypass a down payment, as long as you pay mortgage insurance.

How to Painlessly Switch Mortgages When You Need a New Home

The following is a guest post by George. George writes at Sobredinero.com, a personal finance site for Latinos in the US. Enjoy!

Let me tell you about a man named David. The first thing that attracted David to his condo when he first bought it was how close he was to his job. On top of that, it was near a trendy area packed with nightclubs, bars, and fancy restaurants. It was perfect for David when he was single with no kids. However, David started a family and his housing needs changed.

With a wife, one child, and another child on the way, waiting 10 years to build equity and then liquidate that equity in his condo was not an option for David. He was ready to trade in his two-bedroom downtown condo for a three-bedroom home in the suburbs.

 

Analyze the Options

David knew which house he wanted, but like most people, he could not afford to pay for two mortgages at the same time and even though he was fairly certain that his condo would sell quickly for the asking price, he did not want to risk his family’s financial security.  He thought about moving to the new house and renting out his condo to cover the mortgage while he had the condo on the market. However, after speaking with the condo board president and reading the homeowner’s association paperwork, David discovered that renting out his home would require a lengthy and rigorous vetting process with the board.  He did not have the time or money to do that.

David also considered borrowing against his 401k for the second mortgage, but if he were to leave his job before paying back the loan, he would be obligated to pay the outstanding balance of the loan within 60 days or be hammered with taxes and penalties. He learned fact by reading through the 401k materials he’d received at orientation three years earlier and he also learned that those terms were common for 401k plans. That was a dicey and expensive option.

After thoroughly weighing all of the possibilities, David decided to put his condo up for sale and simultaneously file for a second mortgage. This sounds risky on the surface, but David knew that the bank would only grant the second mortgage after the condo sold. This practice protects the interests of both the lender and the borrower.

 

Factor in the Real Cost

Once David decided on the list and file simultaneously route, he put in some research on mortgage terms. Taking on a mortgage is not just about paying back the amount of the loan itself. Smart borrowers also consider the interest rate, total annual cost, monthly payment terms, and the total payment. Additionally, ancillary costs such as bank fees, housing association requirements, taxes, and transportation need to be factored into the real cost of a new home purchase. David used a mortgage calculator to help him understand the true costs of his mortgage options.

 

Time It

David had everything in place and the only thing left to do was to sign the paperwork. To cancel a mortgage and acquire a new one requires the bank as well as a notary public, so David made sure to schedule the two transactions in one meeting and ensure a smooth process.

This didn’t always used to be the case. Historically, purchasing and selling a home at the same time was a long process. Say for example if David had purchased that condo recently to “flip” (buy for a low price and quickly re-sell at a higher price with inexpensive upgrades), he might not have been able to sell the condo because of restrictions that prevented a home sale if the home been had purchased within 90 days. However, the Federal Housing Administration has eliminated this restriction.

 

Get the Happy Ending

At the end of everything, David and his family turned out just fine. The condo sold, the mortgage terms for the new home were agreeable, and everyone settled into a more comfortable arrangement. Gone are the days of being tied to a house simply because you signed a mortgage. Granted, it’s not as easy to move when owning a piece of property as it is for renters, but it is certainly possible in today’s modern housing market, and the last thing you want to do is be unhappy with your home. Happy house hunting! Be sure to check out more advice about mortgages here, or here.

How to Qualify For a Mortgage When You’re Self-Employed

mortage-self-employed-my-personal-finance-journeyThe following is a post by MPFJ staff writer, Kevin Mercadante, who is a freelance professional personal finance blogger for hire, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.

If you’re self-employed and have applied for a mortgage, you probably have a sense that you were put through a meat grinder. And if you’re self-employed and have merely heard how difficult it is to apply for a mortgage when you’re self-employed, I’m here to tell you that it’s all true.

I spent more than 15 years in the mortgage industry as both an underwriter and a loan originator, and I saw this unfortunate bias against the self-employed again and again. People who are paid by W-2 can often squeak into a mortgage with a shoehorn, but the self-employed must always be prepared to run faster and jump higher.

And even then there may be no guarantees.

The Bias Against the Self-Employed in the Mortgage Industry

I think most of us understand that the job market has become far less reliable since the financial meltdown, and probably going all the way back to the dot-com bust. But in the mortgage universe that doesn’t matter – lenders continue to view salaried employees as if they have a guaranteed income for life.

The reverse is true when it comes to the self-employed. The mortgage industry views the self-employed as if they’re one step away from destitution.

In a way, this view is not entirely without merit. Something like 80% of businesses fail within the first 18 months of operation; if you’re a lender, this is not a statistic that is easily ignored.

Businesses fail for all kinds of reasons, many of which are impossible to know upfront. This is the reason a mortgage lender will generally look for the self-employed person to be in business for at least two years. By contrast, a salaried worker coming out of college can often qualify for a mortgage simply with a promise of employment letter.

If you’re going to apply for a mortgage as a self-employed person, the first step is to recognize that it will be an uphill fight. The second will be to prepare yourself in advance. It’s not impossible to get a mortgage when you’re self-employed – just more difficult. That’s what you have to be ready for.

What the Mortgage Lender Will Be Looking For

The documentation requirements for self-employed borrowers are extensive. The laundry list reads something like this:

  • Evidence that your business has been in existence for a minimum of two years – this may require a copy of a business license, a letter from a CPA, or a letter from a licensing bureau.
  • Income tax returns for the past two years – this includes both personal and business returns, and all schedules.
  • The lender will also verify your income information with the IRS.
  • If any income will be needed from the current year, for which an income tax return obviously has not been filed, you’ll need financial statements provided by a CPA. Under certain circumstances, they may need to be audited statements, which can cost thousands of dollars.
  • Your income will be averaged for the past two years. If your net income (not gross) was $100,000 in 2014, and $50,000 in 2013, your income for mortgage purposes will be $75,000 ($100,000 + $50,000 = $150,000, divided by two years).
  • If your income for the most recent year was lower than it was for the previous year, your income will be based off of the current year, and not averaged.
  • If your income for the most current year is significantly below what it was the previous year, your income may be considered unstable, and the loan application denied.

To put that in perspective, a salaried borrower only needs a copy of a recent pay stub, the previous year’s W-2, a verbal verification from their employer that they are still employed there and likely to be so in the future. The lender will also use current income for qualification purposes (no averaging), even if it has increased substantially from the previous year.

Your Response to Their Demands

If you want a mortgage, your only choice will be to comply with the lender’s requirements. Even if you don’t agree, you will not be able argue around any of those requirements. Since nearly all mortgages are sold to the same agencies (FNMA and FHLMC) or require mortgage insurance from either the FHA or the VA, the guidelines will be the same in all cases.

If you have not been in business for at least two years, you’ll need to be patient and wait until at least that much time has passed. You will also need to make sure that your business shows a pattern of increased earnings from year to year. This is not always entirely within your control, since business cycles can affect your bottom line.

But there is one thing that you can do, and that’s not be overly aggressive with deductions on your income tax return.

All self-employed people have a built-in disadvantage when it comes to applying for a loan of any sort. One of your primary objectives is income tax minimization. You will accomplish that by taking every deduction that the IRS allows. But that strategy works in reverse when you are applying for a mortgage.

The conflict is that filing income taxes focuses on income minimization, while applying for a loan requires income maximization. If you know that you will be applying for a mortgage in the near future, you will do well to go light on your income tax deductions.

Developing Strengths of Offset Your Weaknesses – a.k.a., “Compensating Factors”

A salaried person can often get a mortgage with a minimum down payment, less-than-perfect credit, and even a little bit too much debt. But if you’re self-employed, don’t count on getting similar treatment. Your financial profile will have to present a picture of a stronger borrower.

There is a term in the mortgage industry called compensating factors and while it applies to all borrowers, it’s generally most important to the self-employed. Compensating factors are indirect lending criteria that can make a borrower look stronger, even if that criteria is not strictly required.

Here are some examples of compensating factors that can help you if you are self-employed:

  • Making more than the minimum down payment – if this is 5%, making a 20% down payment will make you a stronger borrower.
  • Strong credit profile – most lending programs require a minimum credit score of at least 620; yours should be well in excess of 700.
  • Cash reserves – this is the amount of cash that you will have available after closing. The typical requirement is liquid savings (not retirement money) sufficient to cover at least two months of the payment on the new home. You should have six months or more.
  • More than the minimum self-employment history – it’s generally at least two years, but you should figure to be in business for at least three years.
  • Not buy more house than you can afford – many borrowers buy a house that’s up to the maximum amount they qualify for. This is usually based on a debt-to-income ratio (DTI) of not more than 36%, and sometimes it can go higher. Make sure that the home you want to buy is keeps your DTI well below 36% .
  • The increase in your house payment should be reasonable – lenders generally consider an increase in your house payment of up to 15% or 20% to be reasonable. A doubling of your house payment could make your loan too risky, and result in a decline.

If you can keep all those factors in mind, and develop a financial profile that largely matches them, your loan will be considered lower risk even though you’re self-employed. No, it’s not fair, but it’s how the mortgage world works. If you are aware of the obstacles – and have a strategy to overcome them – then you’ll get the loan you want.

How about you all? Have you ever applied for a mortgage when you are/were self-employed? What kind of roadblocks did you run into?

Share your experiences by commenting below!

***Photo courtesy https://www.flickr.com/photos/nikcname/4893848354/sizes/q/

Should You Pay Off Your Mortgage Early?

The following is a post by MPFJ staff writer, Derek Sall. Derek is the owner of the blog, LifeAndMyFinances.com, where he teaches people how to get out of debt, save money, and become wealthy.

Have you ever thought about paying off that mortgage faster than the typical 30 year term?

Is it a smart thing to do? What are the pros and cons of doing so? These are all great questions and should be considered carefully. Let’s dive into each of the positives and negatives of doing so, and then you can make a confident decision of what you want to do.

 

The Interest Expense 

When buying a house, most people put a little bit of money down, but then take out a 30-year loan for the majority of the remaining payment. If your loan percent is 4.5% or so on a $250,000 house, then you can plan on paying an additional $180,000 in interest. That’s right, you will pay a total of $430,000 on your $250,000 home.

This sounds like a great reason to pay the house off early, but many home-owners think that they can earn more than 4.5% by investing their money instead of paying off their loan quickly. So, they decide to keep the loan for its 30 year life, but invest a few hundred bucks in the market each month to build their retirement fund.

While this does make sense, many people don’t actually invest the money that they said they would. Instead, it goes toward a new boat or new car, which depreciates in value and often costs them much more in the long run than if they would have put the money toward their home mortgage. By putting extra money toward the home loan, you are guaranteeing yourself a 4.5% return, which isn’t amazing, but it’s something.

 

Mortgage Tax Deduction

Many people are advised to keep their mortgage because of its tax incentives. Because you are paying interest on your loan, the government will reduce the taxes that you owe each year.

It sounds all well and good, but this is how it really works. You pay in 4.5% on your home loan each year and because of this, the government will not tax you on this payment, which essentially pays you back 1% or so. In other words, you pay in $5,000 in interest each year to avoid $1,250 in taxes paid in. By doing the math, you are essentially still losing $3,750 on this deal. Do not buy a house and pay the interest just to avoid tax payments. It makes absolutely no sense.

 

Cash Flow

One of the best ways to get wealthy today is to increase your cash flow.

With more cash each month, you have more opportunity for investing and can then increase your overall wealth much faster than your neighbor down the street (who is making payments on everything you see in his yard). To do this effectively though, you basically need to reduce your cash flow to nothing for a few years while paying off your mortgage debts. Many choose to keep their mortgage and stock up their reduced cash flow (after they pay their mortgage) each month. In the end, the difference may be negligible, but I believe that there is much more power in that large cash flow only a few years later when your mortgage payments are gone. Just think of how much cash you would have each month if you no longer had to pay your mortgage!

 

My Biased Opinion

I’m sure you already know my opinion of whether you should pay off your mortgage or not. Over the last couple of years, I have reduced my consumer debts from $45,000 down to zero, have saved up $15,000 for emergencies, invest over 15% of my income, and am now working to eliminate all of my mortgage debt ($54,000) by the end of this year.

If I can accomplish this, I will owe absolutely nothing to anyone which means I can freely give as much as I want and invest as much as I want – all before the age of 30. With absolutely no payments, do you think I could become wealthy in the next 40 years of my life? Absolutely! And, if you begin working toward debt freedom, I believe that you can soon be wealthy as well.

How about you all? Do you think it’s best to pay off your mortgage as soon as possible, or only pay the minimum required and save the money for later needs?

Share your experiences by commenting below! 

***Photo courtesy of http://www.flickr.com/photos/68751915@N05/6808984167/sizes/l/

Is It Time To Refinance My Adjustable Rate Mortgage?

The following post is by MPFJ staff writer Travis.  Travis is a customer blogger for Care One Debt Relief Services, and also appears weekly at Enemy of Debt.  Travis candidly shares his personal journey to pay off $109,000 of credit card debt and the tips he’s learned along the way. As a father and husband he provides a unique perspective on balancing debt, finances, and family.

We built our home in 2004, at the tail end of the housing boom.  Mortgage lenders did creative financing to get borrowers into as large of a home as possible because with home prices skyrocketing, you could make money hand over fist by selling your home a few years later.

We were no exception.

 

Creating Financing

Our first mortgage is an adjustable rate mortgage (ARM) which stayed at a constant rate for the first 5 years, and then adjusted once a year, on July 1st.  Our second mortgage was set up as a 10 year interest only home equity line of credit.  This setup made our monthly payment as low as possible for the following reasons:

1.)    The fact that our first mortgage was for 80% of the home’s appraised value allowed us to take advantage of a loophole to not pay Personal Mortgage Insurance (PMI).

2.)    The interest rate on our first mortgage (which was an ARM) was low

3.)    Our second mortgage was interest only

 

Mortgage Treatment

ARMs generally have a bad reputation, but to be honest ours has treated us very well.  After the initial 5 years when the rate remained constant, it has adjusted 5 times.  The first four adjustments actually decreased our mortgage interest rate resulting in a lower payment each year.  This year, the rate stayed constant at 2.875%.  In comparison, a 30 year fixed rate mortgage available through my bank according to their website is currently 4.375%.

The second mortgage is a different story.  While it has kept our payment low, we haven’t paid any principal on 20% of the money we borrowed back in 2004.

 

The Refinance Question

Our ARM can adjust upward at most 2% in a single year, with a maximum interest rate of 9%.  Due to the way the rate is calculated, interest rates would have to go up quite a bit for our mortgage to increase the maximum.  However, economic indicators seem to indicate that the economy is on the mend, even if it is a slow recovery.  Which means mortgage interest rates, including our ARM, may be on the rise.

So we have decided to talk to a mortgage representative at our bank about refinancing for the following reasons:

1.)    While all mortgage rates are still very low relative to history, I don’t want to wait until rates increase dramatically and the jump from what we have now to a fixed rate gets larger.

2.)    Our interest only home equity loan will soon be converted to a fixed rate loan that is at a higher rate than the typical 20 or 30 year mortgage.

It seems to me that we are in for a mortgage payment increase if we just let things continue down their current path.  The worst part is that the amount of increase is unknown until we get closer to the adjustment date of the first mortgage, and the conversion date of the second mortgage.

Uncertainty makes it very difficult to build a budget, and that makes me very nervous.  I’m done playing the market and hoping that the ARM adjusts in our favor.  It’s time to lock in and know exactly where we’re at.

How about you readers, have you refinanced recently?  Do you have an ARM?  Do you think the time is right to refinance?

Share your experiences by commenting below!