Types of Mortgage Loans, What Mortgage Is Right for Me?

 

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When buying a home, the vast majority of people need to take out a mortgage. But of the many different options, how do you know which is the right one for you? In this guide, we’ll take a quick look at the different types of mortgage loans available.

Conventional Loans

A conventional loan is any mortgage loan that is not guaranteed or insured by a government entity. It is also the most common type of mortgage loan and likely the first thing that comes to any homebuyer’s mind when they need to apply for a loan.

Conventional loans are provided through private lenders, banks or credit unions. In general, buyers are required to have a minimum credit score of 620 to qualify for a conventional loan, with a debt-to-income (DTI) ratio of 43% or less. Conventional loans come in different shapes and sizes, each with its own benefits. Here are the most common types to look out for:

Fixed-Rate Mortgages

These mortgages span several years and feature an interest rate that stays the same for the duration. This ensures that your monthly payments are predictable, making it much easier to budget for them. However, the duration of the loan impacts how high the monthly payments will be:

  • A 30-year fixed-rate mortgage is among the most common and is ideal for homebuyers looking for smaller monthly payments.
  • A 15-year fixed-rate mortgage allows you to pay off your loan in half the time, but your monthly payments will be significantly higher. On the plus side, the interest rate is typically lower than a 30-year mortgage, and you’ll pay less in total interest payments. These shorter-term loans are great for refinancing and for buyers with a bit of spare change in their pockets.

The minimum duration of a conventional loan is 5-years, ideal for those buyers that want to avoid paying too much in interest and have the cash available for larger monthly payments.

Adjustable-Rate Mortgages

The interest rate on an adjustable-rate mortgage is variable, fluctuating over time. This can be great if interest rates drop but an expensive gamble if they increase throughout the term of your loan. However, the introductory rate is typically far lower than most fixed-rate mortgages, resulting in sometimes drastically lower monthly payments. In addition, it’s locked in place for either 1, 3, 5, 7, or 10 years.

After this initial rate, it will adjust periodically, often annually, though different schemes can be discussed with your lender. Adjustable-rate mortgages are available for various lengths and are ideal for buyers who believe that rates will drop in the future.

Unconventional Loans

Most unconventional loans are backed by a government entity. They are designed to help segments of the population that might otherwise find it hard to qualify for a conventional loan. Here are the most common types of unconventional mortgage loans.

FHA Loans

Insured by the Federal Housing Association, FHA mortgages are aimed at buyers who don’t meet the credit score or DTI ratio requirements of conventional loans. It’s possible to obtain an FHA loan with a credit score as low as 500, though you’ll need 580 to put down a down payment of as little as 3.5%. FHA loans are great for first-time buyers and experienced buyers alike with lower credit scores looking to avoid a 20% down payment.

VA Loans

Guaranteed by the Department of Veterans Affairs, VA loans are designed to help serving and veteran members of the military and their spouses. There are several benefits, including no down payment, no mortgage insurance requirement and competitive interest rates. You will need to pay a VA funding fee, either upfront or rolled into your mortgage payments. This is a relatively modest cost ranging from 1.4% to 3.6%, depending on how much your down payment is.

USDA Loans

Backed by the U.S. Department of Agriculture, USDA loans are designed to ‘improve the economy and quality of life in rural America.’ Only buyers seeking properties in rural areas will qualify, though there are other criteria to meet. USDA loans don’t always require a down payment and provide caps on property prices and income limits. Ideal for buyers looking to settle down in the country.

Conforming and Non-Conforming Mortgages

The loans discussed above fall into the category of conforming loans. These adhere to the loan limits set by the government (Federal Housing Finance Agency – FHFA). In addition, conforming loans meet the underwriting guidelines set by Fannie Mae and Freddie Mac.

Non-conforming mortgages, on the other hand, exceed the limits set by the FHFA and do not conform to guidelines. Jumbo loans are the most well-known type.

Jumbo Mortgages

These are reserved for buyers who meet the strictest criteria, with a minimum down payment of at least 20% and a higher credit score (at least 700) and DTI requirements. They’re designed to finance expensive properties in which conforming loan limits would be breached. Jumbo loans are suitable for buyers of expensive homes who have the funds and credit reliability to make the high repayments.

 
 

 What Is the Ideal Credit Score to Secure a Mortgage?



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Buying a home is certainly exciting, but there are many aspects to consider as you begin to get the ball rolling. One thing that is important from the get-go is your credit score. This can make or break your dreams of homeownership, so it’s important to understand just what is the ideal credit score you need to secure a mortgage.

 

What Is a Good Credit Score?

One of the first questions you need to ask yourself when looking to get a mortgage is whether your credit score meets the lender’s requirements. Different lenders and mortgage schemes have different prerequisites for loan approvals, yet they all have one thing in common: a minimum threshold for the credit score.

Many lenders use FICO® Credit Scores to determine whether a potential homebuyer is eligible for a mortgage loan. These scores range from 300 to 850 and are broken down into the following categories:

  • 579 or lower: Poor
  • 580 to 669: Fair
  • 670 to 739: Good
  • 740 to 799: Very good
  • 800 or higher: Exceptional

However, even if your credit score doesn’t fall within the good 670 to 739 range, it doesn’t mean that homeownership becomes unattainable. In fact, many lenders will accept a credit score of 620 if you’re looking to buy a home.

The ideal credit score will vary from lender to lender, the same way the idea of an ideal home varies from buyer to buyer. Depending on the case, you may find that your credit score is too low for a conventional loan, but it can be used to secure a government-backed loan instead.

 

Minimum Credit Score by Loan Type

Let’s take a closer look at the main types of mortgage loans available to homebuyers and their credit score requirements for each one.

Conventional Loans

A conventional loan is any mortgage loan that’s not backed by a government entity. This type of loan is made available through private lending institutions, such as banks and mortgage companies. The minimum credit score required for a conventional loan is typically 620.

FHA Loans

An FHA mortgage is a loan backed by the Federal Housing Administration, provided through an FHA-approved lender. FHA loans have some of the lowest credit score requirements, yet the figures are closely tied to the down payment amount.

For example, you can qualify for an FHA loan with a credit score of 580 or higher and a down payment of 3.5%. However, if you raise the down payment amount to 10%, you can qualify with a credit score as low as 500.

USDA Loans

USDA loans are made available through the U.S. Department of Agriculture, and they promote affordable homeownership in rural areas. Although the USDA doesn’t set a minimum credit score for the loan, the private lenders who issue the loans do. On average, the lowest credit score figure required by lenders for USDA-backed loans is 640.

VA Loans

VA loan is backed by the U.S. Department of Veterans Affairs (VA) and issued through private lenders. Like in the case of USDA loans, the VA doesn’t have a minimum credit score requirement; however, the private lenders it collaborates with do. The amount can vary depending on the lender, and you can expect the minimum credit score to range from 580 to 640.

Jumbo Loans

jumbo loan is a type of loan that exceeds the maximum amount you can borrow through a conventional mortgage. The larger the loan amount, the bigger the risk for the lender, which is why jumbo loans have a minimum credit score requirement of 700.

 

Why Is a Good Credit Score Important?

When you apply for a mortgage loan, several requirements will determine whether your application will be approved or not. The down payment amountloan size and debt-to-income ratio are just some of the requirements taken into account. But the first thing all lenders will check is your credit score. And because first impressions matter, a good credit score can bring you one step closer to homeownership.

Your credit score will also have a direct impact on your monthly mortgage payments. For instance, lenders will charge higher interest rates for bad credit scores. Similarly, they will take your credit score into account when determining your PMI cost and eligibility. As a result, you will end up paying thousands of dollars more each year if your credit score is too low.

Any type of loan is a potential risk for the lender, and your credit score will essentially be used for risk assessment. Although you can get a home with a credit score of 550, you may incur penalties as lenders try to minimize the risks associated with such a low figure. On the other hand, a credit score of 740 or higher will upgrade your mortgage terms, giving you access to perks such as lower interest rates.

 

How to Improve Your Credit Score

As far as both lenders and borrowers are concerned, the higher the credit score, the better. Raising those figures may seem like a daunting task at first, but there are several ways to improve your credit score.

Step 1: Understand

The first step is analyzing and understanding your credit report. Your credit history will show you what is helping or damaging your credit score. Most of the time, the culprits are easy to identify: a late bill payment or a past-due account. Others are a bit more insidious, such as making too many credit inquiries, which will also snatch points off your credit score.

Step 2: Act

Keeping your credit utilization around 30% or lower will also look good on your credit report. Whenever possible, try to maintain the outstanding balance below 30% and make several smaller payments each month, rather than letting them build up towards the due date. Also, keep in mind that closing old accounts will reduce your available credit, so keep your credit cards open.

Step 3: Double-check

Last but not least, remember to check for errors. Errors do sometimes occur, and in the worst-case scenario, they can severely impact your credit score. Reviewing your report for mistakes and disputing inaccuracies may just give your credit score the boost it needs.

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent, and real estate broker.

 

Update to Canada’s Mortgage Qualifying Rules Explained

 

Earlier this summer, new changes were announced for the federal mortgage stress test, shifting the ground again in terms of how much house new and seasoned home buyers are qualified to purchase. 

In April, Canada’s financial regulator, the Office of the Superintendent of Financial Institutions (OSFI), proposed an increase for the stress test’s minimum qualifying rate on uninsured mortgages. This raised the previous rate from 4.79% to its current value of 5.25%.

As of June 1, 2021, the new qualifying rate for the stress test is applicable to all federally regulated mortgages, including both uninsured and insured mortgages. Insured mortgages apply to borrowers who have a downpayment that’s less than 20% of their home purchase, while uninsured mortgages are available to borrowers who have a downpayment worth 20% or more.

The stress test’s minimum qualifying rate helps ensure borrowers can still make mortgage payments in the event of a change in circumstances, such as a job loss or a rise in interest rates. In its rate increase announcements, OSFI stated Canada’s current housing market, which has seen record-high sales, bidding wars, and soaring prices since mid-2020, puts lenders at risk. The latest rate change helps to “support financial resilience should economic circumstances change,” according to OSFI.

“In a complicated and sometimes volatile housing market, the need for sound mortgage underwriting cannot be underestimated,” said Ben Gully, Assistant Superintendent of OSFI, in a statement regarding the qualifying rate change announcement. 

If you’re in the market to buy a home, then you’ll probably want to know how the latest changes to the mortgage qualification rules will affect you. James Laird, co-founder of Ratehub.ca and President of CanWise Financial mortgage brokerage, gives us some insight on what the most recent set of amendments mean.

What is the stress test, and why did it change?

Canada’s red-hot housing market was already showing signs of cooling down after it reached all-time record levels in March 2021, according to the Canadian Real Estate Association (CREA). In its most recent report, CREA noted the housing market has continued to show signs of moderation, with sales dropping by 7.4% month-over month in May.

However, despite this gradual tapering off, Laird said it became apparent in the first quarter of 2021 that OSFI was going to make a change.

“I think it was quite obvious they were going to do something and I think this is a fairly measured response. The market had already kind of cooled a little bit,” said Laird. “Now it’s in effect for the next time things really heat up.”

Image via Sidekix Media

Originally implemented in 2018, the mortgage stress test is designed to prove you can still make your regular mortgage payments even if interest rates were to rise in the future. When you apply for a mortgage, you are offered a contracted rate, which lenders must check against the stress test’s higher qualifying rate—currently 5.25%, or the contracted rate plus two percent, whichever is higher—to ensure you can make payments. The stress test is applicable to new home buyers, in addition to existing mortgage holders who want to refinance or switch lenders. 

Who does this change affect and by how much?

In terms of how much the latest stress test change has impacted purchasing power, Laird said the new qualifying rate reduces maximum affordability by about 5%. If you’re trying to buy a home or refinance your existing mortgage, this means you now qualify for 5% less than what you would have when the rate was set at 4.79% prior to June 1st, 2021. 

Whenever there is any kind of financial tightening, first-time buyers will be affected the most, said Laird. This is especially true in high-priced markets like Toronto or Vancouver where the barrier to entry tends to be higher. For new buyers who were hoping to purchase near the maximum of their borrowing capacity, they may no longer qualify for the property they wanted to buy prior to the new changes.

Image via James Bombales

“If you had a little bit of wiggle room for what you wanted to do, this 5% reduction [is] probably not going to affect you,” explained Laird. “The people who thought ‘Okay, I just barely qualify for what I want,’ and now [say] ‘Okay, I just barely do NOT qualify for what I want,’ it’s those people who have to do something.”

Buyers who now no longer qualify for the home they desire have a few options, Laird said. This includes adjusting the type of home they want to purchase, or postponing their property purchase until they can save more money or boost their household income.

In comparison to first-time buyers, existing homeowners will likely have built-up home equity, along with potentially higher incomes and better credit scores working in their favour, said Laird.

Will this have an effect on the overall housing market?

In addition to amending the stress test’s minimum qualifying rate, OSFI has now implemented a process to review the rate annually in December ahead of the busy spring market. Laird said elements like the country’s economy, interest rates, and home prices will factor into their decision to make any future changes to the rate. 

Laird also explained the intent of tightening policies is to keep real estate prices in check and to slow price appreciation, which can be a help to first-time buyers. However, with so many other market factors at play, it can be difficult to pinpoint the timeline of this desired outcome, or the precise effect on home prices.

Image via Sidekix Media

“You really can’t tell the effects because it’s mixed in with so many variables, but if you believe this will have its desired effect, then it should mean real estate is a little bit less valuable than it would have been had this policy not been put into place,” said Laird. 

While the stress test plays a role in the outcome of the housing market, it’s only one factor—pent-up demand from households who wanted to change the type of real estate they owned during the pandemic have also had an impact, for example. Laird also points to the return of immigration to Canada, which will bring more buyer demand to the housing market.

“Going forward, yes, the stress test matters, but probably what matters more [is] whenever immigration opens up again and there are new Canadians coming [and] adding demand. That’s extremely significant.” said Laird.

“If and when rates move up, and by how much, that’s more significant than this [change]. This is not nothing, but it’s not the biggest factor that causes a hot or cold market,” he added.

Image via James Bombales

If you’re looking for advice on the latest changes to the stress test, or want to understand more about the current market, recruit the help of a REALTOR® for the most up-to-date information. 

What You Need to Know About Reverse Mortgages

 

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If you need more money in retirement than your income currently provides, you might consider a reverse mortgage loan. In fact, if you have equity in your home but need money for retirement, a reverse mortgage can be one way to access these funds.

While selling your home is another option, a reverse mortgage loan allows you to stay in your home. But, it isn’t without its issues. So, before you commit to this type of financial product, it’s imperative to understand how a reverse mortgage works, as well as the risks.

What Are Reverse Mortgages?

A reverse mortgage is a loan that uses the equity in your home as collateral for the money the lender pays out to you. The loan is then repaid when the home is sold. Alternatively, your estate could pay the principal borrowed along with the interest due.

In a reverse mortgage, your lender can pay you in monthly installments, give you a lump sum or offer you a line of credit. Plus, you don’t have to worry about repaying the loan while you’re still living in the home.

Note that, in a reverse mortgage, you’ll still be the owner of the home and have responsibility for property taxes and homeowners insurance, as well as repairs. If you already have a traditional mortgage, you’ll need to pay that off, as well, perhaps using some of the money from the reverse mortgage.

A Home Equity Conversion Mortgage

The most popular type of reverse mortgage is a home equity conversion mortgage (HECM). The Federal Housing Administration insures this financial product and, while there are other types of reverse mortgages from private lenders, they won’t have this protection.

An HECM can be used if you own a single-family home or a property in a multifamily residential building with up to four units. It can also be used for HUD-approved condominiums and mobile homes constructed since 1976 with a permanent foundation.

To qualify, you must be at least 62 years old, and the property must be your principal residence. You also can’t be behind on payments for any federal debts. And, before you sign on the dotted line, you’ll need to take part in an educational session with a counselor. This is to ensure that you understand what you’re getting into and the risks involved.

How Much Can You Borrow?

The maximum amount that you can borrow from an HECM is $822,375 in 2021. However, the actual amount that your lender will offer to you will depend on current interest rates and the age of the youngest named borrower.

Typically, lenders are willing to offer you a higher amount the older you are and the more your home is worth. Also, keep in mind that you won’t be able to use 100% of the equity in your property and that the lender’s interest has to be paid, as well, so they can’t lend 100%.

Choosing How to be Paid

You have a few different options to choose from when signing up for a reverse mortgage. First, you could opt for a lump sum, which might be the only option available with a fixed rate. You could also select a line of credit or monthly payments for a set amount of time or as long as you remain in the house. These types of reverse mortgages typically have adjustable interest rates and only accrue interest on the money you have taken.

Note that any unused funds in the reverse mortgage line of credit will normally grow at the same rate as the interest on the loan. This means that you don’t lose out by not taking all of your credit when it’s available. You’ll also need to have a good credit score — as you would with a traditional mortgage — in order to get the best terms and conditions.

Reverse Mortgage Fees

In addition to the interest, you’ll eventually pay on the loan, as well. Some fees will need to be paid upfront, such as the origination fee. This has a cap of $6,000 and is comprised of 2% of the first $200,000 of the loan and 1% on the remaining balance. As with any mortgage, you’ll also have to pay closing costs, which are likely to be at least a few thousand dollars.

There are also insurance premiums to pay. These will cost half a percent of the mortgage balance annually, plus 2% of the home’s value upfront. The FHA insurance ensures that both you and the lender will receive the funds when they’re due.

You can also expect to pay a monthly service fee that will be up to $30 for fixed or annually adjusted interest rates. For monthly adjusted interest rates, the maximum service fee is $35. Some of these fees due, as well as the interest rate on the loan, will vary between lenders, so make sure you compare multiple reverse mortgages.

Consumer Protection

As with any financial product, there are people who may try to get you to spend money on a product that either isn’t right for you, is overpriced or is just a complete rip-off. Therefore, be wary of any high-pressure sales tactics.

However, if you decide to proceed, note that you are required to have an appointment with a counselor before you apply for an HECM. There will also be a fee for this appointment, but it can be taken out of the loan amount.

You also have three days to back out of the deal after you sign. But, if you do change your mind, you’ll need to be quick, as this needs to be done in writing using certified mail.

Should You Choose a Reverse Mortgage?

If you hope to remain in your home for a long time, a mortgage like this can allow you to pay for healthcare requirements or cover gaps in other income. It also means you don’t have to worry about repaying the loan and that your spouse will be able to continue living at the property even after your death. Conversely, this option could also reduce the equity left in your home if you need to move into assisted living and will also decrease any potential inheritance for your heirs.

Carefully consider all your options before you choose a reverse mortgage loan. Discuss the matter with a financial advisor or a trusted family member to help you determine if this is a good option for your particular situation.

 
 

How Does Rent-to-Own Work, and When to Consider It?

 

Looking to buy a home but don’t quite have the finances? You might have heard that rent-to-own is the ideal solution. But what exactly is rent-to-own, and how does it work? In this guide, we’ll cover the basics and take a look at whether it’s the right choice for you.

The Basics

A rent-to-own home is based on an agreement that allows you to buy the property after several years of renting it. As a tenant, you will pay an upfront fee, ranging between 1% and 5% of the purchase price, which secures the option to buy the property. On top of this, you will also pay a bit extra in rent each month, which is added to your down payment for purchasing the home. The length of the agreement varies from case to case, often ranging between 1 and 5 years.

Lease vs. Purchase Agreements

Despite the name, not all rent-to-own agreements result in ownership of the property. So it’s important to understand the terminology before you sign any documents.

There are two types of rent-to-own contracts:

  • Lease option: you have the option to buy the property when the contract is up; however, you are not obliged to do so. If you decide against buying, the option simply expires.
  • Purchase option: you are legally required to buy the property at the end of your lease.

Rent-to-Own vs. Normal Renting

Although “rent” is the keyword, there are a few differences between rent-to-own and regular renting to be aware of. For starters, the extra amount you pay each month allows you to invest in the property from the very beginning by building equity as well as saving for a down payment. Meanwhile, regular rentals provide you with a place to live, but the rent itself can hardly be considered an investment towards your future home.

There are also differences when it comes to your obligations as a tenant. Often, rent-to-own contracts will stipulate that it is your responsibility to repair and maintain the property, which is something that falls in the landlord’s court in the case of normal rent contracts.

Also, bear in mind that the upfront fees paid at the start of the rent-to-own contract are non-refundable, unlike the deposit paid with a regular rental. Whether you’re in a lease-option agreement or simply cannot buy the property at the end of the contract, the money will not be returned to you.

When Is Rent-to-Own a Good Idea?

Rent-to-own is an excellent choice if you’re looking to buy a home, but also looking to buy a bit more time. If you’re not yet financially ready, this type of agreement will give you time to reach the credit score needed to secure a mortgage, sort out your finances, as well as save for a down payment. Also, not only is part of your rent building up towards your down payment, but it also helps you build equity while you’re just a tenant.

Think of it as a middle ground between renting and buying, combining the perks of renting with the feeling of stability you get from knowing you’re one step closer to buying your dream home. Rent-to-own also acts as a test drive for the property itself, as well as the neighborhood, school district, local amenities, and so on.

So if you’ve already set your mind on a property that you like and simply need some time to tie financial loose ends, rent-to-own homes are very likely to work in your favor.

When Rent-to-Own Won’t Work for You

The main thing to note about rent-to-own agreements is that they often act as a forced savings plan. While this may work for some future homebuyers, others might find their finances strained as a result. By design, you will pay more each month than you would with a regular rental, so make sure that your budget can accommodate that.

There’s also more at stake with rent-to-own homes. Most contracts have harsh penalties in place for overdue rent, and late payments can void your agreement, losing you all the money already invested in the property. Not only that but if you’re in a lease-option agreement, remember that you will not be able to make a return on your investment.

Rent-to-own agreements have more in common with buying a house than renting, so it’s worth considering your long-term commitment to the property. You will have less flexibility than in the case of regular rentals, and although you can decide to relocate at the end of your lease, you will be forfeiting a hard-earned down payment. Also, if it turns out that the house and the neighborhood are not to your liking, then rent-to-own can be a costly test drive.

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.

 
 

Buying vs. Renting — How the 5% Rule Can Help You Decide

 

Buying a home is often seen as a step forward in the game of life. But choosing the right time can be tricky. If you’re trying to figure out whether you should continue to rent or get your foot on the property ladder, it’s worth having a look at the 5% rule.

What Is the 5% Rule?

The 5% rule was coined by Canadian investment portfolio manager Ben Felix. It stems from the general consensus among potential homebuyers that if you can afford to make mortgage payments that are equal or less than what you’re paying in rent, then buying is a better alternative. However, the 5% rule puts the buying vs. renting dilemma in a different light by factoring in the unrecoverable costs that occur in both cases.

What are unrecoverable costs? If you’re renting, they’re self-explanatory: your monthly rent is an unrecoverable cost. The money spent does provide you with a place to live, but it won’t help you own an asset as homeownership does. Also, the cases in which it can be used to improve your credit score are still rare, and they largely depend on whether your landlord will report those payments to a credit bureau.

In the case of homeownership, unrecoverable costs do not consist of mortgage payments. This is where the 5% rule comes in, highlighting three types of costs and their estimates, as follows:

  • Property tax, estimated at 1% of the home value;
  • Yearly maintenance costs, also estimated at 1% of the property value;
  • Cost of capital, or the mortgage interest rate, estimated at 3%.

When you add them up, these unrecoverable costs can add 5% of your home value to your yearly expenses.

Admittedly, maintenance can be considered a recoverable cost, as it can increase your home value through renovations and upgrades. However, renters looking to buy should factor in the cost of property tax and interest rates into their budget, as they can easily bulk up expenses by thousands of dollars each year.

How Can It Help You Decide?

The easiest way to look at the practical applications of the 5% rule is by using this simple formula: multiply the value of a property by 5%, then divide the number by 12. The result is a monthly break-even point, which could help you decide which is a better financial choice: buying or renting.

Let’s assume that you’re looking to buy a home in Canada, and the average price you’re looking at is around $680,000. Using the 5% rule, your break-even point is at $2,833 each month. This means that if you can find a rental that charges less than that, renting would make more sense. But if you’re paying more than $2,833 on rent, you might be better off buying a home instead.

One thing worth keeping in mind is that the yearly 1% set aside for maintenance is a bit ambitious. True, it is advisable to have that money set aside in case of emergency repairs. Yet, it’s unlikely that you will spend thousands of dollars on renovations and upgrades each year. So you can drop that 1% if you need to negotiate a bit of wiggle room in your budget.

Although the 5% rule can be seen as an oversimplification, it is helpful in giving you a wider perspective over the buying vs. renting conundrum. It is easy to base your decision just on finding a mortgage that’s cheaper than your current rent. The caveat is that this excludes not just hidden costs but also non-recoverable costs, which do not help you build equity.

Can You Use the 5% Rule on the U.S. Market?

It’s best to note that the 5% rule was formulated with the Canadian real estate market in mind. However, the figures are largely similar, especially when it comes to property taxes and mortgage interest rates. So, in theory, the rule can be applied to the U.S. market as well.

Like any mortgage calculator, the 5% rule cannot predict fluctuations in interest rates, taxes or property value. What it can do is give you a sense of perspective when it comes to the financial feasibility of homeownership. Depending on where you live, the 5% rule might even reveal that renting is cheaper than buying.

And speaking of the magical number 5, don’t forget about ‘the 5-year rule’. In most cases, it is advised that you should live in your home or use it as a primary residence for five years before selling it. The longer you live in your home, the more time you have to cushion your initial investment.

As helpful as the 5% rule is when it comes to helping you decide whether to rent or buy, your long-term plans should have just as big an impact on your decision

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.

 
 

Should You Start Saving for a Down Payment or Continue Renting?

 

 

 

Image: kitzcorner / Shutterstock.com

It takes homebuyers an average of seven years to save up for a 20% down payment. As a tenant, you’ve probably asked yourself if it’s better to spend that time continuing to rent or whether to start putting money aside for your future home. Number crunching and prospecting the market play an essential role, but they’re not the only factors that your decision should hinge on. Here are a few things worth considering before you start making plans.

How Much Do You Need to Save?

Start by crunching the numbers. As a potential homebuyer, you most likely already know that it’s best to have a 20% down payment ready. Not only will this reduce your loan amount, but it will also remove the burden of mortgage insurance required by lenders.

Look up the average down payment for the area and home type that might interest you. For better or worse, the amount will fluctuate in the coming years, but you can use it as a starting point. Assuming that it will take you around seven years to save up that amount, break down the figures into periodic installments. How much would you need to set aside each month, and how does that figure compare to how much you’re able to save at the moment?

Assess Your Current Debts

A mortgage loan is likely to be the most significant debt you will ever owe. So before you embark on this loan, it’s wise to settle any smaller debts first. Whether it’s student loans, car loans, credit card debt, even medical expenses, take the time to assess how paying them off will impact your ability to set money aside for the down payment. Paying off high-interest debts should take priority, but at the same time, you should avoid straining your budget.

Factor in Other Types of Savings

Before you start setting money aside for a down payment, ask yourself if there are more pressing savings that need your attention. One thing you should prioritize is your emergency fund. It is recommended that you should have enough money set aside to cover between 3 and 6 months’ worth of living expenses.

Don’t forget about the future either. It’s often advised that you save money for your retirement first and then for a down payment. Juggling both at the same time is rarely feasible, so it’s best to decide in advance which one you should prioritize.

Consider Your Career Plans

The amount you can save each month is tied to your current expenses and how much you earn. It’s worth determining whether you will be able to keep putting money aside at the same rate you are now or if that amount is likely to drop. Also, ask yourself how your job is likely to change in the years to come.

Day-to-day expenses are lower if you’re working from home and not spending money on commuting. But what happens if you can’t work remotely? Similarly, a career change or a costly relocation to another city for work can also alter your plans.

Buying to Invest vs. Buying to Live

How do you see your future house: as an investment or somewhere to live? If your goal is to find a dream home and spend the rest of your life living in it, switching from renting to buying is a good call. But if you think of a house as an investment opportunity, spending the next seven years saving up for a down payment is a risky financial undertaking.

A house is not a liquid asset. To tap into the equity, you need to sell your home. And in order to save enough equity so that there’s some payoff to the sale, you need to live in the house for another five years. If your long-term plans focus on investments, ask yourself whether you might be better off continuing to rent and using your remaining funds on liquid assets.

Don’t Rule Out Renting-to-Own

Rent-to-own properties can be a good middle ground if you’re renting a property you like and planning to live there a long time. In this case, you will pay a bit more in rent, but that extra money is factored in towards your down payment for buying the property at the end of the lease. This kind of agreement can work in your favor if you think you’ll find it challenging to save for a down payment on top of paying rent or if you need some time to improve your credit score.

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.

 
 

Is Buying Really Cheaper Than Renting?

 
man thinking in front of laptop

Image: fizkes / Shutterstock.com

One of the biggest questions among would-be homeowners is whether it’s cheaper to continue renting or to buy a house. Knowing the answer to this complex question can make the difference between using the local market to your advantage or overstretching your finances. But are there any hard and fast rules applicable across the board? In this post, we’ll take a closer look at recent figures and try to find an answer to this age-old question.

Saving for a 20% Down Payment

The main hurdle all homebuyers face is saving up for a down payment on their home. And yet, there’s a significant gap between homebuyers’ expectations and reality.

One of our recent studies found that, although many Millennials hope to buy a house within a year, they still grossly underestimate the actual costs. The U.S. national average for a down payment is $62,000, yet 40% of Millennials expect it to be closer to $10,000. What’s more, 61% had less than that in savings, while 14% had no savings at all.

When drawing out a savings plan for a down payment, it’s important to set a realistic figure but also factor in other expenses. Can you continue paying rent while simultaneously saving for a home, putting money into an emergency fund, paying off high-interest debts, or setting money aside for retirement?

Many experts recommend using the 50-30-20 budgeting rule: spend 50% of your income on essentials, allocate 30% for leisure and save the remaining 20%. Take the time to determine early on whether that 20% of your income can accommodate all your savings needs.

Don’t forget to take the hidden costs of home buying into account. From appraisals and inspections to closing costs and agent fees, there’s more to budgeting for a home than just saving for the down payment.

Rent vs. Mortgage Affordability

It’s essential to assess how local market fluctuations will impact your housing budget in the long run. One of our reports highlighted that mortgage affordability has worsened in 15 out of the 100 largest cities in the U.S. in the past decade. As a result, homeowners now need to pay more than 30% of their income on mortgage, which is higher than the figure recommended by experts. According to the study, in the most unaffordable cities, homeowners need to boost their income by up to $43,567 to avoid being cost-burdened.

At the same time, the rise in income is nowhere near enough to meet the increase in home prices, and in some cases, the difference between home price growth and income growth exceeds 50%.

Similarly, changes in the rental market pack their own share of good and bad news. According to RENTCafé, rents have increased in 13 of the 30 largest U.S. cities, yet they’ve decreased or stagnated in 18. Another encouraging finding for tenants is that rates dropped in all of the top 10 most expensive large cities for renters.

So, depending on the local figures, it might be cheaper to rent than buy in some areas, while it can be more accessible to buy than rent in others.

Crunching the Numbers: Rent vs. Mortgage Payments

One of the most common arguments used in the rent-vs-buy debate is that if you can afford to pay a certain amount in rent, you can afford to pay the same amount in mortgage. In reality, however, budgeting is rarely that straightforward. Here are two rules that can help you better assess your budget:

  • The 30% rule: aim to spend no more than 30% of your gross income on housing costs;
  • The 5% rule: apart from mortgage, expect to pay an additional 5% of your property value on irrecuperable costs: property taxes (1%), property maintenance (1%) and interest rates (3%).

If your housing budget is within that 30% sweet spot, while also factoring in irrecuperable costs, then switching from rent to mortgage is something worth considering. It’s also worth bearing in mind that, as a tenant, your utilities are often included in the rent, and you don’t have to contend with property taxes, HOA fees, maintenance and upkeep, and so on.

What Money Can’t Buy

The decision to buy or rent hinges heavily on their financial implications. Yet, there are some arguments in favor of each that no amount of budgeting can take into account.

On the one hand, renting comes with a lot of flexibility and freedom to relocate, depending on your lifestyle or career choices. You don’t need to worry about a drop in property value, the stress of committing to a lengthy mortgage or having your home foreclosed due to unemployment.

On the other hand, owning your home provides you with a greater feeling of stability. There are tax breaks you can take advantage of, investment opportunities in the form of renting out, and a gradual build-up of equity.

Ultimately, there is no one-size-fits-all scheme, and the decision to buy or rent is a personal one. But before making up your mind, be sure to consult a financial professional for your specific case.

 
 

First-Time Homebuyer Loans & Programs

 

Image: William Potter / Shutterstock.com

Buying a home might seem simple, but there’s actually a lot more involved than you might initially think. For instance, in addition to a variety of new terms to understand, there’s also paperwork to complete and fees to pay before closing on your new home. And, while you might be tempted to rush through the process as quickly as possible, cutting corners could be financially detrimental in the long run.

Fortunately, there are quite a few options to help you purchase your first home. Below, we’ll review first-time homebuyer loans and programs that will give you a better deal when you purchase a house. In fact, if you choose one of these first-time homebuyer programs, you may even see significant savings compared to a traditional or conventional mortgage.

FHA Loans

The Federal Housing Administration (FHA) operates a program to help people who may not have the best credit history. If you have had your share of financial issues, this program might allow you to buy a house — even if you don’t meet the ideal conditions set by conventional mortgages.

For example, affording a large down payment is a challenge for many first-time buyers, but FHA loans allow you to initiate a mortgage with only 3.5% down. The FHA also guarantees your loan through this program, allowing lenders to accept borrowers with lower credit scores. However, you’ll likely have to pay ongoing insurance premiums to protect the lender, so there may be better options.

VA Loans

If you’re a current or former service member, you can benefit from the VA loans program, in which the U.S. Department of Veterans Affairs backs mortgages that could help you secure a home loan without a down payment.

Notably, the VA has minimum requirements for income and debt, but lenders may add additional requirements, as well. VA loans are one of the few $0 down payment loan programs, along with USDA loans.

USDA Loans

If you’re looking for a loan as a first-time homebuyer, the U.S. Department of Agriculture has a program to help people living in rural areas. If you live in a qualifying area, the USDA offers mortgages with no down payment required. Granted, there can be some restrictions on income, although it depends upon your location. Generally, the population or the area will need to be less than 30,000 people in order to qualify as a rural area. And, if you don’t intend to put any money down, this will be one of several important home buying questions to ask your mortgage broker or lender upfront.

Fannie Mae & Freddie Mac

Fannie Mae and Freddie Mac are government-sponsored organizations that make homebuying more affordable by providing conventional loans with discounts. This could mean that you only have to make a 3% down payment with the help of these organizations.

Keep in mind that, when utilizing Fannie Mae and Freddie Mac for a first-time homebuyer loan, you’ll need to have a good credit score.

Good Neighbor Next Door

If you’re a teacher, police officer, firefighter, or emergency medical technician, you could get a discount of up to half off the price of a new home. The program was created by the U.S. Department of Housing and Urban Development (HUD) to provide access to discounted homes for these vital workers.

It’s worth noting that the homes are in locations that are classified as revitalization areas with lower homeownership rates and household incomes. There are also some restrictions on these properties, including the requirement to continue to live in the home for at least three years. But, if you find a home that you’re interested in, act quickly, as the homes are only listed on their website for seven days.

Dollar Homes

HUD also operates a program in which it sells homes for as little as a dollar. And, while you may find it very difficult to find anything other than a tiny property for that amount, they don’t have many homes available on their site, either. Most homes are more expensive than $1, but they do offer a great value compared to conventional listings, as these are homes that were foreclosures and then acquired by the FHA.

State Programs

While these programs are national, you might be lucky to be in an area where the local government offers assistance to first-time homebuyers. You can see what is available to you by browsing your local government website.

Renovation Loan Programs

If you’re interested in buying a home that needs some renovation, there’s more help available, as well. In fact, there are numerous renovation loan programs to choose from as a first-time homebuyer.

Energy Efficient Mortgages

The Energy Efficient Mortgage program (EEM) can help you buy a larger home while saving money on your bills. Note that the home will need to be assessed to find the cost of energy-saving improvements and to evaluate the savings that can be made each month. Then, if the energy-saving improvements are cost-effective, this amount can be added to the mortgage. While your mortgage payments will be slightly higher, you’ll also be saving each month on your energy costs once the improvements have been completed.

If you’re looking to buy an older home, this can be a great way to save money in the long term while adding value to your home. And, because this can be applied to any mortgage, you can also use it in addition to one of the other loan programs previously mentioned.

203(k) Loans

If you’re looking to buy a home that needs a lot of improvements, the FHA’s 203(k) loan program could be for you. This type of loan considers the property’s value once it has been renovated, which will allow you to borrow the money you need to complete the improvements.

The 203(k) loan can also be a great mortgage product to utilize if you bought a foreclosed home and need to do any renovations or improvements.

HomeStyle

Fannie Mae also offers a loan program to help you buy a home that needs renovations. Similar to the 203(k) loan program, it allows you to complete structural and cosmetic renovations on a new property. It also offers an option for a down payment as low as 3% of your mortgage.

CHOICERenovation

Freddie Mac has a program for homes that need improvement, as well. It also offers low down payment requirements and you can finance renovations for up to 75% of the completed value.

Buying your first home is difficult enough, so make the process a little easier by taking advantage of the programs available to you and research these programs to determine which one suits your situation the best. By doing so, you’ll be able to purchase your home at a better interest rate and with a lower down payment and fees.

It’s also essential to note that if you’re self-employed or do a large volume of cash business, the lender will want to verify where your funds are coming from. There will also be far more scrutiny when you have large cash deposits.

As a first-time buyer, you have many choices when it comes to financing. Make sure you do your due diligence before ultimately deciding which financing program is best for you.

 

What Is a Second Mortgage and How Does It Work?

If you’re a homeowner looking to unlock the equity you’ve built up in your home, you might have heard about second mortgages. But, amid a wealth of other options, it’s difficult to know whether it’s the right choice for you. So, let’s see exactly what a second mortgage is, how it works and what the pros and cons are.

What Is a Second Mortgage?

A second mortgage is more or less what it sounds like. As a homeowner with a standard mortgage, you build up equity over time — equity being the portion of the home you own by paying off the original mortgage each month. With a second mortgage, you can take that equity and spend it elsewhere. In fact, it can be spent on pretty much anything you like.

Home Equity: The Basics

Before delving into second mortgages, it’s worth covering the basics of equity. With each mortgage payment you make, you’ll pay interest, but also principal. As you pay principal, the equity you own increases and the more home you own.

Your equity can also grow in other ways. If you’ve made upgrades to your home or the local market is particularly strong, your equity will increase with your home’s assessed value. In the same way, it can also drop if the opposite is true.

With a second mortgage, the more equity you have, the larger the loan you can qualify for.

How Does a Second Mortgage Work?

Normally, the equity you have in your home is tied up, but a second mortgage essentially unlocks it. However, lenders won’t typically allow you to use all of your equity. The amount available is generally calculated by looking at how much equity you have, the amount you still owe on your first mortgage, and your home’s assessed value. In most cases, lenders will ensure that you still have at least 20% of the value of your home left in equity.

After successful application, your lender may offer a lump-sum payment or monthly installments. Either way, you’ll be required to pay back the loan each month. This adds a second monthly payment on top of your regular mortgage payments. If you fail to make the payments on your second mortgage, the equity you’ve built up in your home will be used as collateral.

Do I Qualify for a Second Mortgage?

To qualify for a second mortgage, you’ll need to have built up enough equity, have a credit score of at least 620 and a debt-to-income (DTI) ratio of less than 43%. It’s possible to obtain a second mortgage from your current lender, though they will typically offer higher interest rates than if you applied with a different lender.

Second Mortgage vs. Refinancing

There’s a big difference between taking out a second mortgage and refinancing an existing one. With a second mortgage, you’re adding a new monthly payment on top of the existing one. However, when you refinance a mortgage, you cash out your equity and renegotiate the terms of the loan with the same lender. As such, you only pay one monthly payment when you choose to refinance.

Lenders offering a second mortgage typically take on more risk than lenders who are refinancing an existing mortgage. This is because with a second mortgage, if you fail to make payments and your home goes into foreclosure, the original lender takes priority. The second lender only gets paid after the first has been fully repaid.

As a result, interest charges on a second mortgage are generally much higher than on a refinanced mortgage.

Pros & Cons of Getting a Second Mortgage

Advantages

The main advantages of taking out a second mortgage include:

  • Large loan amount: if you’ve been paying off your first mortgage for many years, you will have built up a lot of equity. In some cases, lenders will allow you to use up to 90% of your equity. This is typically a far larger amount than any other type of loan.
  • No restrictions on use: you can use the loan for anything you want, from investments to home repairs and anything in between.
  • Lower interest rates: compared to credit cards and many other personal loans, a second mortgage typically offers lower rates. This makes it a good choice for paying off large credit card debts.

Disadvantages

However, there are a few disadvantages too:

  • Additional monthly payment: with two mortgage payments to make each month, this can strain your finances, potentially leading to missed payments.
  • Higher interest rates: compared to refinancing your mortgage, you’ll pay more in interest with a second mortgage.

All in all, a second mortgage can be a great option, working especially well for investments.

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.