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Auto Loan

How to Handle an Upside-Down Car Loan

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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Upside-down. Negative equity. Underwater. No matter what you call it, it means you owe more on your car than it’s currently worth. While it happens to most people who finance the purchase of a vehicle at some point, it’s not a good place to be — especially when you’re planning on selling the car or trading it in for a newer model.

It’s also a situation that’s becoming more common. According to the Edmunds Used Vehicle Market Report for the third quarter of 2016, a record 25 percent of all trade-ins toward a used car purchase have negative equity, and the average negative equity at the time of trade-in was $3,635 — also a record in the used-car market.

You can find out if you’re in this position by looking up the value of your vehicle using a research tool such as Kelley Blue Book. If the value is less than the balance on your current car loan, you are upside-down.

Part I: How do you get upside-down in the first place?

There are some reasons car loans may be upside-down.

Low down payment

Dealerships often offer incentives for new cars, including very low or no down payment loans. A new car loses about 20 percent of its value in the first year, so a small down payment can quickly cause the balance of your loan to soar above its actual value. A healthy down payment can help keep your loan balance in line with the worth of your car.

High interest rate

Remember to shop around for an auto loan, because the higher the interest rate, the less you’re paying toward principal each month. That makes it more likely you’ll become upside-down, even if you made a decent down payment.

Anthony Curren, a sales and marketing manager and salesperson with Rick Curren Auto Sales in Corning, N.Y., says he sees this happen pretty regularly when disreputable salespeople charge higher interest rates to make more money off a loan.

“This happened to my girlfriend before we met,” Curren says. “She had an 800-plus credit score and got stuck in a loan charging 5 percent interest. She should have been paying 2 percent or less at that time.”

Longer loan term

According to Experian’s State of the Automotive Finance Market report for the second quarter of 2017, the average length of a new auto loan is currently nearing 69 months. While longer loan terms may keep your monthly payment low, you’ll end up paying more interest, and you’re more likely to be upside-down.

Past upside-down loan

You could be upside-down because you carried negative equity over from your last car loan. Many dealers offer what’s known as a rollover loan: When people trade in an upside-down vehicle, the dealership rolls the negative equity into the purchase of their next car. With a rollover loan, you are upside-down before you even drive off the lot.

People who trade up for a new vehicle every couple of years are most likely to have car loans with rolled-over negative equity. In the first few years of a new car loan, your car depreciates faster while your loan balance declines the slowest due to interest. This means many people are upside down in the early years of their loans. The longer you keep the vehicle, the more likely it is that the loan balance will be less than the current value of the vehicle.

Being upside-down on your car loan may not pose a problem, as long as you are planning on holding onto the car until you have some equity in it. But if an unforeseen financial setback means you need to sell the car, you may need to come up with extra cash to pay off the loan difference. And if your car is wrecked or stolen, your insurance may not pay out enough to retire the loan.

Part II: How to get out of an upside-down car loan

The first step to dealing with an upside-down car loan is knowing your numbers.

Step 1: Figure out how much you owe.

The fastest and most accurate way to find out how much you owe on your loan is to contact your finance company. If you are planning on selling or trading in your car right away, you’ll need to know the payoff amount, not just the amount remaining on your principal. The payoff amount is how much you actually have to pay to satisfy the terms of your loan. It includes the payment of any interest you owe through the day you intend to pay off the loan, as well as any prepayment penalties.

You may be able to find this figure by logging into your lender’s online account portal. Otherwise, you’ll have to call the finance company.

Step 2: Figure out how much your car is worth

You can get a value estimate using Kelley Blue Book’s What’s My Car Worth tool. You’ll need to provide the car’s year, make, model, mileage, style or trim level (the alphanumeric code that helps identify at what level the vehicle is equipped), and the car’s condition. If you’re not sure how to rate your car’s condition, you can take a quick quiz to help you assess it.

Once you input those details, you’ll receive a range suggesting how much (or how little) you can expect to receive from a dealer for a trade-in. Keep in mind that every dealer is different, but you may be able to negotiate.

Step 3: Calculate your negative equity

If the payoff amount on your loan is greater than the value of your car, you are, as we’ve said, upside-down. Subtract the value of your car from the payoff amount to find out how underwater you are. If the difference is small, you may be able to make extra payments toward the loan’s principal to catch up. If the difference is significant, you may have to take more drastic steps.

Step 4: Strategize remedies

If you find yourself upside-down on your car loan, the most prudent course of action is continue to pay down the debt until you have some equity in the car. You can hasten the process by making extra payments toward the loan’s principal.

If that isn’t an option, here are a few other ideas.

Pay off the car with a home equity loan or line of credit

As with most things in life, there are pros and cons to paying off a car loan with a home equity loan or line of credit (HELOC). One advantage is that you can typically lengthen your repayment period, thereby reducing your monthly payment. HELOCs also have more flexible repayment options, compared with the fixed monthly payment that comes with an auto loan. This may be a good option if you’re having trouble making your monthly payment due to a temporary financial setback.

The second advantage of paying off your car loan in this fashion: The interest paid on your HELOC is typically tax-deductible, while interest on your car loan is not. Keep in mind that you’ll have to itemize deductions on your tax return to take advantage of this benefit. If you take the standard deduction, there’s no tax advantage.

But before you pay off a car loan with a HELOC, consider the downsides. First off, HELOCs are often variable-rate loans. If interest rates rise, your monthly payment could go up. Second, even if the interest rate on your HELOC is lower than the interest rate on your car loan, you could end up paying more in interest by stretching out the loan term. Finally, if you can’t make your HELOC payments, you could lose your home.

If you decide to take this route, make a plan to pay down the HELOC as soon as possible. Otherwise, it could well outlive your car, and you’ll be paying off the HELOC and a new loan for your next vehicle at the same time.

Pay off the car with a personal loan

Paying off a car loan with a personal loan could be a good option if you plan on selling your car without buying a new one. In that case, you would sell the car, use the proceeds to pay down the balance of the car loan, then refinance the remaining balance with a personal loan.

However, keep in mind that auto loans are secured by collateral (the car). If you’re unable to pay, the lender can repossess the car. Personal loans are unsecured. If you stop paying, the lender has fewer options for recovering the money. For this reason, personal loans usually come with higher interest rates than auto loans.

The Federal Reserve Bank’s survey of commercial bank interest rates for the second quarter of 2017 shows just how much higher those rates can be. The average 60-month new car loan comes with an APR of 4.24 percent. The average 24-month personal loan has an APR of 10.13 percent. So with the typical personal loan, you’ll pay more than twice as much interest in half the time. Hard to see that as a good deal.

Refinance the car loan

Refinancing your car loan can help in a few ways. You may be able to lower your interest rate and lower the term of your loan, both of which will help you get equity in your car sooner. Curren says deciding whether refinancing is the right option depends on the remaining loan term and interest rate.

He uses the hypothetical example of a person who, because of credit issues, used a subprime loan with an interest rate of 22.9 percent to purchase a car. “My advice to that person is to build their credit up as much as possible and as quickly as possible,” Curren says. “In one year, they should be looking at refinancing the loan with an interest rate as low as 6 or 7 percent, which is still relatively high, but much more palatable. It will save them thousands of dollars in repayment.”

However, Curren says he doesn’t offer the same advice to someone with only a year or two left on a loan. “At that point, the savings is minimal,” he says. “The better advice is to pay off the car quicker.”

Part III: What to watch out for when you have an upside-down car loan

Car dealers push the latest vehicle designs and advertise very attractive incentives for trading in your old vehicle, no matter how upside-down you are at the moment. But take heed: You’ll want to be very careful about trading in an upside-down vehicle for a new loan. Here’s a look at the problems that can arise:

Rolled-over negative equity

As we mentioned above, many car dealers are willing to roll the negative equity from your old car loan into a new loan. This is a popular option because it doesn’t require coming up with any money immediately. But it also means your new car will be underwater before you even drive it home. That new car may be fun to drive, but your monthly will be higher because it includes the cost of your new vehicle and the remaining balance on the old one.

Dealer cash incentives

Some car dealers offer cash incentives that can help pay off your negative equity. For example, if you have $1,000 in negative equity on your current car loan, you could buy a new car with a $2,500 rebate, use $1,000 of the rebate to pay off the negative equity, and still have $1,500 left over to use as a down payment on the new car.

But be wary of dealers advertising they’ll “pay off your loan no matter how much you owe.” The FTC warns consumers that these promises may be misleading because dealers may roll the negative equity into your new loan, deduct it from your down payment, or both. If the dealer promises to pay off your negative equity, read your sales contract very carefully to make sure it’s not somehow folded into your new loan.

Part IV: How to avoid an upside-down car loan

Being upside-down on your car loan, at least for a little while, is very common. But there are things you can do to prevent it from happening.

  • Make a larger down payment. Because a car depreciates by around 20 percent in its first year, putting down 20 percent of the total purchase price (including taxes and fees) can help you avoid going underwater.
  • Choose a car that holds its value. Some makes and models hold their value better than others. Kelley Blue Book, Edmunds and other car research sites regularly release lists of car brands and individual models with the best resale value. Do your research and pick out a car that will depreciate more slowly.
  • Opt for a shorter loan term. Longer terms are more likely to leave you underwater in the early years of the loan because you’re paying less toward the principal each month. Try not to finance a car for longer than you plan on keeping it.
  • Shop around for the lowest rate. The lower your interest rate, the more money you’ll pay toward principal each month. Don’t settle for the first offer you receive at a dealership. Shop around for a car loan before you go to the dealer, so you can feel confident you’re getting the best deal.
  • Avoid unnecessary options. Sunroofs, leather upholstery, rust proofing, extended warranties, fabric protection, chrome wheels — all these attractive add-ons are often overpriced. They’ll increase the purchase price of your vehicle, but rarely add long-term value.

Final thoughts

Being upside-down on your car loan is not an ideal situation, but you do have options. Understand the circumstances that led you to be upside-down in the first place can help keep the problem from recurring, or from carrying over to your next loan.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Mortgage

The Complete Guide to FHA Loans

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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Saving up for a big down payment on a home could be the kind of financial obstacle that prevents first-time homebuyers with little savings from ever becoming homeowners. Fortunately, government-backed Federal Housing Administration (FHA) loans can help potential homebuyers who want a home but struggle to pull together a large down payment.

This guide will cover the pros and cons of using an FHA loan to purchase a home and how homebuyers can begin the process of shopping and getting approved for these loans.

Part I: Understanding FHA Loans

What is an FHA loan?

FHA loans are insured by the Federal Housing Administration, which means that the federal government makes a guarantee to the bank that the government will repay the borrower’s loan if the borrower stops making payments. This guarantee means banks are willing to provide funding to borrowers who may not otherwise be able to qualify for a home loan.

FHA loans are not funded or underwritten directly by the FHA, but rather by FHA-approved lenders. These lenders can be found using the Lender Search tool. Interest rates and fees vary by lender, even for the same type of loan, so it’s important to shop around.

Benefits of FHA loans

FHA loans are designed to promote homeownership and make it easier for people to qualify for mortgages. For that reason, they typically have more flexible lending requirements than conventional loans, including:

Lower minimum credit scores

Many loan programs require a credit score of at least 620 or 640, but FHA loans are available to borrowers with scores as low as 500.

Lower down payments

Borrowers can get FHA loans with as little as 3.5 percent down. However, borrowers with credit scores between 500 and 579 will need at least 10 percent down.

Not just for first-time homebuyers

Although their flexible terms and low down payments make FHA loans appealing to first-time homebuyers, they’re also available to repeat buyers as long as the proceeds are used to purchase a primary residence.

Seller assistance with closing costs

Yael Ishakis, the vice president of FM Home Loans in Brooklyn, N.Y., says another benefit of FHA loans is that they allow sellers to assist with up to 6 percent of sales price for closing costs, including origination fees, points and other closing costs. This helps borrowers struggling to come up with a down payment cover some of the additional costs involved in closing on a home loan. Sellers may not be willing to pay closing costs in a hot housing market, but in a down market, helping with closing costs can mean a faster sale. For conventional loans, the seller can contribute no more than 3 percent toward closing costs unless the buyer has a down payment greater than 10 percent.

Drawbacks of FHA loans

FHA loans are appealing to many borrowers, but they’re not always the best choice. Here are a few reasons you may want to look into alternatives.

Mortgage insurance

FHA loans require mortgage insurance, a policy that protects the lender against losses from defaults on home mortgages. FHA loans require both upfront and monthly mortgage insurance from all borrowers, regardless of the amount of the down payment.

On a 30-year mortgage with a base loan amount of less than $625,500, the annual mortgage insurance premium would be 0.85 percent of the base loan amount, and the upfront mortgage insurance premium would be 1.75 percent of the base loan amount as of this writing.

With a conventional loan, the borrower can avoid mortgage insurance by putting at least 20 percent down. They can also request to have their mortgage insurance premiums removed from their monthly payment once the loan is at 78 percent of the home’s current value, as long as the borrower has been making on-time payments for at least one year. With an FHA loan, mortgage insurance is required for the life of the loan.

Ishakis says this aspect of FHA loans causes her to hesitate before offering FHA loan options to buyers. If an FHA borrower’s home goes up in value, the only way to have the mortgage insurance removed is to refinance to a conventional loan. The refi would require more paperwork, closing costs, and a potential increase to their interest rate if rates have increased. With a conventional loan, getting mortgage insurance removed simply requires sending a written request to the lender once you’ve met the requirements.

Documentation requirements

  • Most recent two months of bank statements
  • Most recent 30 days of pay stubs
  • Most recent two years of W-2s
  • Two years of tax returns
  • Gift letter (if using gifted funds for the down payment or closing costs)

If you have been divorced in the past, declared bankruptcy, are self-employed, or earn income based on commissions, you may be required to provide even more documentation.

FHA Loan

Conventional Loan

Minimum credit score

500

620

Minimum down
payment

3.5%

3%

Maximum seller-
assisted closing costs

6%

  • 3% with down payments
    less than 10%

  • 6% with down payments
    between 10% and 25%

  • 9% with down payments
    greater than 25%

Upfront mortgage
insurance

1.75%

None

Monthly mortgage
insurance

0.85%

Varies based on credit score
and loan-to-value ratio

Borrowers who are able to qualify for a conventional loan may be better off choosing a conventional loan rather than an FHA loan. Conventional loans can require a slightly lower down payment and do not require any upfront mortgage insurance, and borrowers can request to have their monthly mortgage insurance payments removed once they have at least 20 percent equity in the home and have made on-time payments for one year. That can all add up to significant savings over the life of the loan.

Part II: FHA Loan Requirements

With their flexible requirements and low barriers to approval, FHA loans are some of the easiest loans to qualify for. Here’s a look at FHA loan requirements.

Minimum credit score requirements

The minimum credit score for an FHA loan with a 3.5 percent down payment is typically 580. If your credit score is between 500 and 579, you may be approved for an FHA loan, but you will need to put at least 10 percent down.

These are FHA guidelines, but individual lenders may have their own requirements, referred to as lender overlays. A particular lender may require a minimum credit score of 640 or higher, so if you are turned down for an FHA loan by one bank, it’s a good idea to try others.

Income requirements

The FHA does not have minimum or maximum income requirements. However, borrowers must have sufficient income to be able to afford the mortgage payments and their other obligations. Part of the approval process involves verifying your employment and income, but the amount you earn is not as important as the amount of income you have left over after paying your other monthly bills.

Debt-to-income ratio requirements

Debt-to-income (DTI) ratio is another key metric FHA-approved lenders consider when determining whether you can afford a mortgage. DTI measures the amount of debt you have compared to your income, and it is expressed as a percentage.

Lenders look at two debt-to-income ratios when determining your eligibility:

  • Housing ratio or front-end ratio. What percentage of your income would it take to cover your total monthly mortgage payment? According to Kevin Miller, Director of Growth at Open Listings, lenders like to see a front-end ratio below 31 percent of your gross income, although approval with a percentage up to 40 percent is possible depending on the circumstance.
  • Total debt or back-end ratio. Shows how much of your income is needed to pay for your total monthly debts. Miller says lenders prefer a back-end ratio of less than 43 percent of your gross income, although approval with a percentage of up to 50 percent is possible.

Down payment requirements

FHA loans require a down payment of at least 3.5 percent of the purchase price, or 10 percent if your credit score is below 580. In addition to the down payment, the borrower may have to pay other upfront costs including appraisal and inspection fees, upfront mortgage insurance, real estate taxes, homeowners insurance, homeowners association dues, and more.

However, the FHA allows sellers to cover up to 6 percent of closing costs and allows closing costs to be gifted from friends or family members.

Clear CAIVRS report

Any federal debt that hasn’t been repaid and has entered default status can prevent you from getting an FHA loan. The government keeps track of people who default on all types of federal debts, like government-backed mortgage loans, SBA loans, and even federal student loans.

The system they use to track defaults is called the Credit Alert Verification Reporting System (CAIVRS). Borrowers do not have access to CAIVRS, so you’ll have to consult an FHA-approved lender to learn whether you are in the system.

If the delinquency was for a prior FHA-backed loan, you’ll have to wait three years from the time that the Department of Housing and Urban Development (HUD) paid the mortgage lender’s insurance claim.

FHA loan limits

The FHA puts a cap on the size of a mortgage that it will insure. These loan limits are calculated and updated annually and announced by HUD near the end of each calendar year.

Because the cost of living can vary widely throughout the country, FHA loan limits differ from one county to the next. The national maximum for an FHA loan is currently $636,150, but in low-cost areas, the maximum can go as low as $275,665 for a single-family home. You can look up the limit in your area using HUD’s FHA Mortgage Limits lookup tool.

FHA mortgage limits are calculated based on 115 percent of the median home price in the county, as determined by the Federal Housing Finance Agency.

Property requirements

FHA loans are only available when the borrower intends to use the property as a primary residence — investment properties are not eligible.

In addition, the property you intend to purchase must meet certain requirements to qualify for an FHA mortgage. Every FHA loan requires the property to be appraised and inspected by a HUD-approved home appraiser to verify the current market value of the property and ensure it meets HUD’s minimum property standards.

The appraiser will look at the roof, foundation, lot grade, ventilation, mechanical systems, heating, electricity, and crawl space in the home. Their standards are outlined in great detail in HUD’s Single Family Housing Policy Handbook, but essentially the property must not be hazardous or threaten the health and safety of the buyer who will live in the home.

Safety hazards noted during the appraisal will not automatically disqualify the property from an FHA loan. If the issue can be corrected before final inspection — such as the seller repairing a leaking roof — the loan can move forward.

Part III: Types of FHA Loans

There are several types of FHA loans to meet the needs of different homeowners. Here’s a look at the options available.

Fixed-rate mortgages

Fixed-rate mortgages are the most common type of FHA loans. The borrower chooses a loan term between 10 and 30 years, and the interest rate will not change over the life of the loan.

Adjustable-rate mortgages

Adjustable-rate mortgages (ARMs) also have terms between 10 and 30 years, but as the name implies, the interest rate can change periodically, so the payments can go up or down. The initial interest rate on an ARM is lower than that of a fixed-rate mortgage, so this can be a good option for a borrower who plans to own their home for only a few years.

Many ARMs are hybrids, meaning there is an initial period during which the rate is fixed. After that, the rate changes at regular intervals. Most ARMs have caps that limit how much the rate can change at any one time and throughout the life of the loan.

FHA loans offer the following interest rate cap structures for ARMs:

  • One- and three-year ARMs may increase by 1% annually after the initial fixed-rate period and 5% points over the life of the loan
  • Five-year ARMs may either allow for increases of 1% points annually and 5% points over the life of the loan, or increases of 2% points annually and 6% points over the life of the loan
  • Seven- and 10-year ARMs may only increase by 2% annually after the initial fixed-interest rate period, and 6% over the life of the loan

FHA reverse mortgages

Seniors with a paid-off mortgage or significant equity in their home may be able to access a portion of their home’s equity with an FHA Home Equity Conversion Mortgage (HECM), commonly referred to as a reverse mortgage.

The loan is called a reverse mortgage because instead of the borrower making monthly payments to the lender, as with a traditional mortgage, the lender makes payments to the borrower. The borrower is not required to pay back the loan unless the home is sold or otherwise vacated.

Many seniors use reverse mortgages to supplement Social Security income, meet unexpected medical expenses, make home improvements, and more.

Energy Efficient Mortgages

The FHA’s Energy Efficient Mortgage (EEM) program is designed to help homeowners save on utility bills by financing energy-efficient improvements with an FHA loan. The program is available as part of a home purchase or by refinancing the current mortgage.

To qualify for an EEM, the borrower must first get a Home Energy Rating Systems Report performed by a professional rater. The rater inspects everything in the home, from insulation to appliances and windows. Once the property’s current energy efficiency is calculated, the inspector makes recommendations for energy-efficient upgrades.

EEMs are available for $4,000 or 5 percent of the property value up to $8,000. If the EEM is included in the initial home purchase, you do not need to come up with a larger down payment.

FHA 203(k) loans

Homebuyers looking to buy a fixer-upper may be interested in an FHA 203(k) mortgage. This program allows homeowners and homebuyers to finance up to $35,000 into their mortgage for repairs and improvements.

These loans often make it possible for buyers to purchase and rehabilitate properties that other lenders won’t touch because the property is in such bad shape. The loan includes money to purchase the property, enough to make necessary improvements, and, in certain cases, enough to cover rent or the borrower’s existing mortgage for up to six months so the buyer has another place to live while the home is being renovated.

Part IV: Shopping for FHA Loans

As mentioned previously, FHA loans are notorious for requiring a lot of documentation. Here’s a list to get you started:

  • Address of your place of residence
  • Social Security number(s)
  • Names and locations of your employer(s)
  • Gross monthly salary at your current job(s)
  • Two years of completed tax returns (three if you are self-employed)
  • Two years of W-2s, 1099s, or other income statements
  • Most recent month of pay stubs
  • Recent statements for all open loans (such as student loans or car loans)
  • A year-to-date profit-and-loss statement for self-employed individuals
  • Most recent three months of bank, retirement, stocks, and/or mutual fund statements
  • Contact information for your landlord or current mortgage lender
  • Bankruptcy and discharge papers (if applicable)
  • Copies of driver’s license(s)
  • Social Security card(s)
  • Copy of divorce decree (if applicable)
  • Letters of explanation for any past credit issues, bankruptcies, or foreclosures (if applicable)
  • Gift letter if your down payment or closing funds are a gift from friends or family members
  • If you are refinancing or you own another property, you will also need:
  • Note and deed from current loan
  • Property tax bill
  • Homeowners insurance policy

Your lender will also have you sign multiple documents, including authorization to pull your credit report, verify your employment, and obtain a transcript of your tax return from the Internal Revenue Service.

As you get closer to your closing date, you may need to update many of these documents. For instance, if you provided a January bank statement and pay stubs when you started your loan process and your loan doesn’t close until March, your loan officer will likely need a copy of your February bank statement and pay stubs to finalize your loan.

Where can you compare FHA loan rates?

As mentioned above, FHA loans are not provided directly by the FHA, but by FHA-approved lenders, so rates can vary depending on which bank you work with. For that reason, it’s a good idea to shop around for the best rate.

Fortunately, some resources allow you to do a lot of your initial mortgage rate shopping online.

Check out LendingTree’s FHA loan rates here. By filling out an online form with questions about the type of property you’re purchasing, city, state, and a few other details, you can compare personalized rates from several lenders. Note: LendingTree is the parent company of MagnifyMoney.

Part V: The FHA Closing Process

The HUD Handbook 4155.2 explains the FHA loan process in detail, from identifying a lender to the lender’s responsibilities after the loan is closed. The time it takes to close on an FHA loan is pretty comparable to other types of loans. According to a recent Origination Insight Report from Ellie Mae, in August of 2017, FHA loans for new purchases took an average of 44 days to close, compared to 42 days for conventional loans.

Here are the steps that apply to borrowers:

  1. Lender identification. Contact a HUD-approved lender to find out if you are eligible for an FHA loan. All of the major banks and many smaller, regional lenders participate in the FHA loan program.
  2. Loan application. The lender will help you complete a loan application and request a variety of financial documents.
  3. Case number assigned. Every FHA mortgage is assigned a case number that identifies the individual loan and borrower.
  4. Property appraisal. The lender will order a property appraisal from a HUD-approved appraiser to verify the market value of the home and that it meets all of HUD’s property requirements.
  5. Mortgage underwriting. The underwriter reviews your file in accordance with HUD’s guidelines to determine whether you have the ability to repay the loan. They’ll take a close look at your credit history, employment situation, income stability, debt-to-income ratio, and other factors.
  6. Underwriting decision. If your application is approved, you are “clear to close” and will move on to the closing process. If your file is rejected for some reason, the lender will notify you of the underwriter’s decision and will likely tell you why the underwriter came to that decision.
  7. Closing process. The lender “closes” the loan by having all documents signed and ensuring that all money is distributed to the appropriate parties. Borrowers should review all loan documents carefully to ensure accuracy. This is also the time when you’ll need to present a cashier’s check or wire funds from your bank to cover closing costs.

Before you sign

The closing process can be a ceremonious event. It may take place in your lender’s or realtor’s office. You’ll be handed a pen and a big stack of documents that require your signature. A notary will likely be present to witness your signature. But don’t let the pomp and circumstances distract you from the task at hand: making one of the largest financial transactions of your life.

Before you get to closing, you should receive a loan estimate that lays out the important information about your loan, including the loan amount, projected interest rate, estimated monthly payment, and estimated funds required to close. Your interest may be locked in. This means your rate won’t change between the offer and closing date, as long as there are no changes to your application and you close within the specified time frame.

At least three business days before closing, you should receive a Closing Disclosure form listing all final terms of the loan you’ve selected and final closing costs. When you sit down to sign the loan documents at closing, double-check the details to ensure your final documents agree with the Closing Disclosure. The Consumer Financial Protection Bureau has an excellent interactive tool explaining all of the parts of your Closing Disclosure and the details you should review.

Your lender or realtor should give you a list of items to bring with you to the closing. This will likely include a cashier’s check or proof of wire transfer for the funds you need to close and your driver’s license.

Ask questions to ensure you feel comfortable with everything you’re signing and make sure you know when and where to send your first mortgage payment and when it will be due.

Closing costs to consider

Your Closing Disclosure will show all of the closing costs required to finalize your loan. Some of them may be financed into your loan, some may be paid by the seller, and some are your responsibility. Closing costs vary based on where you live and the property you buy. Here’s a list of some common ones:

  • Application fee. Covers the cost of the lender to process your application.
  • Appraisal. Paid to the appraisal company to confirm the value of your home.
  • Attorney fee. Paid to an attorney to review the closing documents on behalf of the buyer or lender.
  • Escrow fee. Paid to the title company or escrow company that oversees the closing of your home purchase.
  • Credit report. The cost of pulling your credit report and credit score.
  • Escrow deposits. You may be required to put down two months or more of property taxes and mortgage insurance payments at closing.
  • Upfront mortgage insurance premium. FHA loans require an upfront mortgage insurance premium of 1.75 percent of the loan amount.
  • Homeowners insurance. Homeowners insurance covers possible damage to your home. The lender may require that you pay the first year’s premium at closing.
  • Origination fee. Covers the lender’s administrative costs.
  • Prepaid interest. The lender may require you to prepay any interest that will accrue between your closing date and the date your first mortgage payment is due.
  • Recording fees. Charges by your local city or county for recording public records.
  • Title company search. A fee paid to the title company for doing a thorough search of the property’s records to ensure that no one else has a legal claim to the property.

Closing costs typically run 3 to 5 percent of the loan amount.

FAQ

Still wondering whether an FHA loan is right for you? The following are some frequently asked questions about FHA loans that may help you decide.

Yes! FHA guidelines require borrowers to wait two years from the discharge of a Chapter 7 bankruptcy or one year from the discharge of a Chapter 13 bankruptcy before applying for an FHA loan. In addition to meeting the waiting period, borrowers with bankruptcies should be able to demonstrate that they’ve worked to re-establish good credit or chosen not to incur any new debts since the bankruptcy. Borrowers will also have to submit a letter of explanation detailing the circumstances that lead to the bankruptcy with their loan application.

Yes. Having a co-signer may improve your chances of getting approved for the loan, especially if it’s a high debt-to-income ratio holding you back from getting approved. The co-signer must also submit to an underwriter review of their income and credit as they will be liable for repayment of the loan if the borrower fails to meet their obligation.

Yes. You can refinance an existing mortgage to a new FHA loan in a streamline refinance as long as you’ve made at least six monthly payments on your current mortgage and it’s been at least 210 days since the closing of that loan. You cannot have any payments overdue by more than 30 days and no late payments in the past 90 days. If you qualify, the streamline refinance does not require an appraisal, credit qualification, or employment verification.

You can also refinance an FHA loan into a conventional loan. This is often a good option for borrowers whose home has increased in value substantially. Since some FHA loans require mortgage insurance be paid during the entire life of the loan, refinancing to a conventional loan can eliminate mortgage insurance.

No. While FHA loans are popular among first-time homebuyers due to their low down payments and flexible requirements, they are available to repeat buyers as long as the loan is being used to purchase a primary residence.

No. FHA loans are only available for purchasing a buyer’s primary residence. However, you can use an FHA loan to buy a property with up to four units, as long as you will live in one unit while renting out the others.

The FHA allows 100 percent of the down payment and closing cost funds to be gifted, as long as the donor signs a gift letter stating that the money is a gift and does not have to be repaid.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Small Business

How to Find Your Best VA Business Loan Options in 2017

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Source: iStock

Veteran-owned businesses make up just under 10 percent of all businesses in the U.S., according to a 2017 report by the Small Business Administration. Despite veterans’ propensity toward entrepreneurship, funding options for veteran-owned business can be difficult to find. According to the same report, nearly 60 percent of veterans’ startup or acquisition capital comes from personal or family savings, while less than 10 percent comes from loans from federal, state, or local government, government-backed business loans from banks, or business loans from banks or other financial institutions.

Obtaining startup financing is always a challenge, but veterans may have an especially difficult time. Because their housing, transportation, and many other daily necessities are handled by the military, they may not have built credit while actively serving.

Fortunately, many organizations, including the U.S. Department of Veterans Affairs (VA) and the U.S. Small Business Administration (SBA) have stepped up to provide resources for veteran entrepreneurs. In this guide, we’ll take a look at the options available for current veteran business owners and veterans looking to start their own business.

Traditional bank loans

Borrowers who bank with a financial institution that caters to military members should talk to a loan officer at their bank first.

Navy Federal Credit Union provides small business financing of up to $50,000 through a combination of term loans, business credit cards, vehicle loans, and business checking lines of credit. A four-page application is available on their website and can be submitted online.

Fort Knox Federal Credit Union, which is available to active duty military, reserve, National Guard, and civil service employees and retired military or civil service members, provides SBA-backed commercial real estate loans. You can request more information by filling out a Commercial Loan Request Form online.

Tammy Everts, a certified business adviser with the Spokane Small Business Development Center, says borrowers with a good credit score seeking a loan of less than $150,000 may be able to qualify for a loan based on their credit score alone. “Talk to your commercial banker where you already have a relationship,” Everts says. “If you’re denied there, then you can expand your search.”

SBA-guaranteed loans

Neither the VA nor the SBA loan money directly to veteran entrepreneurs, but the SBA does guarantee small business loans for veterans. This means that should the business default on the loan, the government will pay a portion of the remaining balance back to the lender. This guarantee encourages banks to lend to applicants that might otherwise be considered too great a risk.

Everts says veterans, unfortunately, have fewer options than they did a few years ago. Prior to 2013, the SBA offered the Patriot Express Loan targeted at helping veterans and active duty military with loans up to $500,000. That program ended, but Everts says it was rolled into the SBA Express Program under the name SBA Veterans Advantage

To qualify, the business must be owned and controlled (51 percent or greater) by a veteran.

The SBA defines a veteran as:

  • Veterans (not those dishonorably discharged)
  • Active-duty military participating in the Transition Assistance Program (TAP)
  • Reservists and National Guard members
  • Current spouses of any veterans, active duty service members, reservists, or National Guard members and widowed spouses of any service members who die while in service or of a service-connected disability.

To document eligibility, the borrower must provide a copy of Form DD 214 or other documentation as outlined in SBA Information Notice 5000-1390. Eligible veterans have four options under the Veterans Advantage Program:

SBA Express loans of $150,001 to $350,000

  • No upfront fees
  • Two-page application and response within 36 hours
  • The SBA guarantees 50 percent of the amount borrowed

SBA 7(a) loans $150,000 and under

  • No upfront fees through 9/30/17 (typically 1.5 percent of the guaranteed portion)
  • Terms up to 10 years for equipment and up to 25 years for real estate
  • The SBA guarantees 85 percent of the amount borrowed

Non-SBA Express loans $150,001 to $500,000

  • The upfront fee is 50 percent less than the fee charged to non-veteran owned small businesses as follows:
    • Loans with terms greater than 12 months: fee is 1.5 percent of the guaranteed portion
    • Loans with terms of 12 months or less: fee is 0.125 percent of the guaranteed portion

Loans of $500,001 to $5 million

  • For loans of $500,001 to $700,000, upfront fee is 3 percent of the guaranteed portion
  • For loans of $700,001 to $5 million, upfront fee is 3.5 percent of the guaranteed portion up to $1 million, plus 3.75 percent of the guaranteed portion over $1 million

Note that for all but the Express Loan, the reduced fees are applicable only for loans made until September 30, 2017. The fee waiver has been extended in the past, but there is no guarantee it will be extended again.

Interest rates on all SBA loans are negotiated between the lender and the borrower.

How to apply

To apply for an SBA-backed loan, borrowers can use the Lender Match tool available on the SBA’s website. Everts says qualifying for an SBA Veterans Advantage loan isn’t really different from other bank loans. “The bank will expect a 15 percent cash contribution from the business owner and a good credit score,” Everts says. “With a credit score over 700, the borrower may be able to get a loan with very little paperwork.

Nonprofit lenders

Nonprofit lenders can often provide small business funding when traditional banks won’t.

CDC Small Business Financing VetLoan Advantage

CDC Small Business Financing’s VetLoan Advantage Program is available to veterans looking to purchase commercial or industrial buildings and equipment.

The VetLoan Advantage loans are backed by the SBA, but they offer lower down payments (typically 10 percent). Mike Owen, Chief Credit Officer and Director of Business Development for CDC Small Business Finance, says CDC provides a cash rebate of up to $3,000 to help veterans offset loan expenses. Borrowers can prequalify for a loan online.

The Jonas Project

The Jonas Project provides startup funding, training, and mentorship for veteran women. To qualify, applicants must be a U.S. military veteran with honorable discharge verification, demonstrate knowledge or skill in their desired field of business, and pass an extensive interview and qualification process. Applications are available online.

Veterans Business Fund

Veterans Business Fund (VBF) was established to assist veterans by providing them with the supplemental capital required to satisfy the equity requirements for a small business loan. VBF loans are non-interest bearing.

Currently, the VBF is not accepting applications until their necessary fundraising is complete, but borrowers should check back in the future to find out more about the application process and requirements.

Microloans

If your borrowing needs are modest, a microloan may be the way to go. Microloans typically range from $500 to $100,000, although the definition of a microloan varies by lender.

Kabbage, a microlender that has provided over $3 billion in funding to more than 100,000 businesses, has a microloan program designed specifically for veteran-owned businesses. Borrowers can apply online or through the Kabbage mobile app for a line of credit up to $150,000.

Angel investment groups

Angel investors are affluent individuals who provide capital for a business startup, usually in exchange for ownership equity in the business. Some angel investors organize themselves into angel investment groups to share research, pool their investment capital, and provide advice to their portfolio companies.

Hivers and Strivers is a Great Falls, Va.-based angel investment group that focuses on investing and supporting startups founded and run by graduates of U.S. military academies. The group concentrates on investing $250,000 to $1 million in a single round, although they can work with other investment groups when larger financing rounds are needed.

Their investors, most of whom have also served in the military and have a broad range of experience in different industries and business models, will also serve as board members and advisers to the businesses they finance. Borrowers can submit their idea for consideration online.

Online lenders

Online lending platforms (sometimes referred to as peer-to-peer lending) are online services that match lenders with borrowers. Because they typically run with lower overhead, they often provide loans with better terms than traditional financial institutions.

StreetShares is an online lending platform that focuses on connecting veteran-owned and -run businesses with investors. They offer three different funding solutions:

Term loans

  • Loan amounts from $2,000 to $100,000
  • Terms of three to 36 months

Patriot Express line of credit

  • Lines of credit from $5,000 to $100,000
  • Terms of three to 36 months

Contract financing

  • Based on future earnings
  • No limit on contract amount

StreetShares only loans to borrowers who have been in business for at least one year and have “reasonable” credit. Borrowers can get pre-approved in minutes, and there is no application fee.

Grants

Grants are attractive to entrepreneurs without a lot of cash available to start or grow a business because, unlike a loan, the funds do not have to be repaid.

StreetShares Foundation

The StreetShares Foundation awards $10,000 in business grants to veterans and military spouses each month. Applicants must be a veteran, reserve, or active duty member of the U.S. armed forces or a spouse of a military member or veteran. Selection criteria are based on the business idea, use of funds and potential impact, product-market fit, team and company history, and influence of the business on the military and veterans community.

Applicants must qualify for the award by downloading or viewing educational materials, then complete an online application that includes writing a 300-word summary of the business and submitting a short video about the project or company.

USDA Outreach and Assistance for Socially Disadvantaged Farmers and Ranchers and Veteran Farmers and Ranchers Program (a.k.a The 2501 Program)

The U.S. Department of Agriculture provides small business grants, education, training, outreach, and other forms of support to veterans and minorities looking to begin or expand agricultural operations. Funding opportunities are closed for 2017.

Veterans can also search for additional grant opportunities through grants.gov; however, Everts says her office typically counsels people to bootstrap their business because the process of searching and applying for grants can take a significant amount of time.

Other small business financing options for veterans

While funding is important, it’s often not the only resource veterans need to successfully start or grow a business. Here’s a look at some other great resources:

Boots to business

The Boots to Business entrepreneurial program is offered by the SBA. The curriculum includes a two-day classroom course on entrepreneurship as well as an eight-week online course with in-depth instruction on preparing a business plan and starting a business.

At the end of the eight-week online course, participants will have the tools and knowledge they need to identify business opportunities, draft a business plan, and launch a small business.

Veteran’s Business Outreach Center

Also funded by the SBA, Veteran’s Business Outreach Centers are a resource for service members, veterans, and military spouses looking to start, purchase, or grow a business. Centers are located in 17 states.

Business counselors at the outreach centers provide mentorship and work with veteran entrepreneurs on business plans, feasibility analysis, and provide training on franchising, marketing, accounting, and more.

Syracuse University Institute for Veterans and Military Families

The Institute for Veterans and Military Families hosts conferences and provides training for veterans transitioning to civilian life. Their initiatives include:

Entrepreneurship Bootcamp for Veterans with Disabilities

Available to post-9/11 veterans with a service-connected disability. The boot camps feature a 30-day online program, nine days of live training, and 12 months of post-program support.

Bootcamp for Veterans Families

Available to military families who serve in a caregiver role to a veteran with a service-connected disability. The boot camps feature a 30-day online program, nine days of live training, and 12 months of post-program support.

Veteran Women Igniting the Spirit of Entrepreneurship

Women veterans and female military spouses can receive entrepreneurship and small business management training through Veteran Women Igniting the Spirit of Entrepreneurship. This three-phase program includes a 15-day online course, a three-day entrepreneurship training event, ongoing mentorship, training, and support opportunities for graduates launching or growing a business.

There is a one-time $75 registration fee for the program, but the SBA covers a two-night hotel stay for event attendees and all meals and educational materials during the conference. Veterans can view the program calendar and apply online.

VetFran

The International Franchise Association created VetFran, a strategic initiative to teach veterans about becoming a franchise business owner. Veterans and their spouses can get help figuring out whether franchising is right for them and search a directory of franchises, many of which offer discounts or grant free franchises to veterans.

American Corporate Partners

American Corporate Partners connects post-9/11 veterans to corporate mentors from companies such as Deloitte, Morgan Stanley, AT&T, Coca-Cola, and Intel for year-long, one-on-one corporate mentoring. Mentors help veterans with small business development, professional communication and leadership skills, and career development.The program is open to service members, veterans, and spouses who meet the following eligibility criteria:

  • Currently serving and recently separated veterans who have served on active duty orders for at least 180 days since 9/11.
  • Surviving spouses and spouses of severely wounded post-9/11 veterans.
  • Service members who served less than 180 days of active duty since 9/11, but who were injured while serving or training.

Applications can be completed online.

SCORE Veteran Fast Launch Initiative

SCORE (previously known as the Service Corps of Retired Executives) is a nonprofit association of thousands of volunteer business counselors throughout the U.S. Their Veteran Fast Launch Initiative provides mentoring and training to veterans transitioning to entrepreneurs. The program is a package of free software combined with mentoring aimed at helping veterans and their families start and succeed as small business owners.

In addition to templates and tools to help veterans plan and operate their businesses, veterans also receive five hours of free financial advice from a CPA.

National Veteran-Owned Business Association

The National Veteran-Owned Business Association (NaVOBA) doesn’t provide funding for veteran-owned small businesses, but it does provide networking opportunities for veteran entrepreneurs, encourages the federal government to spend their contract dollars with veteran-owned businesses, and advocates with state governments to pass laws creating opportunities for veteran-owned businesses.

The Bunker

The Bunker is an incubator for veteran-owned technology startups. They have local chapters throughout the U.S. that provide educational programming, resources, and networking for military veterans and their spouses interested in starting and growing a business. Their EPIC Entrepreneurial Program is a 12-week course designed to help participants launch a business.

The exact information you’ll need and qualifications to be approved for a loan depends on the funding option you’re interest in and the bank you’re working with. Some have simple applications and quick approval processes. Others will want to see collateral, business plans, personal financial statements, bank statements, and credit scores. Whatever funding opportunity you pursue, Everts recommends taking some time to prepare before applying. “Get your numbers in a row and know how much you can contribute to the business,” she says.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Mortgage

Do You Really Need a Home Warranty?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

When I bought my first house years ago, my real estate agent requested that the seller purchase a home warranty to cover our home for one year from the date of sale. It didn’t cost me anything, and I only used the warranty once that year when the dishwasher started leaking water all over the kitchen floor. I called the warranty company, and for a $60 service fee, a contractor repaired the dishwasher, a service that would average somewhere between $100 and $200. Once the year was up, I had to decide whether to pay more than $500 to renew the warranty or let it lapse.

You may find yourself facing the same decision, whether you’re deciding to extend a warranty past the initial year or buy a warranty when the seller is not willing to foot the cost. So, do you need a home warranty?

Unlike a homeowners insurance policy, which is typically required by your lender, home warranties are completely optional.

A home warranty is a service contract on your home’s appliances and systems. Unlike a homeowners insurance policy, which may cover your home’s structure and belongings in the event of a fire, storm, or other accident, a home warranty covers repairs and replacement of systems and appliances due to normal wear and tear. This might include:

  • Electrical systems
  • Plumbing systems
  • Heating and air conditioning systems
  • Washers and dryers
  • Kitchen appliances

How much does a home warranty cost?

The cost of a home warranty varies by location, coverage, and provider. American Home Shield, the largest home warranty company in the country, has plans that cover appliances only starting at $360 per year. Systems plans, that cover heating, air conditioning, and electrical systems but not appliances, start at around $408 per year. Plans that cover both systems and appliances start at around $516 per year.

Cedric Stewart, a residential and commercial sales consultant at Entourage Residential Group at Keller Williams in Rockville, Md., says home warranties range in price from $400 to $650 on average but can go much higher if you opt for additional coverage options. Those options may include coverage for spas and swimming pools, additional refrigerators, water softener systems, or water wells.

How to shop for a home warranty

Your realtor may be able to recommend one or two home warranty providers that they work with on a regular basis and let you know how much the warranty will cost and what is covered. Take a look at a sample contract and read the fine print to see exactly what the warranty will and won’t cover and how much you will pay per service call.

Next, look for online reviews from reputable review sites like Consumer Reports, Angie’s List, or the Better Business Bureau. Pay special attention to the bad reviews. Did customers have to wait days for service? Does the company deny a lot of claims? Were customers happy with the contractors hired to perform the work? These can all give you an idea of whether you’ll be happy with your purchase or experience buyer’s remorse.

Benefits of buying a home warranty

Some people love home warranties for the peace of mind it gives them. “In the event your hot water heater or furnace stop working,” Stewart says, “you make a service call, pay the fee to have someone come out, and they’ll repair or replace that item. Whether it’s the first or the 365th day of the warranty, the coverage is the same. So you could end up getting a $4,000-$8,000 system replaced for $400 bucks.”

Downsides to buying a home warranty

There are many arguments against buying home warranties, especially since home warranty companies have historically been one of the “worst graded” categories on Angie’s List.

  • Your claim can be denied if the problems existed before. Stewart says you should think of a home warranty like an insurance policy. When something happens, you file a claim (referred to as a “service call”). An adjuster comes out to assess the damage and submits his findings to the home warranty company, which renders a decision. That decision could be a denial of your claim. Stewart says one of the most common reasons home warranty companies deny claims is due to pre-existing conditions, or problems that existed before you purchased the policy. The company may even require that you turn over a copy of the home inspection report to ensure that the issue wasn’t cited during the inspection.
  • You can’t pick your contractor. Warranty providers require that homeowners work with specific, pre-approved contractors. Homeowners may sometimes be disappointed in a long wait time for service or poor quality of service provided by these contractors, but they can’t fire them and pick their own.
  • You may get repairs when what you want is a replacement. The service technician will always try to repair the appliance or system first and replace it only if it is beyond repair. That can be a hassle. I found this out when I rented a townhome covered by a home warranty. Several contractors told us that the 20-year old A/C unit should really be replaced, but the warranty company wanted to keep repairing the old system. As a result, the A/C went out three times over the course of one hot summer in Phoenix.

4 questions to ask yourself before you purchase a home warranty

Rocky Lalvani is a wealth coach and rental property owner, so he is well versed in what can go wrong in your first year in a new home. He recommends asking the following questions before deciding whether to purchase a home warranty.

  • What condition are the home, systems, and appliances in? If the heating, air conditioning, and appliances are older, the greater the need to protect against failure.
  • Can you afford to repair the items yourself? If replacing the furnace or buying new appliances in the next year would cause a financial hardship, you may be better off buying a warranty.
  • Are you planning on replacing the items in the near future? If you know you are going to remodel the kitchen and purchase all new appliances shortly, it doesn’t make sense to protect them.
  • What is covered and what is excluded? Read the policy so you know what coverage it provides. Each warranty provider has their own limits, rules, and caps on repair costs. “When you couple that with long wait times to go through the process, these factors may make the warranty not worth the cost,” Lalvani says.

Also, keep in mind that a separate warranty is typically not necessary for new homes since the appliances are covered under the manufacturer’s warranty. Homebuilders usually put a warranty on system and structural defects for 10 years. But read the fine print of your purchase contract to make sure you know what is covered.

The bottom line

If your seller is willing to cover the cost of a home warranty as a condition of sale, do take advantage of the free coverage. Just realize that you will have to pay a service fee, which could range from $50 to $75 per repair.

Otherwise, consider the age of each covered item and compare that to its average life span using this chart from the International Association of Certified Home Inspectors. The older the home and appliances, the more likely it is that something will go wrong. If the systems and appliances are newer or you’re planning on replacing them shortly after you move in, you may be better off setting the money aside in a home-repair fund. That way, you won’t end up paying for something that may not provide the coverage you expect.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Life Events, Mortgage

The Best Mortgages That Require No or Low Down Payment

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

If you’re considering buying a home, you’re probably wondering how much you’ll need for a down payment. It’s not unusual to be concerned about coming up with a down payment. According to Trulia’s report Housing in 2017, saving for a down payment is most often cited as the biggest obstacle to homeownership.

Maybe you’ve heard that you should put 20% down when you purchase a home. It’s true that 20% is the gold standard. If you can afford a big down payment, it’s easier to get a mortgage, you may be eligible for a lower interest rate, and more money down means borrowing less, which means you’ll have a smaller monthly payment.

But the biggest incentive to put 20% down is that it allows you to avoid paying for private mortgage insurance. Mortgage insurance is extra insurance that some private lenders require from homebuyers who obtain loans in which the down payment is less than 20% of the sales price or appraised value. Unlike homeowners insurance, mortgage protects the lender – not you – if you stop making payments on your loan. Mortgage insurance typically costs between 0.5% and 1% of the entire loan amount on an annual basis. Depending on how expensive the home you buy is, that can be a pretty hefty sum.

While these are excellent reasons to put 20% down on a home, the fact is that many people just can’t scrape together a down payment that large, especially when the median price of a home in the U.S. is a whopping $345,800.

Fortunately, there are many options for homebuyers with little money for a down payment. You may even be able to buy a house with no down payment at all.

Here’s an overview of the best mortgages you can be approved for without 20% down.

Type of Loan

Down Payment Requirement


Mortgage Insurance

Credit Score Requirement

FHA

FHA

3.5% for most

10% if your FICO credit score is between 500 and 579

Requires both upfront and annual mortgage insurance for all borrowers, regardless of down payment

500 and up

SoFi

SoFi

10%

No mortgage insurance required

Typically 700 or higher

VA Loan

VA Loan

No down payment required for eligible borrowers (military service members, veterans, or eligible surviving spouses)

No mortgage insurance required; however, there may be a funding fee, which can run from 1.25% to 2.4% of the loan amount

No minimum score
required

homeready

HomeReady

3% and up

Mortgage insurance required when homebuyers put down
< 20%; no longer required once the loan-to-value ratio reaches 78% or less

620 minimum

homeready

USDA

No down payment required

Ongoing mortgage insurance not required, but borrowers pay an upfront fee of 2% of the purchase price

620-640 minimum

FHA Loans

An FHA loan is a home loan that is insured by the Federal Housing Administration. These loans are designed to promote homeownership and make it easier for people to qualify for a mortgage. The FHA does this by making a guarantee to your bank that they will repay your loan if you quit making payments. FHA loans don’t come directly from the FHA, but rather an FHA-approved lender. Not all FHA-approved lenders offer the same interest rates and costs, even for the same type of loan, so it’s important to shop around.

Down payment requirements

FHA loans allow you to buy a home with a down payment as low as 3.5%, although people with FICO credit scores between 500 and 579 are required to pay at least 10% down.

Approval requirements

Because these loans are geared toward lower income borrowers, you don’t need excellent credit or a large income, but you will have to provide a lot of documentation. Your lender will ask you to provide documents that prove income, savings, and credit information. If you already own any property, you’ll have to have documentation for that as well.

Some of the information you’ll need includes:

  • Two years of complete tax returns (three years for self-employed individuals)
  • Two years of W-2s, 1099s, or other income statements
  • Most recent month of pay stubs
  • A year-to-date profit-and-loss statement for self-employed individuals
  • Most recent three months of bank, retirement, and investment account statements

Mortgage insurance requirements

The FHA requires both upfront and annual mortgage insurance for all borrowers, regardless of their down payment. On a typical 30-year mortgage with a base loan amount of less than $625,500, your annual mortgage insurance premium will be 0.85% as of this writing. The current upfront mortgage insurance premium is 1.75% of the base loan amount.

Casey Fleming, a mortgage adviser with C2 Financial Corporation and author of The Loan Guide: How to Get the Best Possible Mortgage, also reminds buyers that mortgage insurance on an FHA loan is permanent. With other loans, you can request the lenders to cancel private mortgage insurance (MIP) once you have paid down the mortgage balance to 80% of the home’s original appraised value, or wait until the balance drops to 78% when the mortgage servicer is required to eliminate the MIP. But mortgage insurance on an FHA loan cannot be canceled or terminated. For that reason, Fleming says “it’s best if the homebuyer has a plan to get out in a couple of years.”

Where to find an FHA-approved lender

As we mentioned earlier, FHA loans don’t come directly from the FHA, but rather an FHA-approved lender. Not all FHA-approved lenders offer the same interest rates and costs, even for the same type of loan, so it’s important to shop around.

The U.S. Department of Housing and Urban Development (HUD) has a searchable database where you can find lenders in your area approved for FHA loans.

First, fill in your location and the radius in which you’d like to search.

Next, you’ll be taken to a list of FHA-approved lenders in your area.

Who FHA loans are best for

FHA loans are flexible about how you come up with the down payment. You can use your savings, a cash gift from a family member, or a grant from a state or local government down-payment assistance program.

However, FHA loans are not the best option for everyone. The upfront and ongoing mortgage insurance premiums can cost more than private mortgage insurance. If you have good credit, you may be better off with a non-FHA loan with a low down payment and lower loan costs.

And if you’re buying an expensive home in a high-cost area, an FHA loan may not be able to provide you with a large enough mortgage. The FHA has a national loan limit, which is recalculated on an annual basis. For 2017, in high-cost areas, the FHA national loan limit ceiling is $636,150. You can check HUD.gov for a complete list of FHA lending limits by state.

SoFi

For borrowers who can afford a large monthly payment but haven’t saved up a big down payment, SoFi offers mortgages of up to $3 million. Interest rates will vary based on whether you’re looking for a 30-year fixed loan, a 15-year fixed loan, or an adjustable rate loan, which has a fixed rate for the first seven years, after which the interest rate may increase or decrease. Mortgage rates started as low as 3.09% for a 15-year mortgage as of this writing. You can find your rate using SoFi’s online rate quote tool without affecting your credit.

Down payment requirements

SoFi requires a minimum down payment of at least 10% of the purchase price for a new loan.

Approval requirements

Like most lenders, SoFi analyzes FICO scores as a part of its application process. However, it also considers factors such as professional history and career prospects, income, and history of on-time bill payments to determine an applicant’s overall financial health.

Mortgage insurance requirements

SoFi does not charge private mortgage insurance, even on loans for which less than 20% is put down.

What we like/don’t like

In addition to not requiring private mortgage insurance on any of their loans, SoFi doesn’t charge any loan origination, application, or broker commission fees. The average closing fee is 2% to 5% for most mortgages (it varies by location), so on a $300,000 home loan, that is $3,000. Avoiding those fees can save buyers a significant amount and make it a bit easier to come up with closing costs. Keep in mind, though, that you’ll still need to pay standard third-party closing costs that vary depending on loan type and location of the property.

There’s not much to dislike about SoFi unless you’re buying a very inexpensive home in a lower-cost market. They do have a minimum loan amount of $100,000.

Who SoFi mortgages are best for

SoFi mortgages are really only available for people with excellent credit and a solid income. They don’t work with people with poor credit.

SoFi does not publish minimum income or credit score requirements.

VA Loans

Rates can vary by lender, but currently, rates for a $225,000 30-year fixed-rate loan run at around 3.25%, according to LendingTree. (Disclosure: LendingTree is the parent company of MagnifyMoney.)

Down payment requirements

Eligible borrowers can get a VA loan with no down payment. Although the costs associated with getting a VA loan are generally lower than other types of low-down-payment mortgages, Fleming says there is a one-time funding fee, unless the veteran or military member has a service-related disability or you are the surviving spouse of a veteran who died in service or from a service-related disability.

That funding fee varies by the type of veteran and down-payment percentage, but for a new-purchase loan, the funding fee can run from 1.25% to 2.4% of the loan amount.

Approval requirements

VA loans are typically easier to qualify for than conventional mortgages. To be eligible, you must have suitable credit, sufficient income to make the monthly payment, and a valid Certificate of Eligibility (COE). The COE verifies to the lender that you are eligible for a VA-backed loan. You can apply for a COE online, through your lender, or by mail using VA Form 26-1880.

The VA does not require a minimum credit score, but lenders generally have their own requirements. Most ask for a credit score of 620 or higher.

If you’d like help seeing if you are qualified for a VA loan, check to see if there’s a HUD-approved housing counseling agency in your area.

Mortgage insurance requirements

Because VA loans are guaranteed by the Department of Veterans Affairs, they do not require mortgage insurance. However, as we mentioned previously, be prepared to pay an additional funding fee of 1.25% to 2.4%.

What we like/don’t like

There’s no cap on the amount you can borrow. However, there are limits on the amount the VA can insure, which usually affects the loan amount a lender is willing to offer. Loan limits vary by county and are the same as the Federal Housing Finance Agency’s limits, which you can find here.

HomeReady

 

The HomeReady program is offered by Fannie Mae. HomeReady mortgage is aimed at consumers who have decent credit but low- to middle-income earnings. Borrowers do not have to be first-time home buyers but do have to complete a housing education program.

Approval requirements

HomeReady loans are available for purchasing and refinancing any single-family home, as long as the borrower meets income limits, which vary by property location. For properties in low-income areas (as determined by the U.S. Census), there is no income limit. For other properties, the income eligibility limit is 100% of the area median income.

The minimum credit score for a Fannie Mae loan, including HomeReady, is 620.

To qualify, borrowers must complete an online education program, which costs $75 and helps buyers understand the home-buying process and prepare for homeownership.

Down payment requirements

HomeReady is available through all Fannie Mae-approved lenders and offers down payments as low as 3%.

Reiss says buyers can combine a HomeReady mortgage with a Community Seconds loan, which can provide all or part of the down payment and closing costs. “Combined with a Community Seconds mortgage, a Fannie borrower can have a combined loan-to-value ratio of up to 105%,” Reiss says. The loan-to-value (LTV) ratio is the ratio of outstanding loan balance to the value of the property. When you pay down your mortgage balance or your property value increases, your LTV ratio goes down.

Mortgage insurance requirements

While HomeReady mortgages do require mortgage insurance when the buyer puts less than 20% down, unlike an FHA loan, the mortgage insurance is removed once the loan-to-value ratio reaches 78% or less.

What we like/don’t like

HomeReady loans do require private mortgage insurance, but the cost is generally lower than those charged by other lenders. Fannie Mae also makes it easier for borrowers to get creative with their down payment, allowing them to borrow it through a Community Seconds loan or have the down payment gifted from a friend or family member. Also, if you’re planning on having a roommate, income from that roommate will help you qualify for the loan.

However, be sure to talk to your lender to compare other options. The HomeReady program may have higher interest rates than other mortgage programs that advertise no or low down payments.

USDA Loan

USDA loans are guaranteed by the U.S. Department of Agriculture. Although the USDA doesn’t cap the amount a homeowner can borrow, most USDA-approved lenders extend financing for up to $417,000.

Rates vary by lender, but the agency gives a baseline interest rate. As of August 2016, that rate was just 2.875%

Approval requirements

USDA loans are available for purchasing and refinancing homes that meet the USDA’s definition of “rural.” The USDA provides a property eligibility map to give potential buyers a general idea of qualified locations. In general, the property must be located in “open country” or an area that has a population less than 10,000, or 20,000 in areas that are deemed as having a serious lack of mortgage credit.

USDA loans are not available directly from the USDA, but are issued by approved lenders. Most lenders require a minimum credit score of 620 to 640 with no foreclosures, bankruptcies, or major delinquencies in the past several years. Borrowers must have an income of no more than 115% of the median income for the area.

Down payment requirements

Eligible borrowers can get a home loan with no down payment. Other closing costs vary by lender, but the USDA loan program does allow borrowers to use money gifted from friends and family to pay for closing costs.

Mortgage insurance requirements

While USDA-backed mortgages do not require mortgage insurance, borrowers instead pay an upfront premium of 2% of the purchase price. The USDA also allows borrowers to finance that 2% with the home loan.

What we like/don’t like

Some buyers may dismiss USDA loans because they aren’t buying a home in a rural area, but many suburbs of metropolitan areas and small towns fall within the eligible zones. It could be worth a glance at the eligibility map to see if you qualify.

At a Glance: Low-Down-Payment Mortgage Options

To see how different low-down-payment mortgage options might look in the real world, let’s assume a buyer with an excellent credit score applies for a 30-year fixed-rate mortgage on a home that costs $250,000.

As you can see in the table below, their monthly mortgage payment would vary a lot depending on which lender they use.

 

Down Payment


Total Borrowed


Interest Rate


Principal & Interest


Mortgage Insurance


Total Monthly Payment

FHA


FHA

3.5%
($8,750)

$241,250

4.625%

$1,083

$4,222 up front
$171 per month

$1,254

SoFi


SoFi

10%
($25,000)

$225,000

3.37%

$995

$0

$995

VA


VA Loan

0%
($0)

$250,000

3.25%

$1,088

$0

$1,088

HomeReady


homeready

3%
($7,500)

$242,500

4.25%

$1,193

$222 per month

$1,349

USDA


homeready

0%

$250,000

2.875%

$1,037

$5,000 up front,
can be included in
total financed

$1,037

Note that this comparison doesn’t include any closing costs other than the upfront mortgage insurance required by the FHA and USDA loans. The total monthly payments do not include homeowners insurance or property taxes that are typically included in the monthly payment.

ANALYSIS: Should I put down less than 20% on a new home just because I can?

So, if you can take advantage of a low- or no-down-payment loan, should you? For some people, it might make financial sense to keep more cash on hand for emergencies and get into the market sooner in a period of rising home prices. But before you apply, know what it will cost you. Let’s run the numbers to compare the cost of using a conventional loan with 20% down versus a 3% down payment.

Besides private mortgage insurance, there are other downsides to a smaller down payment. Lenders may charge higher interest rates, which translates into higher monthly payments and more money spent over the loan term. Also, because many closing costs are a percentage of the total loan amount, putting less money down means higher closing costs.

For this example, we’ll assume a $250,000 purchase price and a loan term of 30 years. According to Freddie Mac, during the week of June 22, 2017, the average rate for a 30-year fixed-rate mortgage was 3.90%.

Using the Loan Amortization Calculator from MortgageCalculator.org:

Assuming you don’t make any extra principal payments, you will have to pay private mortgage insurance for 112 months before the principal balance of the loan drops below 78% of the home’s original appraised value. That means in addition to paying $169,265.17 in interest, you’ll pay $11,316.48 for private mortgage insurance.

The bottom line

Under some circumstances, a low- or no-down-payment mortgage, even with private mortgage insurance, could be considered a worthwhile investment. If saving for a 20% down payment means you’ll be paying rent longer while you watch home prices and mortgage rates rise, it could make sense. In the past year alone, average home prices increased 16.8%, and Kiplinger is predicting that the average 30-year fixed mortgage rate will rise to 4.1% by the end of 2017.

If you do choose a loan that requires private mortgage insurance, consider making extra principal payments to reach 20% equity faster and request that your lender cancels private mortgage insurance. Even if you have to spend a few hundred dollars to have your home appraised, the monthly savings from private mortgage insurance premiums could quickly offset that cost.

Keep in mind, though, that the down payment is only one part of the home-buying equation. Sonja Bullard, a sales manager with Bay Equity Home Loans in Alpharetta, Ga., says whether you’re interested in an FHA loan or a conventional (i.e., non-government-backed) loan, there are other out-of-pocket costs when buying a home.

“Through my experience, when people hear zero down payment, they think that means there are no costs for obtaining the loan,” Bullard says. “People don’t realize there are still fees required to be paid.”

According to Bullard, those fees include:

  • Inspection: $300 to $1,000, based on the size of the home
  • Appraisal: $375 to $1,000, based on the size of the home
  • Homeowners insurance premiums, prepaid for one year, due at closing: $300 to $2,500, depending on coverage
  • Closing costs: $4,000 to $10,000, depending on sales price and loan amount
  • HOA initiation fees

So don’t let a seemingly insurmountable 20% down payment get in the way of homeownership. When you’re ready to take the plunge, talk to a lender or submit a loan application online. You might be surprised at what you qualify for.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Small Business

How to Get Approved for a Small Business Loan

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Getting a loan to start or grow a small business is rarely easy, especially since the financial crash of 2008 and the credit crunch that followed. Finding the right lender and navigating the application and underwriting process is challenging. So being adequately prepared and taking practical steps to improve your chances ahead of time can help reduce the amount of time you’ll spend and reduce your frustration with the process. With that in mind, here are four tips for getting approved for a small business loan.

Know your business credit score AND personal credit score

Gerri Detweiler, Education Director for Nav, a platform that connects small business owners to financing, says that the first thing any small business owner should do before applying for a small business loan is check their business and personal credit score. “Some lenders may review one or the other, and some review both,” Detweiler says.

How to find your business credit score:

Your business credit score is based on trade credit (when a supplier allows you to buy now and pay later) and other debt in the business name, such as credit cards and equipment loans. Business credit is measured on a scale of 0-100, with a score of 75 or more being the ideal range. Both Experian and Dun & Bradstreet calculate business credit scores.

If your business is very new or hasn’t used credit in the past, you may not have a business credit score. In that case, Detweiler says, your personal credit score will probably play a larger role in getting the loan approved. Most lenders look for a personal credit score of 640-660 or higher.

How to find your personal credit score:

There are numerous free credit scores available for you to access; however, not all scores are considered equal. Credit lenders will often pull specific scores, depending on the product you are applying for. Therefore, we have created a simple chart for you to see where you can get specific credit scores from the top two companies — FICO® and VantageScore.

You can order a copy of your personal credit report from each of the three credit reporting agencies once every 12 months, free of charge, by going to AnnualCreditReport.com. Once you have the reports, make sure you recognize all of the information on your credit reports, such as names, addresses, Social Security numbers, credit card accounts and loans. Make sure there aren’t any accounts belonging to another person with the same or a similar name as yours, fraudulent accounts resulting from identity theft, or the same debt listed more than once. If there are any errors, contact the credit reporting agency (Experian, Equifax, or TransUnion) that sent you the report and follow their instructions to dispute the error.

The best option: FICO® Score 8

Where to get it: Credit Scorecard by Discover or freecreditscore.com

Find the right type of lender for a small business loan

Traditional banks may be the first option that comes to mind when you think about a small business loan, but Detweiler says most banks don’t make startup loans. Even existing businesses may have a hard time getting a bank loan of less than $50,000, depending on the lender.

Your first step should be talking to the bank or credit union that holds your business checking and savings accounts. They may be able to offer a term loan or line of credit. They may also be able to help you with a loan backed by the U.S. Small Business Administration (SBA). The SBA’s 7(a) Loan Program is designed to help small and startup businesses with financing for a variety of purposes.

Nonprofit small business loans

If a traditional or SBA loan is not an option, you might consider a nonprofit microlender. These loans are a bit easier for startups to qualify for. Their standards are less stringent because profit is not the lender’s objective. They often focus on helping disadvantaged communities or minority business owners. According to the Aspen Institute’s FIELD program, the top U.S. microlenders are:

  • Grameen America – helps women in poor communities build businesses
  • LiftFund – offers microloans in Texas, Louisiana, Mississippi, Alabama, Arkansas, Missouri, Kentucky, and Tennessee
  • Opportunity Fund – provides loans to low-income residents of California
  • Accion – offers loans from $5,000 to $50,000 throughout the U.S.
  • Justine Petersen – provides loans under $10,000 to entrepreneurs who don’t have access to commercial or conventional loans

Get your financial statements in order

Whether you apply for a loan through a bank, credit union, or non-bank lender and whether you rely on your business or personal credit, anyone who lends money is going to want financial statements.

Getting your financial statements in shape before applying for a loan will increase your chances of approval and help you qualify for more competitive rates. For your business, these are the key documents a lender will want to look at:

  • Profit and Loss (P&L) Statements
  • Balance Sheets
  • Statement of Cash Flows for the past three years

Providing financial statements can be a significant hurdle for small business owners and startups who’ve neglected their bookkeeping. If you’ve been cobbling together the books on your own, you probably haven’t been preparing your business financials in a recognized basis of accounting such as Generally Accepted Accounting Principles (GAAP). You may need to hire an accountant to get your business books in order and prepare the financials. This can be costly, so find out what your lender requires before you get started.

The lender may also want to look at a personal financial statement:

  • Your assets
  • Liabilities (debts) and contingent liabilities (such as a co-signed loan or outstanding lawsuits)
  • Income

You can download a Personal Financial Statement form from the SBA website for an indication of the information you’ll be required to submit, but banks often require their own form.

Run your own background check on Google

Gil Rosenthal, director of risk operations at BlueVine, a provider of small business financing, says lenders will often Google loan applicants and check social media profiles to see what others are saying about the business and its owners.

Loan underwriters are looking to see whether you are considered a trusted authority online, whether you’re using social media to promote your brand, and whether you quickly and effectively respond to customers. Be cognizant of your online reputation, including Yelp reviews, and keep your business and personal social media profiles up to date.

If your online reviews are less than glowing, Rosenthal says, “you can mitigate the impact by being prepared to explain anything negative that comes up in the application process.”

The bottom line

Even if you have all of your proverbial ducks in a row, finding the right terms from the right lender may take some time. By anticipating what your lender will review and require, you’ll greatly increase your chances of getting approved for a small business loan.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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News, Retirement

Here’s How to Find Out How Much Social Security Income You’ll Receive

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

At what age will you retire? How much can you expect to receive each month when you do? These are important questions even if you are decades away from retirement, and there’s an easy way to get answers anytime. We’re going to show you how to get your Social Security benefits statement online and what to do with it once you’ve got it.

A little background:

Depending on your age, you may remember getting a printed Social Security benefits statement in the mail. Prior to 2011, the Social Security Administration (SSA) mailed statements to all workers every year. Those annual mailings were discontinued in 2011 as a cost-saving measure. The following year, the SSA made the statements available online, but their decision caused a bit of an uproar. Despite the agency’s outreach campaign, far fewer people registered for an account than there were eligible workers. So in 2014, Congress required the agency to resume sending printed statements every five years to workers age 25 and older who hadn’t registered for an online account.

That schedule remained until earlier this year when the agency announced that due to budget restraints, paper benefit statements will only be mailed to people who are 60 or older, have not established an online account, and are not yet receiving Social Security benefits. Simply put, don’t expect to get a printed statement anytime soon.

How to get your Social Security benefits statement

Accessing your Social Security benefits statement online is pretty simple, as long as you have an email address and can provide some basic identifying information.

First, go to ssa.gov/myaccount and click on “Sign In or Create an Account.”

If you’ve never created an online account with the SSA, you’ll click on “Create an Account.” If you’ve set up an account before, you won’t be able to create a new account using the same Social Security number. If you’ve forgotten your username or password, the SSA website offers tools to help recover them.

When you select “Create an Account,” the site will lead you through a few questions to verify your identity. You’ll need to provide personal information that matches the information on file with the SSA as well as some information matching your credit report.

Ryder Taff, a Certified Financial Adviser with New Perspectives, Inc. of Ridgeland, Miss., helps many of his clients set up Social Security accounts and says the questions often have to do with past residences or vehicles that may have been registered in your name.

If you have trouble setting up your account online, you can call the SSA for help at 1-800-772-1213.

Information in a Social Security benefits statement

Your Social Security benefits statement provides several valuable pieces of information:

  • A record of your earnings, by year, since you began having Social Security and Medicare taxes withheld.
  • Estimated retirement benefits if you begin claiming Social Security at age 62, full retirement age, or age 70.
  • Estimated disability benefits if you became disabled right now.
  • Estimated survivor benefits that your spouse or child would receive if you were to die this year.

Here’s a sample of what your benefits statement will look like:

Keep in mind that the estimated benefits shown are just that — estimates. The amounts shown are calculated based on average earnings over your lifetime and assume you’ll continue earning your most recent annual wages until you start receiving benefits. They are also calculated in today’s dollars without any adjustment for inflation. The amount you receive could also be impacted by any changes enacted by Congress from now until the time you retire.

What to do with your Social Security benefit statement

It’s a good idea to check your earnings record for errors once per year. It’s not uncommon for earnings from certain employers or even all of your earnings from an entire year to be missing, and you’ll want to get that corrected right away because benefits are calculated on your highest 35 years of earnings. “Any missing years will be just as damaging as a zero on a test was to your GPA,” Taff says. “Gather your documents and correct ANY missing years, even if they aren’t the highest salary. Every dollar counts!”

If you do spot any errors, grab your W-2 or tax return for the year in question and call the SSA at 1-800-772-1213. You can also report errors by writing to the SSA at:

Social Security Agency
Office of Earnings Operations
P.O. Box 33026
Baltimore, MD 21290-3026

Reading your statement is also a good reminder of how much you need to save for retirement outside of Social Security. Chances are, you won’t be happy living on just your Social Security income in retirement.

The good news is, the longer you delay taking your benefit, the higher your annual benefit will be. You can begin taking Social Security retirement benefits at age 62, but your payments will be smaller than they would be if you waited until full retirement age (FRA). Currently, your annual benefit increases by 8% for each year you delay taking your benefit from FRA until age 70.

Colin Exelby, president and founder of Celestial Wealth Management in Towson, Md., says that using your Social Security benefits statement can be particularly useful for retirement planning for couples. “Depending on your age, health, family health history, and financial situation there are a number of different ways to claim your benefits,” he says. “Each individual situation is different, and many couples have different views on the decision.”

If you are nearing retirement, you can use your benefits statement to work with a financial adviser to help you maximize total benefits, or run through various scenarios using a free online tool like the one provided by AARP.

Setting up your Social Security account is simple, free, and helpful for retirement planning, but it’s also a good security measure. It’s impossible to set up more than one account per Social Security number, so registering your account is a good way to prevent identity thieves from establishing an account on your behalf.

Take the time to set up your Social Security account and find out how much you might be entitled to receive in benefits. It could help you feel more empowered to take charge of your retirement plan.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Mortgage, Pay Down My Debt

Should You Use a Mortgage to Refinance Student Loans?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Fannie Mae, the largest backer of mortgage credit in America, recently made it a little easier for homeowners to refinance their student loans. In an update to its Selling Guide, the mortgage giant introduced a student loan cash-out refinance feature, permitting originators that sell loans to Fannie Mae to offer a new refinance option for paying off one or more student loans.

That means you could potentially use a mortgage refi to consolidate your student loan debt. Student loan mortgage refis are relatively new. Fannie Mae and SoFi, an alternative lender that offers both student loans and mortgages, announced a pilot program for cash-out refinancing of student loans in November 2016. This new program is an expansion of that option, which was previously available only to SoFi customers.

Amy Jurek, a Realtor at RE/MAX Advantage Plus in Minneapolis/St. Paul, Minn., says people with home equity have always had a cash-out option, but it typically came with extra fees and higher interest rates. Jurek says the new program eliminates the extra fees and allows borrowers to refinance at lower mortgage interest rates. The policy change could allow homeowners to save a significant amount of money because interest rates on mortgages are typically much lower than those for student loans, especially private student loans and PLUS loans.

But is it a good idea?

Your student debt isn’t eliminated; it’s added to your mortgage loan.

This may be stating the obvious, but swapping mortgage debt for student loan debt doesn’t reduce your debt; it just trades one form of debt (student loan) for another (mortgage).

Brian Benham, president of Benham Advisory Group in Indianapolis, Ind., says refinancing student loans with a mortgage could be more appealing to borrowers with private student loans rather than federal student loans.

Although mortgage rates are on the rise, they are still at near-historic lows, hovering around 4%. Federal student loans are near the same levels. But private student loans can range anywhere from 3.9% up to near 13%. “If you’re at the upper end of the spectrum, refinancing may help you lower your rate and your monthly payments,” Benham says.

So, the first thing anyone considering using a mortgage to refinance student loans should consider is whether you will, in fact, get a lower interest rate. Even with a lower rate, it’s wise to consider whether you’ll save money over the long term. You may pay a lower rate but over a longer term. The standard student loan repayment plan is 10 years, and most mortgages are 30-year loans. Refinancing could save you money today, but result in more interest paid over time, so keep the big picture in mind.

You need to actually have equity in your home.

To be eligible for the cash-out refinance option, you must have a loan-to-value ratio of no more than 80%, and the cash-out must entirely pay off one or more of your student loans. That means you’ve got to have enough equity in your home to cover your entire student loan balance and still leave 20% of your home’s value that isn’t being borrowed against. That can be tough for newer homeowners who haven’t owned the home long enough to build up substantial equity.

To illustrate, say your home is valued at $100,000, your current mortgage balance is $60,000, and you have one student loan with a balance of $20,000. When you refinance your existing mortgage and student loan, the new loan amount would be $80,000. That scenario meets the 80% loan-to-value ratio, but if your existing mortgage or student loan balances were higher, you would not be eligible.

You’ll lose certain options.

Depending on the type of student loan you have, you could end up losing valuable benefits if you refinance student loans with a mortgage.

Income-driven repayment options

Federal student loan borrowers may be eligible for income-driven repayment plans that can help keep loan payments affordable with payment caps based on income and family size. Income-based repayment plans also forgive remaining debt, if any, after 25 years of qualifying payments. These programs can help borrowers avoid default – and preserve their credit – during periods of unemployment or other financial hardships.

Student loan forgiveness

In certain situations, employees in public service jobs can have their student loans forgiven. A percentage of the student loan is forgiven or discharged for each year of service completed, depending on the type of work performed. Private student loans don’t offer forgiveness, but if you have federal student loans and work as a teacher or in public service, including a military, nonprofit, or government job, you may be eligible for a variety of government programs that are not available when your student loan has been refinanced with a mortgage.

Economic hardship deferments and forbearances

Some federal student loan borrowers may be eligible for deferment or forbearance, allowing them to temporarily stop making student loan payments or temporarily reduce the amount they must pay. These programs can help avoid loan default in the event of job loss or other financial hardships and during service in the Peace Corps or military.

Borrowers may also be eligible for deferment if they decide to go back to school. Enrollment in a college or career school could qualify a student loan for deferment. Some mortgage lenders have loss mitigation programs to assist you if you experience a temporary reduction in income or other financial hardship, but eligibility varies by lender and is typically not available for homeowners returning to school.

You could lose out on tax benefits.

Traditional wisdom favors mortgage debt over other kinds of debt because mortgage debt is tax deductible. But to take advantage of that mortgage interest deduction on your taxes, you must itemize. In today’s low-interest rate environment, most taxpayers receive greater benefits from the standard deduction. As a reminder, taxpayers can choose to itemize deductions or take the standard deduction. According to the Tax Foundation, 68.5% of households choose to take the standard deduction, which means they receive no tax benefit from paying mortgage interest.

On the other hand, the student loan interest deduction allows taxpayers to deduct up to $2,500 in interest on federal and private student loans. Because it’s an “above-the-line” deduction, you can claim it even if you don’t itemize. It also reduces your Adjusted Gross Income (AGI), which could expand the availability of other tax benefits.

You could lose your home.

Unlike student debt, a mortgage is secured by collateral: your home. If you default on the mortgage, your lender ultimately has the right to foreclose on your home. Defaulting on student loans may ruin your credit, but at least you won’t lose the roof over your head.

Refinancing student loans with a mortgage could be an attractive option for homeowners with a stable career and secure income, but anyone with financial concerns should be careful about putting their home at risk. “Your home is a valuable asset,” Benham says, “so be sure to factor that in before cashing it out.” Cashing out your home equity puts you at risk of carrying a mortgage into retirement. If you do take this option, set up a plan and a budget so you can pay off your mortgage before you retire.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Featured, News, Tax

File Taxes Jointly or Separately: What to Do When You’re Married with Student Loans

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Married couples with student loans must make a difficult decision when they file their tax returns. They can choose to file jointly, which often leads to a lower tax bill. Or they can file separately, which may result in a higher tax bill, but smaller student loan payments. So which decision will save the most money?

First, let’s discuss the difference between the two filing statuses available to married couples.

Married filing jointly

Married couples always have the option to file jointly. In most cases, this filing status results in a lower tax bill. The IRS strongly encourages couples to file joint returns by extending several tax breaks to joint filers, including a larger standard deduction and higher income thresholds for certain taxes and deductions.

Married filing separately

Because married couples are not required to file jointly, they can choose to file separately, where each spouse is taxed separately on the income he or she earned. However, this filing status typically results in a higher tax rate and the loss of certain deductions and credits. However, if one or both of the spouses have student loans with income-based repayment plans, filing separately could be beneficial if it results in lower student loan payments.

For help figuring out which filing status is better for married couples with student loans, we reached out to Mark Kantrowitz, publisher and Vice President of Strategy at Cappex.com. Kantrowitz knows quite a bit about student loans and taxes. He’s testified before Congress and federal and state agencies on several occasions, including testimony before the Senate Banking Committee that led to the passage of the Ensuring Continued Access to Student Loans Act of 2008. He’s also written 11 books, including four bestsellers about scholarships, the FAFSA, and student financial aid.

Two Advantages to Filing Taxes Jointly:

  • Most education benefits are available only if married taxpayers file a joint return. This can affect the American opportunity tax credit, the lifetime learning credit, the tuition and fees deduction (which Congress let expire as of January 1, 2017, but is still available for 2016 returns), and the student loan interest deduction.
  • Couples taking the maximum student loan interest deduction of $2,500 in a 25% tax bracket would save $625 in taxes. But this “above the line” deduction also reduces Adjusted Gross Income (AGI), which could yield additional tax benefits (e.g., greater benefits for deductions that are phased out based on AGI, lower thresholds for certain itemized deductions such as medical expenses, and miscellaneous itemized deductions).

However, there is a potential downside to filing jointly for couples with student loans.

Income-driven repayment plans use your income to determine your minimum monthly payment. Generally, your payment amount under an income-based repayment plan is a percentage of your discretionary income (the difference between your AGI and 150% of the poverty guideline amount for your state of residence and family size, divided by 12).

  • If you are a new borrower on or after July 1, 2014, payments are generally limited to 10% of your discretionary income but never more than the 10-year Standard Repayment Plan amount.
  • If you are not a new borrower on or after July 1, 2014, payments are generally limited to 15% of your discretionary income, but never more than the 10-year Standard Repayment Plan amount.

Because filing jointly will increase your discretionary income if your spouse is also earning money, your required student loan payment will typically increase as well. In some cases, the difference is negligible; in others, this can add up to a pretty significant cost difference.

“Calculating the trade-offs of income-driven repayment plans versus the student loan interest deduction and other benefits is challenging,” Kantrowitz says, “in part because the monthly payment under income-driven repayment depends on the borrower’s future income trajectory and inflation, not just the inclusion/exclusion of spousal income.”

Fortunately, some tools can help you run the numbers.

An example: Meet Joe and Sally

Here’s a simple scenario that shows how a change in filing status can save on taxes but cost more on student loans:

  • Joe and Sally are married with no children.
  • They live in Florida (no state income tax).
  • Joe is making $35,000 per year and has $15,000 of student loan debt with a 6.8% interest rate.
  • Sally is making $75,000 per year and has $60,000 of student loan debt with a 6.8% interest rate.

First, we can estimate Joe and Sally’s tax liability for filing jointly versus separately. TurboTax’s TaxCaster tool makes this pretty easy. Here’s what we get when run their numbers using 2016 tax rates:

  • Filing jointly, Joe and Sally would owe $13,249 in federal taxes.
  • Filing separately, they would owe $15,178.

So they would save just over $1,900 in federal taxes by filing jointly. But how would filing jointly affect their student loan payments?

We can use a student loan repayment estimator like the one provided by the office of Federal Student Aid to find out. Here’s what we get when we run the numbers and choose the Income-Based Repayment option, assuming they are new borrowers on or after July 1, 2014:

  • Filing jointly, Joe’s minimum required monthly student loan payment under a standard repayment plan would be $143, and Sally’s would be $571, for a total of $714 per month.
  • Filing separately, Joe’s minimum required monthly student loan payment would be $141, and Sally’s would be $474, for a total of $615 per month.

Over the course of a year, Joe and Sally would only save $1,188 on their student loan payments by filing separately. Even with the additional loan payments they would have to make, filing jointly would save them $712 more than filing separately.

What’s best for your situation?

Every situation is different. The simple example above comes out in favor of filing jointly, but you will need to run your own numbers to figure out what is right for you. Here are additional tips to help you figure it out:

  1. Know how much you owe. Make a list of all loan balances, interest rates, and the type of each student loan you have. You can find your federal student loans on the National Student Loan Data System. You can find information on your private student loans by looking at a recent statement.
  2. Estimate your student loan payment options. Using a student loan repayment estimator like the one mentioned above, determine your required payments when filing separately versus jointly.
  3. Calculate your tax liability. Use a tool like TurboTax’s TaxCaster or 1040.com’s Free Tax Calculator to calculate your federal and state tax liability when filing separately versus jointly.
  4. Be aware of long-term consequences. Filing separately might result in lower monthly payments today but more interest paid over time. If you make it to the 20- or 25-year forgiveness point, that could have tax implications down the line. Kantrowitz points out that “forgiveness is taxable under current law, causing a smaller tax debt to substitute for education debt. The main exception is borrowers who will qualify for public student loan forgiveness, which occurs after 10 years and is tax-free under current law.” Keep those long-term consequences in mind as you make a decision.
  5. Consider steps to lower your AGI. Your eligibility for income-driven student loan repayment plans depends on your AGI, which is essentially your total income minus certain deductions. You can reduce this number, and potentially lower both your tax bill and your required student loan payment, by doing things like contributing to a 401(k), IRA, or Health Savings Account.
  6. Keep the big picture in mind. These decisions are just one part of your overall financial situation. Keep your eyes on your big long-term goals and make your decision based on what helps you reach those goals fastest.

Other unique situations

There are a few unique situations that make deciding whether to file jointly or separately a little more complicated. Do any of these situations apply to you?

Divorce and legal separation

Sometimes, determining marital status to file tax returns isn’t cut and dried. What happens when you and your spouse are separated or going through a divorce at year end? In this case, your filing status depends on your marital status on the last day of the tax year.

You are considered married if you are separated but haven’t obtained a final decree of divorce or separate maintenance agreement by the last day of the tax year. In this case, you can choose to file married filing jointly or married filing separately.

You and your spouse are considered unmarried for the entire year if you obtained a final decree of divorce or are legally separated under a separate maintenance agreement by the last day of the tax year. You must follow your state tax law to determine if you are divorced or legally separated. In this case, your filing status would be single or head of household.

Pay as You Earn repayment plans

Pay as You Earn (PAYE) is a repayment plan with monthly payments that are limited to 10% of your discretionary income. To qualify and to continue to make income-based payments under this plan, you must have a partial financial hardship and have borrowed your first federal student loan after October 1, 2007. Kantrowitz says the PAYE plan bases repayment on the combined income of married couples, regardless of tax filing status.

Unpaid taxes, child support, or defaulted federal student loans

If you or your spouse have unpaid back taxes, child support, or defaulted federal student loans, joint income tax refunds may be diverted to pay for those items through the Treasury Offset Program. “Spouses can appeal to retain their share of the federal income tax refund,” Kantrowitz says, “but it is simpler if they file separate returns.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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Tax

What to Do When You Owe Taxes to the IRS

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Owing a debt you can’t pay is a situation nobody wants to find themselves in, and it can be especially stressful when that debt is owed to the IRS. Many people fear the IRS and not without reason.

The IRS has collection powers that many creditors don’t have, including garnishing wages, seizing bank accounts, and even putting liens on property. Yet many people occasionally face a situation where they have a tax debt they just can’t pay. There are many options for dealing with tax debt, but ignoring it and hoping it goes away is not one of them. If you find yourself in this unfortunate situation, check out these tips for facing tax debts.

Filing for a filing extension will not give you more time to pay back the debt

Some people mistakenly believe that if they extend their tax return, they’ll have additional time to pay the amount due with their return. But an extension is just an extension of time to file, not to pay. You are still obligated to calculate the amount you’ll owe and pay that by April 15, even if you’re not yet ready to file.

Pay as much of the debt as possible by the filing deadline

When you file an extension but don’t pay 90% of the tax you owe for that year, the IRS will charge a failure-to-pay penalty. The penalty is generally 0.5% per month on the balance of your unpaid balance, and it starts accruing the day after taxes are due. It can grow to as much as 25% of your unpaid taxes.

In addition, interest will accrue on any unpaid tax from the due date of the return until you pay your balance in full. The interest rate is determined quarterly and is the federal short-term rate plus 3%.

If you can’t pay the amount you owe, filing your return without making a payment won’t avoid penalties and interest, but it’s important to know that filing an extension won’t help you avoid them either. Just file on time and pay as much as you can to reduce penalty and interest charges.

Now that you’ve filed your return and know how much tax you owe, it’s time to consider your options for paying the balance due.

How to pay your tax debt

By credit card

If you don’t have the money to pay the amount due immediately, the IRS does accept credit cards, but be wary of paying your tax debt with plastic. Although the IRS doesn’t charge a fee to pay by credit card, the company that processes your payment will charge a fee ranging from 1.87% to 2.00% of the payment amount. Plus, you’ll need to consider the interest your credit card company will charge until you pay off the balance.

The IRS will charge a far lower interest rate than your credit card, which means you can pay off the debt much quicker.

Enroll in an IRS repayment plan

Paying a tax debt via credit card may not be an option if the amount due exceeds your credit limit, or it may not be the best choice if your credit card has a high interest rate. In that case, you may be able to work out a payment arrangement with the IRS. Just be aware that your account will continue to accrue penalties and interest until the balance is paid in full.

Here are three types of IRS repayment plans:

Short-term extension to pay

If the amount you owe is relatively small and you believe you can pay it off within 120 days, call the IRS and ask for a short-term extension of time to pay. This is not a formal payment plan. The IRS will just make a note on your account that you’ve been granted additional time to pay the full amount. During this period, they will not take any collection action against you.

Installment agreement

If you aren’t able to pay your debt in full within 120 days, Scott Taylor, a CPA with Piercy Bowler Taylor & Kern in Las Vegas, Nev., recommends that you contact the IRS to arrange an installment agreement. An installment agreement is basically a monthly payment plan. You can apply online for an installment agreement if you owe $50,000 or less in combined tax, penalties, and interest. For balances over that amount, you will need to complete Form 9465 and Form 433-F and send them in by mail.

With an installment agreement, you decide how much money you will pay each month and on what date you’ll make the payment. As long as your debt will be paid off within three years and you owe less than $10,000, the IRS has to accept your payment plan.

Fees

Keep in mind that the IRS also charges user fees for installment agreements. “Unfortunately for taxpayers, the fees have gone up as of January 2017,” Taylor says. The cost to set up an installment agreement is $225. If you apply online and choose to have the monthly payments directly debited from a bank account, the fee drops to $31.

If your ability to pay the agreed upon amount changes later on, you’ll need to call the IRS immediately. When you miss a payment, your agreement goes into default and the IRS can start taking collection action. For example, if your agreement calls for a $300 payment and you lose your job and aren’t able to make the payment, call the IRS before you miss a payment. They may be able to reduce your monthly payment amount to reflect your current financial situation.

Partial payment installment agreement

What if you owe so much that you can’t pay it off in a reasonable period of time? In that case, you may be eligible for a partial payment installment agreement. Like a regular installment agreement, you will make regular, agreed upon payments for a set period of time. However, the payments will not pay off the entire debt. After the agreement period ends, the remaining debt will be forgiven.

As you can imagine, the IRS doesn’t take debt forgiveness lightly, so applying for a partial payment installment agreement is more complicated than applying for a regular installment agreement. Instead of letting you decide how much you can afford to pay each month, the IRS will calculate your monthly payment by taking into account your outstanding balance, the remaining statute of limitations for collecting the debt, and the reasonable potential of collection.

To request a partial payment installment agreement, it’s best to consult a tax professional with experience handling tax debts. Before the IRS approves a partial payment installment agreement, you will need to have filed all of your tax returns and be current on your income tax withholding or estimated payments.

How to settle your tax debt (offer in compromise)

You’ve probably heard the television commercials promising to help you “settle your tax debt for pennies on the dollar.” These ads refer to an offer in compromise (OIC), and they’re not as easy to get as those ads would have you believe.

With an OIC, you agree to a lump-sum or short-term payment plan to pay off a portion of your debt in exchange for the IRS forgiving the remainder of the debt.

To qualify, you must prove that you are unable to pay off the entire debt through an installment agreement or other means. It can be difficult to meet the income and asset guidelines to qualify for an OIC, so it’s best suited for taxpayers with low income and very few assets.

You can check to see if you are eligible for an OIC by using the IRS’s pre-qualifier tool. To apply, you’ll need to complete Form 656 and Form 433-A and submit them along with an application fee of $186. You’ll also be asked to provide documentation to support the financial information provided in the forms.

Again, it’s a good idea to get help from a tax professional with experience working with OICs to help you complete the forms and walk you through the complex process. Be wary of tax resolution firms making promises that sound too good to be true. Check with the Better Business Bureau and the state attorney general’s office for complaints before you pay a retainer.

Tax debt discharge

There is a 10-year statute of limitations on tax debt collection, so if you are having serious financial issues and can’t pay at all, letting that statute run out may be an option. To do this, you’ll need to get your tax debt in currently-not-collectible (CNC) status by demonstrating that you cannot pay both reasonable living expenses and your tax debt.

To request CNC status, the IRS will ask you to provide financial information on Form 433-A or Form 433-F and provide documentation to support amounts listed on the statement. If you have any assets that the IRS believes could be sold to pay your debt, they may not grant CNC status.

While your account is in CNC status, the IRS will not pursue collection, but if you are owed any tax refunds on returns filed while your account is in CNC status, the IRS may keep your refunds and apply them to your debt. They may also file a Notice of Federal Tax Lien, which can affect your credit score and your ability to sell your property.

The IRS will review your income annually to see if your situation has improved. If you maintain CNC status until the 10-year statute of limitations runs out, you may no longer be required to make payments, regardless of whether your financial situation improves later on.

What if you don’t agree with the amount due?

If you owe a lot more than you expected, take a moment to review your completed return carefully to look for errors. Make sure you didn’t accidentally enter the same income twice or forget an important deduction, and make sure you answered all of the questions correctly. One missed question or checkbox can cause you to miss out on valuable tax benefits. Also, compare this year’s return to last year. If your tax bill went up drastically even though your situation hasn’t really changed, find out why.

Occasionally, taxpayers receive notices from the IRS indicating an amount due that they don’t agree with. Don’t feel like you have to pay an amount you don’t believe you owe just because it comes on IRS letterhead. Taylor says each notice will include a section detailing how to respond.

“The IRS may have made an error in matching up 1099s or W-2s, and the amount owed needs to be adjusted,” he says, and he recommends that you send a letter via certified mail in response, with a full explanation. “A CPA can help you with this letter, but if you follow the guidelines provided by the IRS, you should be able to respond appropriately and have the fees resolved or adjusted.”

IRS collection enforcement

If your taxes are not paid on time and you do not communicate with the IRS, they can issue a Notice of Levy. An IRS levy permits the legal seizure of your property. They may garnish your wages or seize your bank account, vehicles, real estate, or other personal property to satisfy the debt.

Taylor says IRS notices will only come via U.S. mail, so be sure you check your mail and read all IRS notices. “It seems like a simple thing,” Taylor says, “but with many financial and personal transactions occurring online, many people ignore their mailbox for long periods of time.”

Whatever your situation, Taylor says it’s important to remain in contact with the IRS to show your intent is to pay your debt. “Don’t ever ignore IRS notices,” Taylor says. “The IRS is willing to coordinate payment plans, and the consequences of ignoring them are always difficult to adjust.”

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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