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5 Ways You Can Leverage Your Home Equity

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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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.

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.

Jamie Wiebe
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Jamie Wiebe is a writer at MagnifyMoney. You can email Jamie here

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5 Questions to Ask Yourself Before Buying a House

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Buying a House

The housing market is heating up and so is the homebuying competition. Recent data from the National Association of Realtors show that pending home sales are up nearly 5%.

Still, don’t let the increased activity pressure you into getting a mortgage before you’re truly ready. Take inventory of your personal and financial preparedness first.

Step back and ask yourself the following questions before you start your homebuying journey.

Question 1 How much house can I afford?

Prior to your house hunt, be sure you have a concrete understanding of exactly how much house you can comfortably afford. A common way to determine affordability is to get a mortgage preapproval.

A preapproval is a letter from a mortgage lender that tells you how much money you might qualify to borrow for a home purchase along with an estimated interest rate. In order to get preapproved, you’ll need to submit several documents and other pieces of information to the lender, including:

  • A government-issued I.D. (e.g. driver’s license)
  • Social Security number
  • Pay stubs
  • Bank statements
  • Tax returns

The lender will also pull all three of your credit reports and scores to help determine your creditworthiness.

Getting preapproved for a mortgage not only gives you a price range to use when you start shopping for a house; it also gives you an advantage over other buyers, and legitimizes you when it’s time to put in offers.

Question 2 How long do I plan to live in the home?

Homeownership is a commitment. You’re committing to the mortgage you borrow, the home you choose and the surrounding community — this isn’t the case as a renter.

The financial commitment is just as real as the moral one. Financial experts commonly say it takes five years to make the money back you spent on your house, should you decide to sell it. Owners typically stay in their home for a median of 10 years before selling, according to the Homebuyer and Seller Generational Trends Report from the National Association of Realtors.

Question 3 Am I financially secure enough for homeownership?

Don’t focus solely on stashing away just enough cash to cover your down payment. Factor in the many other costs of buying and owning a home.

Before you’re handed the keys, you also have closing costs to pay. This could run you anywhere from 2% to 5% of your home’s purchase price — not to mention all the deposits and expenses related to moving in.

You’ll also want to have a sizable cash cushion for maintenance and unexpected expenses. Aim to have at least three to six months’ worth of your living expenses saved in an emergency fund, such as a personal savings account. Be mindful of how your expenses might change as a homeowner and tweak your savings amount to reflect those changes.

Another consideration is how you’re handling your current debt obligations. If you’re struggling to stay afloat as is, a mortgage lender likely won’t approve you. That’s because one of the main qualification factors a lender pays close attention to is your debt-to-income ratio, or the percentage of your income that is used to pay your debt every month. A good DTI ratio for all your debt payments, including your estimated monthly mortgage payment, is a maximum of 43%.

Question 4 Is my credit history positive enough?

You’ll need to demonstrate your creditworthiness as a potential mortgage borrower before you’re approved. Start by pulling your credit reports from all three credit reporting bureaus — Equifax, Experian and TransUnion — by visiting AnnualCreditReport.com. You’re entitled to one free report from each bureau once a year.

Review your reports for any negative remarks and errors. Do you have a history of multiple late payments? Are your credit card balances close to the limit? If you see room for improvement, you might need to postpone your homeownership goals until your credit profile is in a better position. Lenders want to see overwhelmingly positive credit habits from mortgage applicants.

You’ll generally want to have at least a 580 credit score to qualify for an FHA loan and a 620 score for a conventional loan. Read our guide on minimum mortgage requirements for more information on credit score specifics for other mortgage products.

Question 5 Which mortgage type is best for me?

There are several different mortgage products available and one may fit your financial situation better than others. For example, if you don’t have a lot of money for a down payment and have a credit score in the 600 to 700 range, you might want to go with an FHA loan, which requires just a 3.5% down payment. On the other hand, if you have at least a 5% down payment and a score above 700, you could benefit from a conventional mortgage.

There are also VA loans, which cater to military service members and veterans, USDA loans that focus on homes in designated rural areas and several other options. Speak with your lender to get a rundown of their available mortgage programs.

The bottom line

It takes some time and effort to decide to buy a home. To help in your decision, it’ll be worthwhile to develop answers to the above questions.

Once you’re ready to take that leap, shop around with multiple lenders to get the best deal. Data show that homebuyers stand to save more than $36,000 in interest on a $300,000 mortgage over a 30-year term by shopping around, according to LendingTree’s Mortgage Rate Competition Index.

Review the Loan Estimates you’ll receive from each mortgage lender after submitting your application to compare interest rates and the many other costs that come with borrowing.

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.

Crissinda Ponder
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Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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Guide to Reverse Mortgages: Is the Income Worth the Risk?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Real estate investment. House and coins on table
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Although they have received increased attention in recent years, many consumers still have a hard time fully understanding what reverse mortgages are, how they work and who they benefit.

Continue reading for a thorough explanation on the above topics, plus a discussion of the advantages and disadvantages of this complex financial product.

What is a reverse mortgage?

A reverse mortgage is a loan that allows senior homeowners to borrow money against their home’s equity. Instead of making monthly payments to their mortgage lender, the homeowner receives money every month from their lender — or receives a larger amount in a lump sum. The balance owed to the lender grows over time and isn’t due until the homeowner moves out, sells the property or passes away.

Reverse mortgages are the opposite of a “forward,” or traditional, mortgage, which allows a borrower to purchase a home and repay their lender on a monthly basis. With traditional mortgages, the balance owed reduces over time until it’s completely paid off.

In both forward and reverse mortgages, the property is used as collateral for the loan. Only homeowners who are at least 62 years old can take out a reverse mortgage.

Reverse mortgage types

There are three types of reverse mortgages available to homeowners depending on their situation.

Home Equity Conversion Mortgage (HECM)

This is the most common reverse mortgage and is backed by the Federal Housing Administration (FHA). A HECM offers more flexibility in terms of how payments are disbursed to borrowers. Payment options include:

  • A single, lump-sum disbursement.
  • Fixed monthly advances over a specified period of time.
  • Fixed monthly advances as long as you live in your home.
  • A line of credit.
  • A combination of a credit line and monthly payments.

Single-purpose reverse mortgage

As the name suggests, this type of loan is used for a single purpose, such as covering home repairs or property taxes. Loan proceeds are typically distributed in a lump sum to cover the homeowner’s financial need. Single-purpose reverse mortgages are offered by nonprofit agencies and some local and state governments.

Proprietary reverse mortgage

This loan is offered by private lenders and usually benefits borrowers with high-value homes because they may receive bigger advances.

How a reverse mortgage works

A reverse mortgage is a loan that takes a portion of your equity and converts it into payments made to you. The money you receive is typically tax-free, according to the Federal Trade Commission. Unlike a traditional home equity loan, you are not required to pay back a reverse mortgage on a set schedule.

Let’s look at an example of how a reverse mortgage works:

John is retired, has paid off his mortgage and owns his home outright. He wants to stay in his home, but needs to supplement the monthly income he receives from Social Security and his pension.

The total amount John can borrow using a reverse mortgage is based on his age and that of his spouse, current mortgage rates and the home’s value; these limits are imposed by HUD. Here’s how the numbers could possibly work out for him, based on LendingTree’s reverse mortgage calculator:

Value of the home$300,000
Title holder’s age70
Mortgage balance$0
Lump sum estimate$145,902

Based on the calculator, John might qualify for as much as $145,902 if he decides to go the single disbursement route. An advantage of getting a lump-sum payment from your lender is that the interest rate will be fixed, unlike the other options which have an adjustable interest rate.

The reverse mortgage loan limit is $726,525 for 2019, which is 150% of the conforming loan limit of $484,350 for forward mortgages. Still, even if the amount of equity you have is lower than the loan limit, you won’t be allowed to borrow the full amount.

The amount you’re allowed to borrow for a reverse mortgage is determined by the age of the youngest borrower, the home’s appraised value and the anticipated interest rate. Generally, the older you are, the more you can borrow.

Costs and fees

The most common fees associated with a reverse mortgage include:

  • A loan origination fee, which could cost up to 2% of the loan amount.
  • An initial mortgage insurance premium, which is a flat 2% fee.
  • An annual mortgage insurance premium, which is 0.5%.
  • Housing counseling, which usually costs about $125.

There are also additional closing costs and interest fees.

Reverse mortgage requirements

Senior homeowners who are interested in borrowing a reverse mortgage must meet the following requirements:

  • Be at least age 62 or older.
  • Own your home outright or have a small remaining mortgage balance. If you still have a loan, a good rule of thumb is to have at least 50% equity in your home, because you’ll first need to use the reverse mortgage funds to pay off the outstanding balance on your forward mortgage.
  • Must be seeking a loan backed by your primary residence.
  • Have no federal debt delinquencies, including student loans and taxes.
  • Proof of sufficient income to cover your property taxes, homeowners insurance and other housing-related expenses.
  • Demonstrate your creditworthiness as a potential borrower. While there isn’t a minimum credit score requirement, it helps your case to be responsible with your credit usage by maintaining on-time payments, keeping your balances low, etc.
  • Participate in an information session with a HUD-approved reverse mortgage counselor.

Most reverse mortgages have what’s called a “non-recourse feature,” which means if the lender takes legal action against you due to default, the lender can only use the home to satisfy the defaulted debt and can’t come after you for any difference between how much you owe and the home’s value. This also applies to your heirs in the event you pass away and the home is sold to repay the debt.

4 things to watch for when taking out a reverse mortgage

Just like all other financial products, a reverse mortgage comes with its share of risks, which typically include the following:

Higher financing costs

Compared with a forward mortgage, the fees associated with a reverse mortgage are more costly. As an example, a HECM lender can charge an origination fee equal to $2,500 or 2% of the first $200,000 of your home’s value, whichever is greater, plus another 1% for any home value amount above $200,000. The maximum allowable origination fee is $6,000. By contrast, the average origination fee for a traditional mortgage is just under $1,000, according to data from Value Penguin, a LendingTree company.

Increase in debt

You receive income from a reverse mortgage, but it’s still a loan that you or your estate will be responsible for repaying. Since you’re borrowing from your home’s available equity, your loan balance increases over time, which adds to your outstanding debt load.

No tax deductibility

The IRS treats the income received from reverse mortgages as loan advances, and for that reason any interest paid on a reverse mortgage isn’t tax-deductible.

Rising interest rates

The majority of reverse mortgage products have an adjustable interest rate, which is subject to market fluctuations. Your rate will be at a high risk of increasing very quickly.

Reverse mortgage pros and cons

Consider the following benefits and drawbacks before applying for a reverse mortgage:

Pros

  • Increase in your monthly income. If you opt for monthly payments from your lender, a reverse mortgage gives you additional income every month on top of any retirement income you already receive.
  • Flexibility to use the funds how you see fit. If you take out a HECM or proprietary reverse mortgage, there aren’t restrictions imposed on what the money is used for.
  • Ability to stay in your home. Not only do you get to keep your home, but you can keep it in your family after you pass away if your estate is able to fully repay the reverse mortgage.
  • Free from underwater mortgage stress. If your loan balance becomes greater than your home’s value, you likely won’t be on the hook for the difference between the two.

Cons

  • High upfront costs. There are origination fees, mortgage insurance expenses and closing costs in a reverse mortgage transaction. If you choose to cover these costs with your loan, you’ll receive a smaller payout.
  • Decrease in your home equity. With a reverse mortgage, your loan balance grows and your available equity shrinks over time.
  • Loan becomes due if you have a change of heart. If you decide you want to move out of or sell your home, the outstanding balance on your reverse mortgage becomes due immediately.
  • Adjustable-rate mortgage. Most reverse mortgages have adjustable interest rates that will likely increase over time. As of January 2019, the latest month for which data are available, reverse mortgage rates range from 3.583% to 7.019%, according to FHA statistics.

Shopping for a reverse mortgage

The first few steps you should take when you decide you want to apply for a reverse mortgage are to educate yourself on how reverse mortgage programs work, and to determine which loan type works best for your financial situation.

Once you have those details figured out, gather multiple quotes from reverse mortgage lenders and compare the costs and fees to find the best deal available. Ask questions about any and everything that seems unclear, and don’t forget to consult a HUD-approved reverse mortgage counselor for extra help.

Consider the interest rate each lender charges, as well as the origination fee and other closing costs. Additionally, work with each lender to determine how folding the financing costs into your loan will affect the amount you ultimately receive and whether it makes sense to pay those costs out-of-pocket instead.

After you’ve closed on a reverse mortgage and — for some unforeseen reason — decide you no longer need it, you have a “right to rescission,” which means you’re allowed to cancel the deal without penalty. You have a minimum of three business days after the loan closes to notify your lender in writing, and the lender has 20 days to refund any money you’ve paid toward the financing of that loan.

FAQs about reverse mortgages

The timeline varies by lender, but the lending process could take two months or longer. Be sure to ask your loan officer for a rough idea.

No, interest paid on reverse mortgage balances is not tax-deductible.

When you pass away, your reverse mortgage becomes due and payable. If you have a surviving spouse or heirs, they will be responsible for paying back the loan, which might involve selling your house.

For HECM loans, you can find an FHA-approved lender through HUD’s website. For other types of reverse mortgages, a quick online search will reveal public and private lenders in your area.

Reverse mortgage alternatives

A reverse mortgage isn’t the best option for every senior homeowner. If you need money to fund renovations, repairs or other expenses, here are some alternative options.

Borrow a home equity loan or line of credit

If you have a sizeable amount of equity in your home, you might qualify to take out a home equity loan or home equity line of credit (HELOC). You borrow a lump sum of cash with a home equity loan and you’re granted a line of credit, similar to a credit card, with a HELOC. Either of these products might work better if you’re still employed, as they require you to make monthly payments after borrowing the funds.

Refinance your existing mortgage

For those borrowers who still have a mortgage balance, you could refinance your loan by extending the term and lowering your monthly payment amount, which frees up some cash in your budget. You could take advantage of a cash-out refinance, which allows you to borrow a new mortgage that’s larger than what you actually need for your house and pocket the difference.

Rent out a room

Empty-nesters with more home space than they actually need might benefit from renting out one of their bedrooms either through short- or long-term rentals. This generates extra income that can be used for remodeling, traveling or other expenses.

Don’t forget your retirement accounts

As long as you’re old enough to tap your 401(k), IRA or other retirement account without any early withdrawal penalties, going this route is a less costly way to supplement your income. Generally speaking, you can withdraw from your retirement accounts without penalty starting at age 59 ½.

The bottom line

Reverse mortgages come with additional considerations that may not always be a concern for forward mortgages, but they may provide relief for some older homeowners who want to supplement their income and also age in place.

If you can comfortably manage your insurance, tax and other obligations related to homeownership, maintain your property and keep it in good condition, and are confident that your heirs will take care of your home after your passing, a reverse mortgage could work well for you.

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.

Crissinda Ponder
Crissinda Ponder |

Crissinda Ponder is a writer at MagnifyMoney. You can email Crissinda here

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