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Learn the Role Mortgages Play in Your Efforts to Achieve Financial SuccessMortgage banking was once a solid, staid industry. To get a loan, you went to a bank. Every bank was the same: They offered fixed-rate, 30-year mortgages. And you would send your monthly payment to your bank until you paid off the loan or sold the house.
Bankers now take a back seat to mortgage brokers, who represent not one bank but dozens, allowing mortgage officers to shop rates and programs on behalf of their clients. Indeed, the mortgage industry now offers dozens of loan programs and is introducing new ones constantly. And it is virtually certain that the lender that provides your loan will sell it to a loan servicing company, and it's that company to whom you'll send your monthly payment (until they sell it again, that is).
- Believe it or not, now you can borrow more money than your home is worth. Up to 25% more, in fact. This means that a person who lives in a $400,000 home can borrow $500,000. The "loan" is actually two loans, combining a first and second mortgage. The first loan (for up to 100% of the home's current market value) is a traditional loan of your choice - such as a 30-year fixed rate, a 1-year Adjustable Rate Mortgage, a 5-year balloon or other common loan program; the additional 25% will be a fixed-rate second mortgage at rates of 13% to 17% depending on your credit history). The term of the second mortgage can be as long as 20 years.
You can use the money either for debt consolidation or home improvements, reflecting the fact that lenders now realize that both uses represent sound money management. Here's their thinking: Lenders do not want you to default or enter bankruptcy. Either can happen if you owe a lot of money to credit cards. Therefore, it's in the lender's best interest to help you eliminate your other debt - even if it means lending you more money at the tax-deductible rate of 15% so that you can pay off credit cards that charge non-deductible rates of 18% and 21%. Even though the lender is increasing its risk by loaning you more money, you actually become a lower risk because you are now less likely to default.
Mortgage lenders also like people who want to make home improvements: By lending money that you essentially "reinvest" back into the house, the home's value will rise (at least, the lender hopes so). Thus, if you later default, the lender merely sells the now higher-valued house to recoup its money.
Of course, borrowing more money than the house is worth puts you "upside-down" - meaning you owe more on your mortgage than the house is worth. This could present a crisis if later you need to sell (and, thus, you should not use this strategy unless you plan to live in the house for at least 10 years, and preferably much longer). Still, for those wanting to make improvements, and for those trying to eliminate other debt, this latest loan program is an interesting idea, and one worth considering.
In order to qualify for a 125% loan, you must have an income that can support such payments. Indeed, as with all mortgage loans, qualifying is based primarily on your income, not merely on the value of the house. This makes the 125% loan program particularly attractive for high-income families who do not yet have substantial assets. Many younger workers and those newly married often meet this description.
- Another innovative program allows you to borrow against the future increased value of your home, instead of the current value. This allows purchasers and existing homeowners to add rooms, install a pool or even completely remodel their new or existing homes - without having to empty their wallets.
If you're looking to buy, you can finance 95% of the value of the house - based not on the house's current value, but the value after all the renovations have been completed. A professional appraiser must estimate what the new value will be, based on comparable properties in the area, and contractors will be paid as the work is completed.
Here's an example: Kris, was looking for a new home. She found an okay house in a great neighborhood. It was small, but listed for only $100,000. She figured that by adding a second floor, a garage and an in-ground pool, it would be a great home. Unfortunately, the additions would cost another $100,000.
Ordinarily, it would have been impossible for Kris to buy the house and still have enough cash to make all the improvements she planned. But the new renovation programs make that easy: Because the appraiser agreed that the home would be worth more than $200,000 after Kris completed the improvements, she could get the money to do the work simply by putting down an additional $7,500 now. Thus, for this small cash outlay, she is able to install $100,000 worth of improvements!
New loan programs like these can benefit current homeowners, too, because they allow you to borrow up to 90% of the estimated future value of the property. For example, if your home is worth $150,000 but you plan to add improvements worth $50,000, you can borrow up to 90% of $200,000. That's $180,000 - or $30,000 more than your home is currently worth!
If you're going to seek this kind of loan, keep in mind that spending $50,000 on improvements doesn't necessarily mean your property will grow in value by $50,000. Many so-called "improvements" fail to boost property values, so make sure you consult with a real estate agent and an appraiser before you begin any work.
This warning aside, if you find a fixer-upper with the potential to be the home of your dreams, or if you want to make some changes to your present home but don't have a wheelbarrow full of money, this can be an excellent way to achieve your goal while minimizing your cash outlay.
- You no longer need 20% down to avoid Private Mortgage Insurance. Chances are, you're paying for it currently, and quite possibly, unnecessarily. To understand why, and to learn how you can stop wasting money, let's review the background about PMI.
When lending money to homebuyers, lenders take several steps to make sure they get paid back. They require the homeowner to post the house as collateral, and if your down payment is less than 20% of the price of the house, they also require that you buy PMI, which could add $50-$200 to your monthly payment. This insurance protects the lender in case you default on the loan. Lenders waive the PMI requirement when you put down 20% or more, because homebuyers who put so much cash into the purchase are unlikely to default. Besides, if you do default, the lender needs to sell the house for only 80% of its value in order to recover the money it loaned to you.
Few people are able to put 20% down, so they are forced to buy PMI. Others who could manage to scrape together 20% are left cash-poor, with no cash reserves or other investments. Such homebuyers face a dilemma: Either pay the 20% (which avoids PMI, but leaves you with no cash), or put down less (which leaves you with some cash, but forces you to pay for PMI). Most choose the latter.
Today, though, a variety of lenders allow homebuyers (as well as those refinancing) to avoid PMI with as little as 5% down. This offers you the chance to get into your home with very little cash and, even if you can afford to put down 20%, this eliminates your incentive to do so. (Previously, I used to advise clients to put down 20% whenever they could, simply to save the cost of PMI.)
Lenders are willing to waive PMI in exchange for a slight increase in the interest rate, usually ?-?%. Although this slight increase translates to a somewhat higher mortgage payment, it offers several advantages, including: your total monthly payment is still lower than it would have been if you were paying PMI; and PMI isn't tax deductible, but the extra interest you're paying is - which further reduces the net cost of this alternative.
The best news is this: You don't necessarily need to refinance in order to eliminate PMI. Denise bought a $150,000 house 10 years ago, with 10% down. Her monthly payment therefore includes the cost of PMI. But now, her mortgage balance is only $123,000 (because she's made 10 years' worth of payments) and the value of her home is $225,000. Thus, Denise now has $100,000 in equity in her home - which is well above the 20% necessary to avoid mortgage insurance!
If you are in a similar situation, and you're still paying for mortgage insurance, all you need to do get an appraisal to prove to your mortgage company that you've got at least 20% in equity, so you can tell them to eliminate the charge. If they refuse, simply refinance. You can do so for little or no cost, and you could save yourself hundreds of dollars every year!
These are just three examples of how mortgages can now help you with financial and lifestyle issues that go far beyond mere homeownership. Your home mortgage is an important tool in helping you achieve financial success.
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