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Mortgage

5 Ways You Can Leverage Your Home Equity

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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A home equity loan helps you turn your home into cash — without selling the property. The loan provides cash to help with renovations, a down payment on a second property or unforeseen expenses and can even help you consolidate credit card debt.”You can take a home equity loan for a variety of other reasons, but first ask yourself: What are your other options for financing?” asked Tendayi Kapfidze, the chief economist at LendingTree, MagnifyMoney’s parent company. While home equity loans help in a number of situations, they do require taking a risk: You will have to put your home up as collateral.

Assuming you’re comfortable with that risk — and able to afford the loan payments — here’s how to determine how much money you can take out.

First, you need to understand exactly how much equity you have. To do this, subtract the amount you owe on your mortgage from your home’s market value. The best way to know your home’s market value is by hiring an appraiser, but local realtors may also be able to help you determine a number and internet research may help you find a ballpark value — although you should always confirm the number before moving forward.

Let’s say your appraiser says your home is worth $250,000, and you have $150,000 left on your mortgage. That leaves you with $100,000 in equity. Most lenders limit loans to 85% of your equity, so you would be able to take out a $85,000 loan.
Here are five ways to leverage that equity.

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Home improvements

Renovations can be extremely costly. A midrange kitchen remodel costs an average of $63,829 — that’s a lot of cash to save. And sometimes, homeowners aren’t able to plan ahead: Roof repairs or replacements can cost anywhere between $5,000 and $25,000. Even the healthiest emergency funds may not cover that sudden expense. If your home is in need of repair or renovation, a home equity loan may be an excellent source of funds.

But how can you know if a home equity is right for your renovation? When you meet with your appraiser or realtor to determine your home value, ask how that value might change with your planned renovations. Knowing the market value of your property after alterations is essential when determining if you should take out a home equity loan.

Some renovations increase your home value considerably. For instance, adding a wooden deck costs an average of $10,950 and is estimated to recoup $9,065 when you sell your house — that’s almost an 83% return on investment. You can even deduct some home equity loan interest on your taxes when performing home improvements, saving you even more money.

If you’re planning to sell your home in five to 10 years, a home equity loan is a smart way to affordably increase your home’s value. You’re using home equity to build equity. And, if you’re preparing your home for immediate sale, the loan can help you make essential updates and repairs designed to entice buyers and increase the asking price. Pay the loan off immediately after closing to avoid paying interest.

But some renovations won’t nearly recoup their value. That $63,000 midrange kitchen renovation may only increase your selling price by around $37,000. That doesn’t mean a home equity loan is a bad choice. If the renovation will increase your quality of life and you expect to stay in the house for decades to come, pulling from your equity may be the right decision.

Education

The cost of college education keeps rising — and if you have a high school senior on the verge of moving out, you may start eyeing a home equity loan with interest.

A home equity loan offers a lower interest rate than many student loans, especially if you have good credit. Student loan rates are set directly by the federal government. The Direct PLUS Loan — the only loan available for parents — is currently fixed at 7.6% interest. If you’re funding your own education, direct loans begin at 5.05% for undergrads. Interest rates for private loans will likely run higher.

Interest rates for home equity loans of $100,000 may start as low as 4.25%, as of this writing. If your lender offers an interest rate dramatically lower than the federal government’s, using a home equity loan to cover the cost of education may be a smart idea.

Before borrowing, make sure you understand the loan’s terms and monthly repayment expectations. Direct PLUS Loans, for example, offer repayment periods of 10 and 25 years. For a home equity loan, this time period can vary between five and 30 years. A short repayment period may make the monthly payments insurmountable, so be sure to run the numbers against your budget before committing because going into default on a home equity loan is riskier than on a standard student loan. With a home equity loan, your home is collateral. If you fail to repay the loan as agreed, the lender has the right to foreclose on your home. That’s a big risk.

Up to $2,500 of student loan interest can be deducted on your taxes, but home equity loan interest cannot be deducted unless it is used to renovate your home or buy a new one. If interest rates are near-even, this tax break may be the deciding factor that pushes you toward a standard student loan.

Consolidate credit card debt

When your debt feels tall as a mountain, a home equity loan may feel like an attractive option. And sometimes it’s true — a home equity loan can make debt manageable. Instead of making multiple smaller payments to various creditors, you’ll make one single payment. And the interest rate for home equity loans is often significantly smaller than your credit card’s rate.

Doing the math is the best way to determine if this strategy suits your situation. In the short term, the lower interest rate will almost always save you money, but if you consolidate your debt into an affordable 10- or 20-year home equity loan, you may pay more in interest fees than if you paid off the credit card in a decade or less.

The biggest risk is, of course, your house. Falling into delinquency on a home equity loan means the creditor can repossess your property. With credit cards, it’s only your credit score or bankruptcy you have to worry about — and in many cases, bankruptcy doesn’t automatically mean losing your home.

If you’re considering this option, consider negotiating with your creditors first. They may offer a reduced payoff rate or be more willing to work with you on monthly payments if you tell them you’re considering a home equity loan. Handling credit card debt with the issuing company should be a first resort before putting your house on the line.

Medical expenses

Americans pay a collective $3.4 trillion each year in medical expenses. If you’re burdened by a surprise medical expense, a home equity loan may help you dig out of debt, but think carefully before taking this option.

If you can’t afford to pay medical expenses out of pocket, a home equity loan can prevent the account from going to collections, which can have a major impact on your credit score. The three major collection agencies — Experian, Equifax and TransUnion — offer a six-month grace period before your medical debt becomes a permanent addition to your credit file. But if you can’t figure out payment in that period, your credit score will drop.

Before taking out a home equity loan, talk to your creditor. Medical offices are often willing to reduce your debt or negotiate a payment plan if they know the debt may be headed to collections. But if they’re not budging, your alternatives may be limited.

Down payment on second home

Tapping into your home’s equity to expand your real estate portfolio — or buy a home — may be a good way to fund a sizable down payment. And, unlike when consolidating credit or paying off medical expenses, the loan’s interest is tax deductible.

Whether it’s a smart idea “depends on how much equity you have,” Kapfidze said. “If you have 100% equity and take out 20 or 30% of that equity, it’s a good idea. You have to evaluate it holistically with all of your other financial obligations.”

It also depends on if you’re buying property to rent or to live in. Rental mortgages typically require a higher down payment — 15% to 20% for a single-family home and 25% for a multi-family property.

Taking out a home equity loan can help you cover the gap between your savings and the increased down payment. And the additional income will help you pay back the loan — but run the numbers first. How much can you charge in rent, and will that be enough to cover both the second mortgage and the home equity loan? What if the unit is unoccupied for several months in a row? If you can’t repay the loan, you’ll lose your first home: Is that a risk you’re willing to take?

Home equity loans can be a way to leverage your current home for some much-needed cash. As interest rates rise, pay attention to the loan terms and make sure that alternative financing methods, like traditional student loans, aren’t a better option. But as long as you can afford the monthly payments and are comfortable putting your house up as collateral, these loans can help you stay afloat in a number of situations.

This article contains links to LendingTree, our parent company.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

Getting Preapproved for a Mortgage: A Crucial First Step

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Getting a mortgage preapproval is a crucial stepping stone on your way to becoming a homeowner, but it doesn’t mean you’re in the clear to borrow from a lender just yet. A preapproval does give you a leg up over the competition, though.

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What is a mortgage preapproval?

A mortgage preapproval means a lender has vetted your credit and finances and has made an initial loan offer based on its findings. Lenders share this information in writing, so you may hear it referred to as a preapproval letter.

Getting prequalified for a home loan is not the same as a preapproval. Mortgage prequalification provides a rough estimate of how much you might qualify for, based on a surface-level review of your financial information.

A preapproval, however, is a more thorough vetting of your finances and provides a more accurate idea of what a lender may offer in terms of a loan amount and interest rate. You provide financial documentation and agree to a review of your credit profile, which means the lender will pull your credit reports and scores. With a prequalification, you typically self-report your financial information and lenders don’t check your credit.

5 steps to getting preapproved for a mortgage

It’s not worth falling in love with a house until you know the sales price matches up with a mortgage amount you can realistically afford. Here’s how to get preapproved for a mortgage.

  1. Determine your homebuying timeline. The best time to apply for a mortgage preapproval is before you start house hunting. You may want to hold off on a preapproval if you’re not quite ready to begin the homebuying process. Even if you’re not yet prepared, you can get started by pulling your free credit reports from each bureau at AnnualCreditReport.com and reviewing minimum mortgage requirements.
  2. Review and improve your credit profile. With your credit reports in hand, it’s time to look for areas of improvement. The minimum credit score you need for a mortgage varies by program type, but you’ll need at least a 620 credit score in many cases. Dispute any inaccurate information you find, keep your credit card balances low and consistently pay your bills on time. Refrain from applying for new credit and closing any of your existing accounts, too.
  3. Pay down your debt. Pay down your debt. Aside from your credit scores, lenders care about how you manage your debt now and how you’ll fare if you get a mortgage. Your debt-to-income ratio, or the percentage of your gross monthly income used to repay debt, should stay at or below 43%. The less debt you have, the less risky you appear to lenders.
  4. Gather your documents. Lenders will request several documents from you for a preapproval, including:
    • Government-issued photo ID
    • Social Security number
    • Bank statements from the last 60 days
    • Pay stubs from the last 30 days
    • Two years of W-2s or 1099 tax forms
    • Credit reports and scores from all three bureaus
  5. Apply with multiple lenders. Consider banks, credit unions, mortgage brokers and nonbank lenders when applying for a mortgage preapproval, and shop around with three to five lenders to get the best rates. Additionally, keep your shopping period within 14 to 45 days to minimize the impact of those credit inquiries against your credit scores.

How long does a mortgage preapproval last?

A mortgage preapproval typically lasts for 30 to 60 days. The average time to close on a house is 48 days, according to Ellie Mae’s latest Origination Insight Report, so there’s a chance you can get through the full homebuying process before time runs out.

If your preapproval letter expires before you close, you’ll need to go through the process again, submit documentation and have your credit reports and scores pulled, which creates a new credit inquiry and affects your score.

Pros and cons of mortgage preapproval

The mortgage preapproval process includes several benefits, but there are also drawbacks to consider.

Pros:

  • You’ll get a better idea of how much house you could afford, which helps narrow down your price range.
  • Home sellers take you more seriously because you’ll have proof that a lender is willing to back you when you submit an offer.
  • You can comparison shop before committing to a lender.
  • Even if your preapproval is denied, you may walk away with an analysis of where you stand financially and how you can improve.

Cons:

  • A preapproval is not a full approval. It doesn’t guarantee you’ll qualify for a mortgage.
  • Preapprovals typically last for 30 to 60 days. If you don’t buy a home within this time frame, you’ll need a new mortgage preapproval letter.
  • Making changes that affect your credit, such as applying for a new credit line or racking up debt, can prevent you from getting a full mortgage approval.

What happens after you get preapproved for a mortgage?

Once you’ve been preapproved and have chosen a mortgage lender, it’s time to find your home and submit an offer to buy it. You’ll also continue working your way through the mortgage approval process, which includes:

  • Providing your lender with any additional documents needed to finalize your loan.
  • Getting a home appraisal and home inspection.
  • Preparing for your walk-through and closing day.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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Mortgage

Bridge Loans: What They Are and How They Work

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re shopping for a home in a hot real estate market, you might find that sellers aren’t willing to wait for you to sell your home before you buy. In that case, a bridge loan can help you purchase your next home without the pressure of selling yours first.

Before you take the plunge into the bridge lending world, learn the ins and outs with this guide to understanding bridge loans.

What is a bridge loan?

A bridge loan is a short-term mortgage you can use to access equity in a home you are selling in order to purchase a new home. Bridge loans are commonly used in tight housing markets where bidding wars demand competitive purchase offers without any contingencies.

How does a bridge loan work?

Bridge loans work in two different ways — as a first mortgage to pay off your current loan and fund the down payment of a new house, or as a second mortgage, with the money applied to the down payment of a new home. Let’s explore how each of these work.

First mortgage bridge loan: One large loan is taken out for up to 80% of your home’s value. The funds are initially used to pay off the current mortgage balance. Any extra money leftover is used toward the down payment for your new home.

Second mortgage bridge loan: This option involves borrowing the difference between your current loan balance and up to 80% of your home’s value. The mortgage on your current loan is left alone, and the second mortgage bridge funds are applied to the down payment on the home you’re buying.

Here’s an example of how each option would look if your current home is worth $350,000 with an outstanding loan balance of $200,000, assuming you borrow 80% of your current home’s value.

Bridge loan optionMaximum loan amountHow funds are applied
First mortgage bridge loan$280,000$200,000 to current loan payoff

$80,000 to down payment new home
Second mortgage bridge loan$80,000$80,000 to down payment new home

Pros and cons of buying a home with a bridge loan

Pros

Tap home equity while your home is for sale. A bridge loan lets you tap the equity you’ve built in your current home while it’s for sale to buy a new home. Standard lending guidelines for conventional loans don’t allow cash-out refinancing on a property listed for sale.

Avoid making an extra move. A bridge loan allows you to move while your current home is still being sold so you’re not stuck finding a temporary place to live if you can’t time both sales perfectly.

Pay off the balance of your current loan and get extra cash. If you have a significant amount of equity in your home, you may be able to pay off your current mortgage while you wait for your home to sell. You can then use any extra cash toward a bigger down payment on your new home. This prevents you from paying two mortgage payments until your old home is sold.

Use bridge funds as a second mortgage to buy your new home. If your current mortgage rate is low, paying the entire balance off with a bridge loan doesn’t make sense. If you borrow the equity you have you in your current home as a second mortgage, you’ll have a lower bridge loan balance and payment.

Buy a new home without waiting for your current home to sell. A bridge loan eliminates the need for a home sale contingency, making your offer more competitive in a tight housing market.

Make interest-only payments until your home sells. Some bridge loan programs offer an interest-only option, which means you pay only the interest charges accruing each month. The interest rate may be slightly higher, but it will soften the impact of having two monthly mortgage payments.

Cons

You’ll make two or three mortgage payments. Once you borrow against your equity and buy your new home, you’ll be carrying at least two, possibly three monthly mortgage payments, depending on how you use the bridge loan. This can add up fast and become unsustainable.

Higher interest rates and closing costs. Like most short-term lending options, bridge loans come with higher interest rates and closing costs. Lenders charge higher rates and fees to make it worth their while because you are borrowing only for a short time. You might have trouble making the payments on both mortgages if you have a hard time selling your current home.

Increases the risk of defaulting on two mortgages. Bridge lenders expect you will be able to pay off the loan within a year. If the balance isn’t paid by then, they can foreclose on your home. As a result, your credit and finances will take a massive hit, and you might be unable to repay the mortgages on both homes.

Need substantial equity to qualify. Bridge loans are not a viable choice if you don’t have a good chunk of equity in your home. You can borrow up to 80% of the value of your home, so if you’re in an area where neighborhood values have dropped, you’ll want to come up with alternative financing.

Not as regulated as traditional mortgages. When regulatory reform was passed, it was intended to focus on long-term loan commitments to protect borrowers from taking out loans they couldn’t repay. The new rules don’t apply to temporary or bridge loans with terms of 12 months or less, meaning you’ll have less protection.

How to qualify for a bridge loan

Bridge loans are specialty mortgage loans, and they aren’t approved based on the same standards as a regular mortgage. Lenders that offer these loans have a few extra qualifying hoops for you to jump through, and rates and fees vary depending on property type, too.

Here are some key qualifying requirements unique to bridge loans:

Enough income to cover multiple mortgage payments

Bridge lending guidelines are often set by private investors or are specialized programs offered by institutional banks. That means they can create their own guidelines. Some bridge lenders may not count your current mortgage payment against you because they approve the loan knowing your intent is to pay it off quickly.

Other lenders will require you to qualify with both loans, which could mean you can’t tap into the full amount of your equity unless you have enough income.

At least 20% equity in your current home

Bridge loans work best if you have more than 20% equity, but the bare minimum requirement is 20%. If you don’t, it’s unlikely you’ll qualify for a bridge loan.

A commitment to paying off the loan quickly

Bridge lenders will scrutinize the home you are selling more than the home you are buying to make sure it’s priced to sell within bridge loan’s term period, usually 6 to 12 months. An appraisal will be required on your current home, and if the value comes in significantly lower than what your asking price is, your loan amount will be reduced.

Average closing costs for a bridge loan

Bridge loan closing costs typically range from 1.5% to 3% of the loan amount, and rates can be as high as 8% and 10% depending on your credit profile and how much you are borrowing. Beware of any lender that asks for an upfront deposit to approve a bridge loan; they probably aren’t a legitimate lending source and you should steer clear.

How to find a bridge loan lender

Bridge lending is a niche product, so not every lender will offer the option. You’ll need to shop around with mortgage brokers and institutional banks. Also, ask your current mortgage broker or loan officer whether they have experience closing bridge loans.

Work with a legitimate, licensed loan officer. You can check licensing requirements for all 50 states with the Nationwide Multistate Licensing System Consumer Access link. Type in your loan officer’s name or company information. Here are examples of lenders who may offer bridge loans:

Institutional lenders

Start with your local bank to discuss their bridge loan programs. If you have a substantial amount of deposits with a bank, the bridge loan terms might be more flexible and approval might go more smoothly.

Alternative lenders

Mortgage brokers and mortgage bankers often have relationships with alternative lenders. They can often find a bridge loan source if your current bank doesn’t offer them.

Hard money lenders

A hard money loan may be a good fit for bridge financing to purchase fix-and-flip investment property. Hard money lenders are often private investors, or groups of private investors, looking for high returns on short-term real estate loans. Interest rates can run into the double digits, and you can expect a prepayment penalty and fees range between 2% to 10%, depending on how risky your credit profile is.

Alternatives to using a bridge loan

You can do some advance planning to avoid needing a bridge loan, or at least limit how much bridge financing you need to purchase a home. Here are some other options to consider:

Use an existing home equity line of credit (HELOC)

If you already have a HELOC on your home before you start searching for a new home, you can use the HELOC toward a down payment on your new home. Typically there are no limitations on how you can use HELOC funds. A few drawbacks: You might have to pay a close-out fee when your home sells and the HELOC is paid off and closed, and you won’t get a mortgage interest tax deduction on the extra borrowed equity. You also risk losing your home if you can’t repay the loan because your home is serving as collateral for the loan.

Take out a 401(k) loan

Your retirement savings account can be another tool to bridge the gap in financing, and the rates and payment may be significantly less than what you’ll pay for a bridge loan. Check with your plan provider for any restrictions on loans for home purchases. It may be more cost-effective to take out a 401(k) loan to avoid the closing costs and high interest rates that come with a bridge loan.

The drawback to a 401(k) loan is that the borrowed money is taken from your retirement savings and won’t be working for you in the market. Consider this option only if you plan to repay the loan immediately after your current home sells.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.