Mortgage

Understanding Construction Loans

Thursday, September 13, 2018

Editorial Note: 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 prior to publication.

Janet Berry-Johnson

Mortgages are typically easy to find. But most home loans are only available for houses that already exist. If you need financing to build a home, a construction loan can help you cover the costs of buying land and building the home of your dreams.

Construction loans bear some resemblance to traditional mortgages, but the process of applying is different in many ways. After all, the loan’s collateral doesn’t exist yet.

What is a construction loan?

A construction loan is usually a short-term loan used to pay for the cost of building or remodeling a home.

With a traditional mortgage, the lender pays out the full amount of the mortgage to the seller upon closing. But a construction loan is typically paid out to the homebuilder in a series of advances as the project progresses. For example, the lender may disburse a portion of the funding once the foundation is poured, another portion after framing is completed, etc.

During construction, you typically make interest-only payments based on the funds that have been disbursed, although some construction loans do not require payments until the project is complete. At that time, you will need to either pay off the balance of the loan in a lump sum, convert your construction loan into a traditional mortgage or apply for a new loan.

Types of construction loans

What happens to your construction loan once the project is complete depends on whether you have a one-time close loan or a two-time close loan.

One-time close

One-time close construction loans, also known as “all-in-one loans” or “construction-to-permanent loans,” wrap the loans for construction and the mortgage on the completed home into a single loan. Once your home is complete, the construction loan converts to a regular mortgage. There is no additional approval process or closing costs.

The downside of a one-time close construction loan is that construction projects tend to run over budget. If your project goes over budget, you’ll need to come up with the difference out of pocket or take out a second loan to cover the overages. For that reason, unless you have a solid grasp of the costs and schedule for the project, a one-time construction loan may not be right for your project.

Two-time close

A two-time close construction loan is two separate loans — a short-term loan for the construction phase and a long-term mortgage for the completed home. Essentially, you will refinance your construction loan once the project is complete.

A two-time close construction loan can be more costly because you need to go through the approval process and pay closing costs twice. But you’ll have more flexibility in the loan amount if your project goes over budget.

How construction loans work

Getting a construction loan requires a little more red tape than getting a traditional mortgage. Here’s a step-by-step walk through the process.

1. Get your finances in order

The qualifications for a construction loan will vary from lender to lender. As with any loan, the higher your credit score and the stronger your financial situation is, the more options you’ll have.

Fannie Mae, one of the leading sources of financing for mortgage lenders, requires a minimum credit score of 620 and a maximum debt-to-income ratio of 45%.

Adham Sbeih, CEO and founder of Socotra Capital, a real estate lending and investment firm based in Sacramento, Calif., said borrowers need to demonstrate an ability to handle the monthly payments and handle potential change orders and cost overruns. “Borrowers also need to show they have a viable exit strategy for completing construction,” he said. “After all, construction loans are temporary.”

2. Meet with a lender to get preapproved

Once you have your finances in order, it’s time to meet with a lender to find out how much you can borrow.

The lender will look at your debt, income and asset information. The amount the lender preapproves you for will be an essential part of your discussions with your builder in deciding what to include in your new home. The lender can also answer any questions you have about how construction loans are structured.

3. Create your wish list

Create a wish list and ideas of what you want your home to look like. Keep in mind that you may have to compromise on some of these items if your wish list is larger than your budget.

4. Find a builder

Look for a reputable, experienced builder. Before approving your loan, your lender will review your contractor’s experience, reputation, credit and licenses to ensure your contractor can get the job done on time and within budget.

The builder will put together detailed specifications, including floor plans, a materials list, a line-item budget and a draw schedule. This is sometimes called a “blue book.”

5. Apply for the loan

Once you have a signed construction or purchase contract with your builder, it’s time to complete the application process for your loan. The lender will perform a more thorough review of your finances, review your contractor and the building specifications in detail. They will likely also have an appraiser review the specs of the house and the value of the land to come up with an appraised value for the finished project.

6. Purchase the land

If you don’t already own the land on which you plan to build a home, you’ll need to purchase it. A construction loan can include financing for the purchase of a lot. Your lender will ask for a copy of the contract to purchase the land as part of the loan application.
If you already own the land and have an outstanding loan on the property, the first disbursement of your construction loan will pay off that loan before construction starts on the home.

7. Build the home

Once your loan closes and you’ve purchased your land, construction can begin. Your lender will continue to monitor the progress of the project, pay the builder according to the draw schedule and send an inspector to the property on a regular basis to ensure the project is proceeding as planned.

Sbeih said the two big potential pitfalls borrowers run into during this phase are time and budget. “If construction is delayed and takes longer, the borrower pays interest on the construction funds for a longer period of time, which costs more,” he said. “The more dangerous concerns are change orders and budgets that are not rock-solid. If you do not have a solid budget [that] includes padding for contingencies, you are flirting with disaster. This is how you end up with a project that is 80% complete and has no funding to make it to the finish line.”

8. Transition to a permanent loan

When the home is complete, you will transition to a permanent loan. If you have a one-time close loan, this process is automatic. If you have a two-time close loan, you will need to reapply and pay closing costs on a new loan.
Keep in mind that if you have a two-time close loan, you will need to go through the approval process again to transition to a permanent loan. If your income, credit or financial situation change for the worse during the construction phase, you may be unable to get a mortgage on the completed home and could end up losing the house to foreclosure before you even have a chance to move in.

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What it takes to get approved for a construction loan

The approval process and documentation required for a construction loan vary by lender, but the following list should give you a good idea of what you’ll need.

Documentation

If you own the land, you’ll need to show a copy of the deed to the land and the settlement statement for the purchase if you bought it within 12 months of applying for the loan
A copy of the contract to purchase the land if you don’t already own it
Your contract with the builder
Complete information on your builder, including name, address, phone number, etc.
Building plans and specifications
Proof of insurance from the builder
Proof of insurance covering the project
Documentation of your income, such as W-2s, tax returns and pay stubs
Authorization to perform a credit check
Information on your debts so the lender can calculate your debt-to-income ratio

Down payment

Lenders typically require a down payment of 20% to 25% of the appraised value of the home, at a minimum. This ensures you are invested in the project and are less likely to default on the loan or walk away if the project runs into issues.

If you already own the land on which you’ll build, the value of the land can be included in that equity contribution.

Cash reserves

Conventional loans require a borrower to have cash reserves of anywhere from two to 12 months’ worth of mortgage payments. You’ll likely need more for a construction loan because you’ll have to make payments on your construction loan during the building phase, as well as make rent or mortgage payments on your existing home.

Construction Loan vs. Traditional Home Loan

	Construction loan	Traditional home loan
Down payment	A down payment of 20% to 25% is the norm	You may be able to get a loan with no down payment or only 3% down
Interest rates	Typically variable interest rates during the construction phase. Higher than traditional mortgage rates.	May be fixed or variable
How the loan is disbursed	Paid out in draws to the builder at predetermined project milestones	Paid in full to the seller at closing
Documents required	All the documentation necessary for a traditional home loan, plus information on the builder and detailed building specifications for the project	Requires documentation on borrowers’ finances and appraisal of the property
Term	Typically one year	15- or 30-year terms are most common
Credit required	Excellent credit	Borrowers with credit scores as low as 500 may be able to get approval
Closing	Takes 7-10 days longer than a traditional mortgage	1½ months, on average
Monthly payments	Usually interest-only during construction	May be interest-only or interest plus principal

Where to find a construction loan

Talk to your bank to begin the process of applying and qualifying for a construction loan. Most construction loans are issued by banks rather than mortgage companies, as the bank will hold on to the loan until the project is complete.

Not all banks offer construction loans. Among those that do, interest rates, terms and fees can vary widely. So it’s a good idea to talk to a few different banks to make sure you’re getting the best deal.

Is a construction loan right for you?

Few homebuyers would be able to build a home to their exact specifications if it weren’t for construction loans. But a desire to design your own dream home isn’t the sole factor to consider when deciding whether a construction loan is right for you. They have stricter underwriting requirements, require larger down payments and have higher fees because of the ongoing inspections required during the construction phase.

If you have excellent credit, can afford a substantial down payment and have an adequate financial cushion to see you through unexpected delays and cost overruns, a construction loan can finance building your dream home. But if your financial footing isn’t as solid, you’re probably better off buying a home that’s already been built — or waiting until you can afford to weather the risks and uncertainties inherent in building.

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Janet Berry-Johnson |

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

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Mortgage

Can You Get a Home Equity Line of Credit on an Investment Property?

Monday, August 6, 2018

Janet Berry-Johnson

Many homeowners look to home equity lines of credit (HELOCs) to fund home improvements, pay off high-interest debts and cover emergency expenses. But this type of loan, which allows a property owner to borrow against the equity in the home, can be difficult to get – especially when the property in question is an investment property.

In this post, we’ll explain whether or not you can get a home equity line of credit on an investment property, and the pros and cons.

What are investment property loans?

Investment property loans are mortgages used to buy, build or improve second homes and investment properties – essentially any property other than the borrower’s primary residence. They may come in the form of a primary mortgage used to buy or refinance the property, a HELOC or a home equity loan.

Of those, the HELOC is unique in that it acts more like a credit card that is collateralized by your home. Like a credit card, the lender approves you to borrow up to a certain amount, then you borrow against the available credit when needed. As you repay the amount borrowed, your available credit is replenished. And you only pay interest on the money that you actually use.

Lenders are typically far more strict in their underwriting of investment property loans than they are for a borrower’s primary residence, and usually require more money down. Why?

Adam Smith, president and CEO of Colorado Real Estate Finance Group in Greenwood Village, Colo., said it’s because investment properties are already considered high risk. “You have to have somewhere to live, so the assumed risk factor is lower on a primary residence than it is on an investment property,” Smith said. In other words, you’re probably more likely to cover expenses for a primary home if you find yourself in a financial pickle, versus prioritizing a secondary property.

And with a HELOC, there’s an extra risk factor involved as well. Unless you own the property free and clear (meaning you paid cash or paid off the mortgage), a HELOC is a “junior-lien.” In other words, it’s secondary to your first mortgage.

If you stop making mortgage payments and the property goes into foreclosure, when the property is sold to pay off your debts, your primary mortgage will be paid off first. If there is not enough equity to pay off both the first mortgage and the HELOC, the HELOC lender may not get the full amount owed.

“So you’ve got a higher risk due to the occupancy and a higher risk due to the loan position,” Smith said. “It’s the perfect storm of high-risk lending.”

Getting a HELOC on an investment property

Despite these challenges, it is possible to get a HELOC on an investment property. Just keep in mind that the bar for approval may be set higher than it would be if you were applying for a mortgage to purchase an investment property or a HELOC on your primary residence. Let’s take a look at some of the potential hurdles you might be facing.

What is your credit score?

While there are many mortgage programs available to help borrowers with credit troubles, borrowers seeking a HELOC on an investment property will likely need good credit to get approved.

Minimum credit scores will vary by lender and are taken into account along with other factors, but a report from Equifax revealed that in 2017, more than 80% of HELOC borrowers had credit scores of 700 or above.

If you need to boost your credit score before applying for a HELOC, here are a few places to start:

Get a copy of your credit report. You can get a free copy of your credit report every 12 months from each of the three credit reporting agencies. Order yours at AnnualCreditReport.com and check it for errors, such as incorrectly reported late payments or credit balances. If you find any errors on your report, follow the credit bureau’s instructions for disputing them.
Check your credit score. A credit report won’t tell you your all-important credit score. To get a free one, check out our list here.
Pay your bills on time. On-time payments are one of the most significant factors the credit bureaus consider when calculating your credit score. If you have trouble remembering to pay your bills on time, set up reminders or enroll in automatic payments. A late payment remains on your credit report for seven years, but the more time has passed since the late payment occurred, the less of an impact it has on your score.
Reduce the amount you owe. Work on paying down your balances on credit cards, auto loans, student loans, etc. Paying off your outstanding debts, especially revolving credit card debt, can have a significant impact on your credit score.

What is your debt-to-income ratio?

Another factor lenders consider in approving a HELOC on an investment property is the owners debt-to-income (DTI) ratio. DTI measures your ability to manage your debt payments by comparing your monthly debt payments to your overall income. To calculate your DTI, divide your monthly recurring debt payments by your gross monthly income.

For example, if you have total monthly debt payments of $2,500 (including your current mortgage, auto loan, credit cards, student loans, etc.) and your income is $5,000 per month, then your DTI would be 50%.

When you apply for a HELOC, the lower your DTI, the better your chances of getting approved. As with credit score requirements, each lender has their own maximum DTI requirements, but if your DTI is higher than 43%, you may have a hard time finding a lender willing to approve your HELOC.

How much equity do you have in the property?

To qualify for a HELOC, you need to have available equity in the property, meaning the amount you owe on the first mortgage is less than the value of the property. Banks typically set a maximum loan-to-value (LTV) limit for how much you can borrow. That may be somewhere around 80% to 90% of the value of the property, minus the amount you owe.

For example, say your property is worth $400,000, and you currently have a mortgage balance of $300,000. Your current LTV would be 75% ($300,000 ÷ $400,000). If your lender has a maximum LTV of 80%, you may only be able to borrow $20,000 from a HELOC. That’s five percent of $400,000, which would bring your total LTV up to 80%.

Smith says a lender considering a HELOC would require more equity on an investment property than they would on a primary residence.

“Ideally, your HELOC would be in first position – you would own the property free and clear. But if you do have an existing mortgage, you would owe only about half of what the property is worth,” he said.

Borrowers who do not have enough equity in the property to qualify for a HELOC don’t have a lot of good options for building it quickly. Equity increases when a) you pay down the mortgage, or b) the value of the property increases. If you’re interested in a HELOC, you probably don’t have a lot of extra cash laying around that can be used to pay down your existing mortgage balance. You may be able to make some improvements to the home that will increase its value, but that also requires investing funds into the property. And finally, you don’t have any control over the real estate market and how your home’s value fluctuates based on supply and demand in your area. So without enough equity to qualify for a HELOC, you may have to consider other alternatives.

Alternatives to getting a HELOC on an investment property

Whether you are an ideal HELOC borrower or not, it’s a good idea to look into alternatives to a HELOC on your investment property. Here are a few you might consider:

Cash-out refi

A cash-out refinance is the refinancing of your existing mortgage loan. Your new mortgage will be for a larger amount than your current mortgage, and you receive the difference between the two loans in cash.

Getting approved for a cash-out refi also requires having adequate equity in the property. However, the advantage of a cash-out refi, as opposed to a HELOC, is that cash-out refis are generally fixed-rate loans. HELOCs are typically adjustable-rate loans, so if interest rates go up, your monthly payments could go up as well.

Personal loans

Personal loans and lines of credit are similar to a HELOC, but they are unsecured loans, meaning you don’t have to pledge the property as collateral. So if you run into financial trouble and can’t afford to make loan payments, you aren’t at risk of losing the property.

There are two potential downsides of choosing a personal loan over a HELOC. First, since personal loans aren’t collateralized, they typically come with higher interest rates. Second, personal loans usually have shorter loan terms. A personal loan is usually repaid over two to seven years, whereas a HELOC will generally allow you to withdraw funds for up to 10 years and give you up to 20 years to repay.

Credit cards

If your cash needs are modest and you don’t qualify for a HELOC on your investment property, you might consider using a credit card. However, the interest rate on a credit card will likely be much higher than you’d receive with a HELOC, unless you can find card with a decent intro APR.

Bottom line

If you believe a HELOC is the right choice for you, Smith recommended starting your search with a retail bank. “The wholesale mortgage world is still a little skittish,” he said. “Your best bet is banks that primarily do depository business. They’ll offer HELOCs to keep their checking account holders happy.”

There are a lot of potential barriers to taking out a home equity line of credit on an investment property, but a HELOC can be a smart financing tool for a property owner in need of funds to fix up the property or invest in another one.

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

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Mortgage

Best Ways to Add Value to Your Home

Friday, March 23, 2018

Janet Berry-Johnson

203k loan

If you’re tired of the way your home looks and feels but don’t necessarily want to move, you don’t have to settle. Whether you crave more square footage, an upgraded interior or better curb appeal, you’ll find an endless supply of ideas that can improve your home’s functionality and style.

But, that doesn’t mean that all remodeling projects are created equal — not by a long shot. While plenty of home upgrades can be “worth it” in a financial sense, there are ways you can improve your home that may cause its value to drop as well.

Before you remodel, it pays to research the best ways to add value to your home and which projects might offer the most “bang for your buck.” With the right strategy and a professional remodeling team by your side, it’s possible to create your dream home while building equity in the process.

Benefits of making home improvements

There are plenty of ways homeowners can benefit from a home remodel, but one of the biggest perks is an increase in their home’s value. With a home addition, a new kitchen, upgraded bathrooms or big project completed, it’s very likely your home will appraise at a higher value than it did before you remodeled. That means you’ll have a larger share of equity in the property, which is any homeowner’s ultimate goal.

And in when your home is worth more, there are several benefits you’ll get to enjoy.

The potential to remove private mortgage insurance (PMI) from your home loan:Private mortgage insurance is typically charged as an added fee when you buy a home with less than a 20% down payment. This fee can vary, but it’s usually equal to 0.15% to 1.95% of the loan amount. If your home’s value increases after you remodel, it may be possible to have your home appraised and the PMI charges removed from your monthly mortgage payment.
Increased net worth: An increase in your home’s value could boost your net worth — the measure of all your assets minus your liabilities.
Sell your home at a profit: The more your home is worth, the more likely you will be able to sell it for a profit if you need to move.
Easier qualification for home equity loans: By remodeling to improve your home’s value, your ability to qualify for a home equity loan or HELOC will improve. The amount you can borrow may also be higher.

In addition to the financial benefits of remodeling, there are other personal benefits you can acquire as well. Realtor Guillermo Salmon of Pearson Smith Realty says one of those benefits is the fact that you get to enjoy the fruits of your labor yourself if you stay in the home.

“It’s your home, and you want to be comfortable,” said Salmon, who sells real estate in the Washington, D.C., area. “I always tell my clients to make updates early so they can enjoy them instead of waiting to remodel until right before you sell.”

Salmon’s thoughts seem to line up with national statistics regarding home remodeling projects. According to the 2017 Remodeling Impact Report from the National Association of Realtors, 75% of homeowners who responded to the survey had a greater desire to be in their homes after their remodeling project was completed. And 65% of those polled also reported increased enjoyment in their homes.

Another important benefit of remodeling is the fact that it may improve your home’s utility, says Salmon. The NAR survey also revealed that 36% of homeowners reported better functionality and livability as the most important result from their project.

When you think about it, that makes a lot of sense. A kitchen with a better layout or a bathroom with a new garden tub could make living in your home a more positive experience, for example.

Last but not least, remodeling your home may help you avoid moving and all moving-related costs. Remember that moving to a new home may require hiring movers, some remodeling of your new home, realtor fees to sell your home, and of course closing costs on your new home loan.

“If the space is there and you are able to remodel, the price of a big project or full-home remodel could be well worth it,” said Salmon. “There are a lot of moving costs that people don’t think about, and it is often a lot more expensive than people realize.”

Home improvements that can add value to your home

While remodeling your home can make it more appealing to the eye and more functional, the right remodeling project can also boost the value of your home. The key to increasing your home’s value through remodeling is making sure you’re choosing projects that will actually pay off.

Kitchens and bedrooms and bathrooms, oh my

According to Salmon, kitchens, master bedrooms and master bathrooms are the areas buyers pay the most attention to — as well as the areas that could add the most value to your home if you remodel. Other bathrooms in the home are also important, he says, because “buyers don’t want to have to remodel rooms they need, and bathrooms are some of the most used rooms in a home.”

Salmon also says that paint may be more important than people think.

“Paint the interior of your home so it looks clean and fresh, but make sure to choose a neutral color,” he said. Salmon notes that many buyers lack imagination, so if they walk into your home and see lots of bright colors or a lack of cohesion in the color palette, they may be scared off.

“Some people hate bright wall colors or bold wallpaper,” he said.

Open concept conversion

Residential designer Paul DeFeis of Trade Mark Design & Build in the New Jersey area says another project that typically pays off is opening up walls to create an open living space.

If you have an older home with a boxy and broken-up interior, opening up the walls to create a larger living space is often one of the best “bang for your buck” remodeling projects. “Opening up a wall that connects an adjacent room to your kitchen is huge,” said DeFeis.

Curb appeal

Last but not least, both DeFeis and Salmon agree that curb appeal is important, and that improving the exterior look of your home can go a long way toward fetching a higher sales price or just upping your home’s value.

Salmon says that planting nice bushes, adding mulch or painting your exterior door can make your home pop. You should also make sure your grass is mowed and debris is removed. “Even basic yard cleanup can go a long way,” he said.

The National Association of Realtors also offers their own list of home upgrades that can pay off the most over time. According to their study, the home upgrades they believe will increase your home’s value the most in 2017 included:

Complete kitchen renovation
Kitchen upgrade
Bathroom renovation
Add new bathroom
New master suite
New wood flooring
HVAC replacement
Hardwood flooring refinish
Basement conversion to living area
Attic conversion to living area
Closet renovation
Insulation upgrade

In terms of exterior home remodel projects, they list new roofing, new vinyl windows, a new garage door and new vinyl siding as the top four upgrades that will appeal to buyers and increase the value of your home.

Home improvements that can negatively impact your property values

While there are plenty of improvements that can be a net positive for your finances, there are just as many that can make no impact in your home’s value — or worse, decrease your home’s value.

This list isn’t all-inclusive and the type of projects that can hurt your home’s value also vary depending on your neighborhood and where you live. If you want to avoid completing updates that won’t be worth it, think long and hard before you tackle any of the projects below:

Garage conversions
- Cost: $5,000 – $30,000 and potentially more depending on job site conditions and square footage. While it might be tempting to convert your garage into a room to increase your square footage, DeFeis says this is often a bad idea. Not only can a converted garage look awful from the road, but it could be a zoning issue as well. Further, many buyers will want a garage over more square footage and may not consider your home without one.
Swimming pools
- Cost: $30,000 – $100,000 depending on construction materials, landscaping and upgrades. Swimming pools may be standard or popular in warmer climates, but you could limit your potential pool of buyers by adding one no matter where you live. “It depends on the buyer,” he said. “Some buyers want a pool and some people absolutely refuse to have one.”
Nonconforming additions
- Cost: $30,000 – $60,000 and potentially more for a home addition depending on size. Adding onto your home can increase your square footage and make your home more livable, but that doesn’t mean all additions look great from the outside of your home. “If you’re driving down the street and your house looks out of place, then it’s not going to help your home’s value,” said DeFeis.
Luxury upgrades
- Cost: $1,000 – $2,500 per linear square foot for custom kitchen cabinets, $22 – $32 and up per square foot for marble flooring including installation. While luxury upgrades like custom cabinets or Italian marble flooring may have been all the rage a few decades ago, these products seem to be taking a back seat to more mainstream products, says DeFeis. “People want the look but they do not want the luxury product anymore.”
Overdone landscaping.
- Cost: pricing varies. Too much landscaping can make buyers feel overwhelmed, but it depends on the neighborhood. Ideally, you’ll want your landscaping to look similar to your neighbors.
Overbuilding
- Cost: pricing varies. Last but not least, don’t forget it’s possible to improve your home too much. Making your home a lot bigger than the rest of the homes in your neighborhood may not be a good investment, for example. “If the average price point in your neighborhood is $400,000 and your home is worth that amount but you add a $100,000 addition to your home, that doesn’t mean your home will be worth $500,000,” said Salmon.

Final thoughts

Whether you want to remodel to sell or to make your home into what you want it to be, it’s smart to research different remodeling projects to gauge your potential return on investment. While some projects can absolutely pay off, there are just as many home “upgrades” that can hurt your home’s value or make no impact at all.

Janet Berry-Johnson |

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

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Mortgage

How to Budget for Closing Costs and Fees on a Mortgage

Monday, January 22, 2018

Janet Berry-Johnson

When you buy a home, in addition to your down payment, you need to budget for closing costs. Closing costs are the fees paid to third parties that help facilitate the sale of a home. The amount you’ll pay depends on several factors including the price of your home, your lender’s requirements, and the location of the property. We’ve put together this guide to help you get a sense of what to expect.

What costs to expect when closing on a mortgage

The type and amount of fees you’ll pay vary widely based on the lender you work with, the loan you choose, and your location. Here are some common fees to expect when closing on a home loan:

Fee	Description
Appraisal fee	Paid to a professional who gives the lender an estimate of the home's market value.
Attorney fees	In some states, an attorney may be required to represent the interest of the buyer and/or lender. This fee is paid to the attorney to prepare and review all closing documents.
Credit report	Some lenders charge a fee for accessing your credit information.
Flood determination	Paid to a third party to determine whether the property is located in a flood zone. If your property is in a flood zone, your lender may require you to purchase flood insurance in addition to homeowners insurance.
Home warranty fees	If you choose to purchase a home warranty on the property, the annual premium may be included in your closing costs.
Homeowners association (HOA) fees	If your home is located within a homeowners association, the association may charge a fee to help pay for services and capital improvements. You may also need to prepay a portion of your annual dues at closing.
Homeowners insurance	The first year's premium for your homeowner's insurance is typically paid in full at closing.
Inspection fees	Paid to a home inspector to evaluate the home and tell you whether the property you want to buy is in good condition. You may also have a separate pest inspection to check for termites and other pest infestations.
Land survey	Your lender may require that a surveyor conduct a property survey.
Origination charges	Upfront charges from your lender for making the loan. This may include an application fee and underwriting fees.
Notary fees	The cost of having a licensed notary public certify that the persons named in the documents did, in fact, sign them.
Points	An upfront fee paid to the lender in exchange for a lower interest rate.
Prepaid interest	If you close on your loan in the middle of the month, your lender will collect interest on your loan from the closing date until the end of the month.
Private mortgage insurance premium	Depending on the type of loan you choose and how much money you put down, you may have to pay mortgage insurance – a policy that protects the lender against losses from loan defaults. Some lenders require an upfront premium, some collect it in monthly installments, and some do both.
Property taxes	Six months of property taxes are typically paid at closing.
Recording fees	State and local governments typically charge a fee to record your deed and other mortgage documents.
Real estate broker or agent fee	Fees paid to seller's real estate broker for listing the property and to the buyer's broker for bringing the buyer to the sale. The seller of the property typically pays these fees.
Title insurance	Provides protection if someone later sues and says they have a claim against your home, either from a previous owner's delinquent property taxes or contractors were not paid for work done on the home before you purchased it.
Title search	A fee paid to the title company to search the public records of the property you are purchasing.
Transfer taxes	Taxes imposed by the state, county, or municipality on the transfer of property. They may also be called conveyance taxes, stamp taxes, or property transfer taxes.

The amount you’ll pay depends largely on your location. A 2017 survey from ClosingCorp, a provider of residential real estate closing cost data, found that the national average closing costs totaled $4,876. That figure is based on closing cost data reported to more than 20,000 real estate service providers across the country. ClosingCorp compiled the average closing costs in each state, and based on the average purchase price in each state, average closing costs ranged from about 1% to about 4% of the purchase price. (The actual closing costs you pay could be higher or lower — a general rule of thumb says to expect paying about 2 to 7% of your home’s purchase price in closing costs.)

States with the highest average closing costs were:

District of Columbia: $12,573 (2.01% of average purchase price)
New York: $9,341 (2.60%)
Delaware: $8,663 (3.36%)
Maryland: $7,211 (2.28%)

But based on percentage of average purchase price, these states had the highest average closing costs:

Pennsylvania: $6,633 (3.50%)
Delaware: $8,663 (3.36%)
Vermont: $6,839 (2.99%)
New York: $9,341 (2.60%)

States with the lowest average closing costs were:

Missouri: $2,905 (1.63%)
Indiana: $2,934 (1.89%)
South Dakota: $2,996 (1.48%)
Iowa: $3,138 (1.70%)

And by percentage:

Hawaii: $5,528 (0.84%)
Colorado: $3,994 (1.09%)
Massachusetts $4,273 (1.14%)
California: $6,288 (1.20%)

In areas where home prices are high, closing costs will typically be high as well because many closing costs are calculated as a percentage of the home’s purchase price. In other areas, the ClosingCorp report pointed to high county transfer taxes as the principal reason certain areas have such closing costs.

Fortunately, there are steps to you can take to save on closing costs.

How to save on closing costs

Step 1: Choose your location

The location has a lot to do with the total closing costs you’ll pay. Factors that affect closing costs include:

Home price. Since many costs are calculated as a percentage of the home’s purchase price, buying a less expensive home can lower your closing costs.
Property taxes. You may have to prepay six months of property (or real estate) taxes at closing, so buying a home in a state with high-property tax rates can significantly impact your closing costs. The Tax Foundation publishes a list of the property tax rates by state. New Jersey is the highest with an effective tax rate of 2.11%, and Hawaii is the lowest at 0.28%.
Laws and customs governing the closing process. Some states require an attorney to handle closings, resulting in higher legal fees at closing. In other states, closing costs are lower because closings are handled by a title or escrow company.
Real estate transfer taxes. Transfer taxes are imposed by state and local government entities and can vary widely by locale. The National Conference of State Legislatures publishes a list of real estate transfer taxes by state. Some states, such as Alaska and Louisiana, have none as of 2017. In some localities in Colorado, the rates can be as high as 4%.

Ask your lender or real estate agent about closing costs in your area. If you’re not determined to live in a particular area, you could save thousands in closing costs by buying in a neighboring state or county.

Step 2: Shop around

A crucial step to saving on closing costs is to shop around. Home loans are available from many different types of lenders, and different lenders may quote you different rates and fees, even of the same type of loan. You should contact several lenders for quotes.

When you receive a quote, don’t just get the interest rate, APR, or monthly payment amount. The lender should provide you with a Loan Estimate that discloses the loan terms, amounts, interest rate, total monthly principal and interest, and whether the item can increase after closing. It also communicates which closing costs you can shop around for and which are fixed no matter which lender you choose.

Also, take a look at the homeowners insurance premium listed on Page 2 of the Loan Estimate. The lender will estimate an amount for the Loan Estimate, but your homeowner’s insurance premium is set by the insurance company, not the lender, and insurance rates can vary drastically by company. Comparison shopping for insurance can have a significant impact on your closing costs, as you’ll typically pay the first year’s premium at closing.

Step 3: Negotiate

Jeffrey Miller, co-founder of AE Home Group in Baltimore, Md., says knowing whether closing costs are negotiable or non-negotiable depends on whether or not they’re being charged for the mortgage company’s labor or to an outside service. “Line items like origination fee can be negotiated lower, whereas line items like the county recording fee are set by an outside third party and are non-negotiable,” Miller said.

Page 2 of your Loan Estimate will list the services you cannot shop for and the services you can shop for. The services you cannot shop for may be set by a government program or a third party rather than the lender. Your lender may provide you with a list of approved vendors for the services you can shop for.

Miller says in his experience, the line item with the most potential savings is the survey. “As a buyer, you have the right to select the survey company that is used,” Miller said. “We’ve seen this price range anywhere from $120 to $600. If this amount is on the high side, then it may be advisable to select a new survey company.”

Step 4: Ask the seller to pay closing costs

Many loans, including FHA loans, allow sellers to contribute a percentage of the sales price to the buyer as a closing costs credit. This is especially useful for buyers who are short on cash for the down payment and closing costs but can handle a slightly higher loan balance.

For instance, say the seller is asking $200,000 for the home. The buyer can offer $204,000 but asks the seller to cover up to two percent of the original asking price in closing costs ($200,000 x 2% = $4,000). The seller is able to get the same net profit on the sale, and the buyer reduces his closing costs by $4,000.

Keep in mind that lenders may have restrictions on how much the seller can credit to the buyer at closing. For instance, FHA loans limit the seller concession to 6% of the home’s sales price. There may also be restrictions on the types of closing costs that can be covered by the seller credit. For instance, they may restrict the seller credit to covering non-recurring items like the title insurance and loan origination fees.

Step 5: Time your closing

Part of your closing costs consists of prepaid interest charges for the time between your closing date and the end of the month. The earlier in the month you close, the more you’ll pay in prepaid interest. To reduce the amount you’ll need out of pocket, you can consider closing at the end of the month. The difference may be small, but if you’re really strapped for cash to close, this could help. However, timing your closing at the end of the month doesn’t actually save you any money in the long term. It just impacts the amount you’ll need to come up with at closing.

Step 6: Sign in person

Kevin Miller, Director of Growth with Open Listings, an online house-hunting service based in Los Angeles, says you may be able to reduce the costs you’ll pay at closing simply by asking your escrow company. “You should contact them at the beginning of the process to discuss the fees they charge you,” he said. “If you agree to use electronic documents and sign in-person, you may be able to avoid fees for a mobile notary, printing, and mailing.”

Should I get a no-closing cost mortgage?

While shopping around for a mortgage, you may have come across a “no-closing cost mortgage” and wondered if it’s the right deal for you.

A no-closing-cost mortgage is worth looking into, but “no closing costs” doesn’t actually mean you won’t have to come up with any cash for closing. Instead, it means that the lender doesn’t charge any lender fees. However, they may charge a higher interest rate to cover the costs of making the loan or add the closing costs to your loan amount.

Either way, you won’t need to come up with as much cash to close, but you’ll typically have a higher monthly payment.

Also, keep in mind that you may still have to pay costs at closing, such as title insurance and appraisal fees. Before you get locked into a no-closing-cost mortgage, ask the lender for a Loan Estimate and take a look at the interest rate, APR, monthly payment and the amount you’ll need at closing. Consider whether reducing the cash you need to close is worth paying more in the long run with a higher interest rate or larger loan amount.

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The bottom line

When you’re in the market for a mortgage, it pays to shop around. Review your paperwork carefully. Ask your lender about any costs and fees you aren’t familiar with, or anything that changes from your Loan Estimate to the closing documents. Negotiating can be intimidating for many people, but your home is a big investment. The more you can save on closing costs, the more cash you’ll keep in your pocket for moving, buying furniture, and making your new place feel like home.

Janet Berry-Johnson |

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

TAGS: closing costs, Mortgage, Mortgage fees

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P2P Lending: The Complete Guide for Peer-to-Peer Lending

Thursday, January 18, 2018

Janet Berry-Johnson

Peer-to-peer lending is a modern name for a practice as old as money itself — individuals loaning money among themselves. What’s modern is the scale afforded by technology. Ten years ago, an individual needing a loan to start a business, consolidate debt, or cover unexpected home improvements would have been limited to borrowing from his or her immediate friends, family, and acquaintances outside of a traditional bank loan. Today, online peer-to-peer (P2P) lending platforms connect individuals who need to borrow money with investors willing to lend. Technology now allows perfect strangers to borrow from and lend to each other.

For many people, borrowing from peers can be a great alternative to borrowing from a bank, but it’s not for everyone. We’ll take a look at how peer-to-peer lending works and what you need to know before you apply.

How P2P loans work

The Small Business Administration (SBA) defines P2P lending as, “Individual investors providing small sums to lend personal loans to individuals via internet platforms.” Some of the most popular platforms include LendingClub, Prosper, Upstart and Funding Circle, although there are several others.

Potential borrowers can apply for credit on the platform, and borrower qualifications vary by lender. For example, the interest rate a LendingClub borrower receives depends on an internal score developed by the company, which is one of the largest P2P lenders. “They will give you a grade between A (the best grade, qualifying for the highest amount at the lowest rates) and G (the lowest grade with the highest interest rate),” a LendingClub spokesperson told MagnifyMoney.

LendingClub currently caps its personal loans at $40,000. Prosper caps its loans at $40,000. Typical loan terms range between three and five years.

Who invests in P2P loans

P2P loans may be funded by an individual investor or a group of investors. According to MarketWatch, P2P loans can be a good way to diversify the portfolio of income investors who take time to understand the risks and rewards. Income investing generates a cash income in the form of dividends and interest. In other words, investors don’t buy a stock, bond, or other investment and wait for it to appreciate in value so they can sell it and earn a profit. Simply holding on to the investment generates income.

P2P loans are an income investment because once an investor opens an account and chooses to participate in a loan, principal and interest payments (less fees charged by the platform) are deposited into the investor’s account on a monthly basis.

The investors may be individuals or institutions, such as banks, pension plans, foundations, finance companies, asset managers, insurance companies, broker-dealers, and hedge funds. Individual investors can open an account with Lending Club with an initial investment of $1,000, but other platforms are available only to institutions and accredited investors (those who can demonstrate high-earned income and net worth).

Connor Murphy, a public relations and communications specialist with Funding Circle, says their platform in the U.S. is only open to accredited investors and institutional investors. “We actually use the term ‘marketplace lending’ rather than peer-to-peer lending,” Murphy said, “because investors on our platform globally include large financial institutions and even governments.”

Whether the investor is an individual with $1,000 or an institution looking to invest $250,000, they select loans to invest in and earn monthly returns on. According to Sarah Cain, head of communications at Prosper, borrowers do not know their lenders. “They simply know if their loan has been funded or not,” Cain said.

Why P2P loans?

P2P lending platforms started gaining traction more than a decade ago as a way to bypass banks and use technology to connect investors with money to the borrowers that need it. P2P lenders have claimed their online platforms help them reduce costs, and that, in conjunction with analytics and proprietary algorithms, allow them to offer borrowers lower interest rates or provide loans to individuals who have been refused loans by traditional banks.

LendingClub currently advertises APRs for personal loans from 6.16% to 35.89%. The company surveyed borrowers during the first seven months of 2017 and found that borrowers who received a loan to consolidate existing debt or pay off credit card balances reported that they saved an average of $287 per month. However, that statistic compares high-interest credit card rates with personal loan rates – not P2P personal loan rates to bank personal loan rates.

As of August 2017, the average APR on credit cards carrying a balance was 14.89 percent, but banks may offer much lower rates for personal loans. Of course, whether you choose a P2P loan or a bank loan, having a high credit score can help you get the lowest rate offers, while a lower credit score will likely stick you with higher interest rates, if you are approved for a loan at all.

Some borrowers just prefer the idea of avoiding large, traditional banks. But as with any borrowing decision, you should compare apples to apples when seeking financing for any purpose and shop around for the best rate.

Applying for a peer-to-peer loan

To apply for a loan, a potential borrower visits a P2P lending website and fills out an application.

The platform leverages online data and technology to assess risk, determine a credit rating and assign an appropriate interest rate. Applicants may receive offers within a few minutes and can evaluate options without impacting their credit score. Once you select a loan offer, you’re required to complete an online application that gathers information about your income and employment as well as identifying information, such as address and Social Security Number.

You may also be required to provide additional documentation to verify your identity, income, and employment. That may include:

Tax forms such as W-2s and 1099s
Tax returns
IRS Form 4506-T, which is used to request a copy of your tax forms or returns directly from the IRS
Recent bank statements or pay stubs
Proof of income from alimony or child support, pension or annuity income, disability insurance or workers compensation benefits, if applicable
Copies of government-issued photo ID
Utility bills

Once you’ve completed the application and submitted the necessary documents, your application is reviewed and the platform matches you with investors to fund the loan. Once the loan is approved, the funds are deposited into your bank account. The process can take anywhere from seven to 45 days.

Each P2P site has its own rules and approval criteria, including minimum credit score, so an application declined by one platform doesn’t necessarily mean that you won’t be approved by the others.

The Financial Industry Regulatory Agency (FINRA) reported that P2P lenders tend to be more forgiving than banks when it comes to short credit histories, but if you’re trying to get a P2P loan with less than stellar credit, don’t expect the lowest rates.

Lending Club states that applicants who qualify for the lowest rates have:

An excellent credit score
A low percentage of total outstanding debt compared with income
A long history of credit with significant successful credit lines

APR

6.16%
To
35.89%

Credit Req.

600

Minimum Credit Score

Terms

36 or 60

months

Origination Fee

1.00% - 6.00%

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LendingClub is a great tool for borrowers that can offer competitive interest rates and approvals for people with credit scores as low as 600.... Read More

Upstart looks for borrowers with:

A minimum FICO score of 640 (although they do accept borrowers with insufficient credit history to produce a FICO score)
No bankruptcies
No accounts currently in collections or delinquent
Fewer than six inquiries on their credit report in the last six months (other than inquiries for student loans, vehicle loans, or mortgages

APR

8.36%
To
29.99%

Credit Req.

640

Minimum Credit Score

Terms

36 & 60

months

Origination Fee

0.00% - 8.00%

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Upstart’s initial focus was to help recent graduates that were struggling with debt, but they have expanded to provide options for those with strong credit profiles as well. They have a unique algorithm that takes into account things such as education, career, job history, and standardized test scores, but you will still need a minimum FICO score of 640.

Prosper’s minimum criteria include:

A minimum FICO score of 640
Debt-to-income ratio below 50%
No bankruptcies within the last 12 months
Fewer than seven credit inquiries within the last six months

APR

6.95%
To
35.99%

Credit Req.

640

Minimum Credit Score

Terms

36 or 60

months

Origination Fee

2.41% - 5.00%

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Prosper is a peer-to-peer lending platform that offers a quick and convenient way to get personal loans with fixed and low interest rates. ... Read More

For example, a three-year $10,000 loan with a Prosper Rating of AA would have an interest rate of 5.31% and a 2.41% origination fee for an annual percentage rate (APR) of 6.95% APR. You would receive $9,759 and make 36 scheduled monthly payments of $301.10. A five-year $10,000 loan with a Prosper Rating of A would have an interest rate of 8.39% and a 5.00% origination fee with a 10.59% APR. You would receive $9,500 and make 60 scheduled monthly payments of $204.64. Origination fees vary between 2.41%-5%. APRs through Prosper range from 6.95% (AA) to 35.99% (HR) for first-time borrowers, with the lowest rates for the most creditworthy borrowers. Eligibility for loans up to $40,000 depends on the information provided by the applicant in the application form. Eligibility is not guaranteed, and requires that a sufficient number of investors commit funds to your account and that you meet credit and other conditions. Refer to Borrower Registration Agreement for details and all terms and conditions. All loans made by WebBank, member FDIC.

While the approval process isn’t without its hurdles, peer-to-peer loans give borrowers another — sometimes less expensive — option for borrowing beyond credit cards and bank loans. Because P2P lenders facilitate borrowing without a bank intermediary, there is less overhead and none of the capital reserve requirements that drive up costs for traditional banks. As a result, the cost of originating and funding loans is lower, providing more competitive rates to borrowers and a faster approval process.

Plus, some borrowers just like the idea of borrowing outside of the traditional banking industry. Cain says although the process is online, P2P lending is not simply a different way of dealing with a faceless lender. “We do have a robust customer service team that is available to help,” Cain said.

What if your loan isn’t funded?

If your loan application is denied, you will receive an adverse action notice that provides the specific reason for the denial.

Cain says it’s hard to say exactly why a loan application would be denied, as every person’s credit profile is unique. However, some common reasons credit applications may be denied even though the borrower has a good credit score include:

Problems verifying employment. A stable job and stable income indicate that you’ll be able to pay your lender back. If the lender has trouble verifying your employment history, they may decline your application.
Not enough income. If you don’t have enough income in relation to your existing debt obligations to pay back the loan, most lenders will deny credit.
Bankruptcy. Lenders are often wary of approving a loan after you’ve declared bankruptcy. A bankruptcy may remain on your credit report for up to seven or 10 years, depending on the type filed.
Credit card utilization. If you are using a large percentage of your available credit, you may be seen as a potential risk to lenders.

If your loan application is denied, check your credit report to make sure that there are no inaccuracies that are dragging down your credit score. You can check your credit report with each of the three credit reporting agencies for free once a year at annualcreditreport.com.

Also, review your loan application to ensure you filled it out completely and accurately. If you find any errors in your credit report or application, correct them and apply again. Otherwise, take a look at the adverse action notice and see what you can do to improve your situation.

While there are no quick fixes for a bad credit score, small steps can improve your score over time.

Reduce the amount you owe. Stop using credit cards and make a plan to pay down existing balances.
Pay your bills on time. Payment history accounts for as much as 35 percent of your FICO score, so set up payment reminders to avoid missed or delinquent payments.
Avoid closing unused cards. Part of your credit score depends on the average length of time you’ve been using credit, so closing old accounts can actually hurt your score.
Don’t open new accounts too rapidly. A large number of new accounts in a short time frame can make you look risky to lenders, so apply for and open new accounts only as needed.

Shopping around

Each platform has their own lending criteria, loan limits, fees, interest rates, and areas of operation. Take a look at the FAQs and other information on the provider’s website to get an overview of the types of loans they offer, and the rates and fees they charge.

Here are a few to get started:

Lending platform	Loan amount	Terms	Who it’s best for:
Upstart	$1,000-$50,000	36 & 60 months	Borrowers who may not have an excellent FICO score (or any score at all) but are good loan candidates based on other factors such as education and job history
Prosper	$2,000-$40,000	36 or 60 months	Borrowers interested in a personal loan to consolidate credit card debt, fund home improvements, vehicle purchases or other life events, or start, or expand a small business
Lending Club	$1,000-$40,000	36 or 60 months	Borrowers interested in a personal loan for consolidating high-interest debt, funding home improvements, or paying for unexpected expenses
Funding Circle	$25,000-$500,000	6 months to 5 years	Borrowers looking for funding to start or expand their business

Keep in mind that interest rates and other terms can change, so you should compare rates and other terms from a variety of lenders every time you need to borrow.

The P2P lending market is only a little over a decade old, thus P2P platforms have not had the long history of government oversight to which banks and credit unions have been subjected.

And there is reason to be cautious about getting involved in P2P lending. In 2016, the Department of the Treasury released a report, Opportunities and Challenges in Online Marketplace Lending, looking at the opportunities and risks of P2P lending. Their concerns included:

The use of data-driven algorithms for making credit decisions has the potential to violate fair lending laws and doesn’t allow applicants to check and correct the data being used.
Interest rates may be high. The report acknowledged that the majority of loans are made to borrowers with good credit scores, but some platforms offer loans to borrowers with poor credit (FICO scores as low as 580) at interest rates as high as 36 percent.
Borrowers using P2P lending to refinance federal student loans lose the protections available to federal student loan borrowers, including income-driven repayment plans, loan forgiveness, and deferral or forbearance while the borrower returns to school or faces economic hardship or disability.
Many borrowers use P2P loans to fund small business development, but it may be difficult to enforce consumer protection laws and regulations, contract law, or fair lending laws with P2P platforms since these platforms are not subject to the same oversight as traditional banks.
While many marketplace lenders clearly disclose loan rates and terms, not all platforms are as transparent. The report acknowledged a need for standardized disclosures.
Most P2P platforms service loans only until a loan becomes delinquent, at which point collection is outsourced to a collection agency. Not all platforms have plans in place to work with borrowers who are experiencing financial distress or plans to continue servicing loans if the company goes out of business.

However, they are required to follow the same state and federal laws as other lenders. If you encounter any problems with a P2P lender, you should submit a complaint to the Consumer Financial Protection Bureau.

The CFPB began accepting complains about P2P lenders in March of 2016. We reviewed the complaints database in December of 2017 and counted more than 300 complaints about some of the largest P2P lenders. Consumers who submit complaints assign categories themselves and can opt not to have their complaint narrative published, so it’s difficult to parse the top complaints, but they include:

Having difficulty getting the loan
Problems making payments
Problems with the payoff process
Being charged interest or fees that aren’t expected
Inaccurate information reported to the credit bureau

These problems aren’t unique to P2P lenders, given that borrowers from traditional banks can face similar frustrations. Still, it’s important to know what other borrowers have experienced if you’re thinking of pursuing a P2P loan.

Lending Club and Prosper are the most popular platforms, but experts expect the industry to grow, so it’s worth expanding any comparison shopping beyond the biggest players. Just do your research before providing your personal information.

Search for the lender online. Is the platform mentioned in roundups of the best P2P platforms from reputable financial websites? Do your search results include consumer complaints?
Check the platform’s rating with the Better Business Bureau.
Make sure the platform takes steps to protect your personal data. They should have security and privacy certification from a company like TRUSTe or Symantec.

Alternatives to a P2P loan

It makes sense for anyone interested in a P2P loan to also compare alternatives before committing to a loan:

Community banks
Credit unions
Friends and family

Peer-to-peer lending can be a less expensive alternative to high-interest credit cards and easier to get than a bank loan. But, like all borrowing decisions, it needs to be carefully considered for your individual financial circumstances. The bottom line is that P2P is another option, and more options and increased competition are always good for borrowers.

APR

5.99%
To
35.99%

Credit Req.

Minimum 500 FICO

Minimum Credit Score

Terms

24 to 60

months

Origination Fee

Varies

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LendingTree is our parent company.... Read More

Janet Berry-Johnson |

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

TAGS: Funding Circle, Lending Club, P2P lending, peer to peer lending, Personal Loans, Prosper, Upstart

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How to Handle an Upside-Down Car Loan

Monday, October 30, 2017

Janet Berry-Johnson

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 is a writer at MagnifyMoney. You can email Janet here

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Mortgage

The Complete Guide to FHA Loans

Friday, September 22, 2017

Janet Berry-Johnson

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:

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.
Loan application. The lender will help you complete a loan application and request a variety of financial documents.
Case number assigned. Every FHA mortgage is assigned a case number that identifies the individual loan and borrower.
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.
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.
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.
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.

I have declared bankruptcy in the past. Can I still qualify for an FHA loan?

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.

Can I have a co-signer on an FHA loan?

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.

Can I refinance an FHA loan?

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.

Are FHA loans only for first-time homebuyers?

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.

Can an FHA loan be used on an investment property?

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.

How much of my down payment can be gifted?

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 is a writer at MagnifyMoney. You can email Janet here

TAGS: Buying a House, fha loans

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Small Business

How to Find Your Best VA Business Loan Options in 2017

Tuesday, August 22, 2017

Janet Berry-Johnson

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 is a writer at MagnifyMoney. You can email Janet here

TAGS: Military, small business loans, veterans

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Mortgage

Do You Really Need a Home Warranty?

Tuesday, August 8, 2017

Janet Berry-Johnson

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 is a writer at MagnifyMoney. You can email Janet here

TAGS: home insurance, home warranty, Homeownership

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Life Events, Mortgage

The Best Mortgages That Require No or Low Down Payment

Friday, August 4, 2017

Janet Berry-Johnson

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	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	10%	No mortgage insurance required	Typically 700 or higher
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	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
USDA	No down payment required	Ongoing mortgage insurance not required, but borrowers pay an upfront fee of 2% of the purchase price	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 agenc y 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	3.5% ($8,750)	$241,250	4.625%	$1,083	$4,222 up front $171 per month	$1,254
SoFi	10% ($25,000)	$225,000	3.37%	$995	$0	$995
VA	0% ($0)	$250,000	3.25%	$1,088	$0	$1,088
HomeReady	3% ($7,500)	$242,500	4.25%	$1,193	$222 per month	$1,349
USDA	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 is a writer at MagnifyMoney. You can email Janet here

TAGS: Buying a home, FHA, first time homebuyer, homeready, Mortgage, real estate, SoFi, veterans

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Janet Berry-Johnson

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