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It’s Now Easier for Millions of Student Loan Borrowers to Get a Mortgage

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Student loan borrowers who are making reduced income-driven repayments on their loans will have an easier time getting mortgages under a new policy announced recently by Fannie Mae.

Nearly one-quarter of federal student loan borrowers benefit from reduced monthly student loan payments based on their income, Fannie Mae says. However, there’s been some confusion about how banks should treat the lower monthly payments when they calculate a would-be mortgage borrower’s debt-to-income ratio (DTI): Should banks consider the reduced payment, the payment borrowers would have to pay without the income-based “discount,” or something in between?

It’s a tricky question, because student loan borrowers have to renew their qualification for the lower payments each year, meaning a borrower’s monthly DTI could change dramatically a year or two after qualifying for a mortgage. The banks’ confusion over which payment amount to use can mean the difference between a borrower qualifying for a home loan and staying stuck in a rental apartment.

There’s even more confusion when a mortgage applicant qualifies for a $0 income-driven student loan payment, or when there’s no payment amount listed on the applicant’s credit report. Previously, in that situation, Fannie Mae required banks to use 1% of the balance or a full payment term.

As of last week, Fannie has declared that mortgage lenders can instead use $0 as a student loan payment when determining DTI, as long as the borrower can back that up with documentation.

That announcement followed another Fannie update issued in April telling lenders that they could use the lower income-based monthly payment, rather than a larger payment based on the full balance of the loan, when calculating borrowers’ monthly debt obligations.

“We are simplifying the options available to calculate the monthly payment amount for student loans. The resulting policy will be easier for lenders to apply, and may result in a lower qualifying payment for borrowers with student loans,” Fannie said in its statement.

Taken together, the two announcements could immediately benefit the roughly 6 million borrowers currently using income-driven repayment plans known as Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), Income-Contingent Repayment (ICR), and Income-Based Repayment (IBR).
Freddie Mac didn’t immediately respond to an inquiry about its policy in the same situation.

What This Means for Student Loan Borrowers Looking to Buy

Michigan-based mortgage broker Cassandra Evers said the changes “allow a lot more borrowers to qualify for a home.” Previously, there was a lot of confusion among borrowers, lenders, and brokers, Evers said. “[The rules have] changed at least five or six times in the last five years.”

The broader change announced in April, which allowed lenders to use the income-driven payment amount in calculations, could make a huge difference to millions of borrowers, Evers said.

“Imagine you have $60,000 in student loan debt and are on IBR with a payment of $150 a month,” she said. Before April’s guidance, lenders may have used $600 (1% of the balance of the student loans) as the monthly loan amount when determining DTI, “basically overriding actual debt with a fake/inflated number.”

“Imagine you are 28 and making $40,000 per year. Well, even if you’re fiscally responsible, that added $450-a-month inflated payment would absolutely destroy your ability to buy a decent home … This opens up the door to a lot more lenders being able to use the actual IBR payment,” Evers said.

The Fannie Mae change regarding borrowers on income-driven plans with a $0 monthly payment could be a big deal for some mortgage applicants with large student loans. A borrower with an outstanding $50,000 loan but a $0-a-month payment would see the monthly expenses side of their debt-to-income ratio fall by $500.

It’s unclear how many would-be homebuyers could qualify for a mortgage with an income low enough to qualify for a $0-per-month income-driven student loan repayment plan. Fannie did not have an estimate, spokeswoman Alicia Jones said.

“If your income is low enough to merit a zero payment, then it is probably going to be hard to qualify for a mortgage with a number of lenders. But, with the share of IBR now at almost a full 25% of all federally insured debt, it’s suspected that there will be plenty of potential borrowers who do,” Jones said. “The motivation for the original policy and clarification came from lenders’ requests.”

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Understanding Construction Loans

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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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What Does a Mortgage Rate Spike Mean for Buyers and Sellers?

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.

Buying a home became more expensive this year but the good news is not by much. Mortgage rates are on the rise, with 30-year fixed mortgages consistently above 4% in 2018 but rates remain at record lows. A decade ago, rates were consistently above 6% and well into the double digits in the 80s and early 90s.

“While rates are certainly going up, the impact to the borrowers is not as drastic as some may think,” said David Gorman, a division executive with Bank of America. “It’s a pretty emotional topic. People hear rates are going up and they jump pretty quickly, but it’s not as aggressive as many would make it sound.”

Although higher rates signal a tighter market for both homebuyers and sellers, it’s important to understand the context in which they’re happening and how you can maximize your opportunities even if rates continue to rise.

Why mortgage rates are changing

It’s not the Fed’s fault. The Federal Reserve raised its benchmark interest rate earlier this year, a move that consumers sometimes associated with changes in mortgage rates. However, the Fed rate has less influence on fixed-year mortgages than you might think.

For one thing, the Federal Reserve doesn’t set mortgage rates so it doesn’t have a direct impact on the terms of your potential home loan. Jace Stirling, mortgage divisional manager at SunTrust, explained that the federal funds rate, which is the average rate at which financial institutions lend to one another, “is really, really short term” and isn’t necessarily an indicator of what’s going to happen with long-term mortgage rates.

The Federal Reserve benchmark rate primarily affects loans and lines of credit influenced by the prime rate. This means that adjustable-rate mortgages that are approaching reset and home equity loans and lines of credit are susceptible to fluctuations along with the Federal Reserve.

Keep your eye on the 10-year Treasury note. When it comes to long-term fixed mortgages, it’s the 10-year Treasury note you want to watch. This note represents the expected long-term Treasury yield, and it influences not only the Federal funds rate but interest rates on a number of financial products, mortgages included. The Federal funds rate can influence Treasury yields, but it does not directly impact it, according to Pete Boomer, head of mortgage protection for PNC Bank. There have been instances of “flatter or inverted yield curves,” he said. “So while it generally has an influence, they are not specifically tied together.”

Boomer added that similarly, the 10-year Treasury note and mortgage rates “are not tied together, but they do have a close correlation.”

So far in 2018, increases in the Treasury yield rate have influenced the mortgage market this year. “As the 10-year moves up, so will your long-term interest rates,” Stirling said.

Stirling added that the other factor that is currently influencing the cost of homebuying is low real estate inventory, which is driving up valuations for available properties.

How rising rates impact homebuyers

The prospect of higher interest rates motivates some buyers to become more aggressive in their home searches. Gorman said that people who have been considering purchasing a home but have been on the fence may take a more proactive approach in higher rate environments.

“When they hear that rates are going up, they’ll jump in feet first and they’ll start to look to move,” he said.

The impulse to act quickly makes sense, especially since higher monthly payments aren’t the only consequences of rising rates. Higher interest rates may also mean lower approval values on borrowers’ mortgage applications.

“If you’re a buyer, things are going to get more expensive, so you may be able to borrow less money,” said Tendayi Kapfidze, chief economist at LendingTree. “It’s less affordable to purchase a home or get a mortgage.”

But lower approval amounts may not be a bad thing. Buyers sometimes make purchase decisions based on the maximum amount for which they can qualify, rather than based on what makes sense for their budgets, which can lead to long-term financial strain.

“What a lot of people will do is start looking for homes without truly understanding their borrowing power, and then they try to stretch themselves to a point that might not be comfortable,” Gorman said. Instead, he recommended meeting with a loan officer and finding out your borrowing ability, then beginning the search from there.

Keep calm and carry on

It’s also important to keep perspective when you read that interest rates are increasing. Yes, they are higher than last year. But that doesn’t necessarily mean you won’t find an affordable property. Rates are still relatively low, as we noted before.

Stirling said that the lower rates are, the more compressed payments become. In other words, the increase in monthly payments may not be as substantial as borrowers fear. He offered the example of a traditional $300,000 mortgage in which payments on the principal and interest at 4% would be about $1,432. At 5%, he said, the payment would increase to about $1,610.

“The difference isn’t insubstantial but it’s not the end for many people,” Stirling noted. But with rates still closer to the zero end of the spectrum, even a modest increase “still allows [borrowers] to take advantage of the great opportunity of where rates sit today.”

Boomer said rising interest rates could encourage borrowers to look at products they might not otherwise have considered. Rather than choosing a 30-year fixed mortgage to lock in a low rate, they might explore hybrid adjustable-rate mortgages (also known as ARMs) or low down-payment options that have been introduced to the market in recent years.

Hybrid ARMs typically include low introductory rates before the variable rate period begins at three, five, seven or 10 years, depending on the loan structure, Stirling explained. “If the consumer has no intention of living in the property beyond this fixed period, an ARM can be a great option, as the payments on the home will be lower than that of a 30-year fixed rate,” he said.

Boomer noted that products from Fannie Mae and Freddie Mac, as well as those created by lending banks, may offer attractive alternatives to traditional fixed-rate mortgages for some borrowers.

Comparison shopping still key

Whatever type of mortgage you pursue, it’s worth meeting with several different lenders and comparing their products and rates. Even with interest rates increasing, you may be able to find a better-than-average offer, according to Kapfidze.

“Let’s say the average mortgage rate is 4.5%. That means people are getting rates ranging from 4% to 6%, so there’s a wide range of rates available in the marketplace,” Kapfidze said. “The more you shop around, the more likely you are to find a favorable rate.”

The key to making the right buying decision is education. Stirling recommended getting in touch with a loan officer early on to determine your options. Jorge Davila, a vice president in the direct lending department at Flagstar Bank, suggested that borrowers ask questions until they feel comfortable with their purchase decisions and fully understand how the rates they’re offered will impact their payments. “It’s all about understanding what you’re looking for as a buyer, what makes sense for you and your family price-wise,” he said.

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How rising interest rates impact sellers

Homebuyers aren’t the only ones who may be calibrating their plans in light of rising interest rates. Sellers, too, will need to decide how they respond to this shift in the market. If buyers move quickly to purchase homes before interest rates rise further, sellers may find themselves able to move their property quickly.

But once they’ve sold their homes, they’ll need a place to move — and that means they may end up having to take out a loan at a higher interest rate than what they pay on their current properties. Kapfidze describes this as a lock-in effect. When rates rise, some owners opt to stay in their homes rather than risk paying more for a new house.

If you choose to stay in your home, you don’t necessarily need to maintain the status quo, though. Kapfidze said that instead of selling, some homeowners will apply for home equity loans or lines of credit and improve their existing houses. Knowing this, lenders may offer competitive terms on home equity products, so sellers should consider a variety of offers before deciding which to accept.

Keeping perspective

Buyer or seller, the consensus among these experts was to maintain perspective and focus less on short-term increases and more on the long-term implications of your buying and selling decisions.

“People are going to consistently be moving for jobs, for schools, for families growing, downsizing, so the housing market will always be one that is necessary and relatively strong,” Gorman said. “So we tend to tell clients, worry less about the rate environment and worry more about what’s best for you.”

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Home Equity Loan vs. Home Equity Line of Credit

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.

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Looking to borrow against the equity in your home? Maybe you have heard the terms home equity loan and home equity line of credit (HELOC) before and wondered what the difference really is. This article will compare the two types of borrowing and take you through the pros and cons of each one.

Home equity loan vs. HELOC: What’s the difference?

Home equity loan. With a home equity loan, you borrow a lump sum of cash using the value in your home as collateral. The loan will have a fixed schedule for repayment, usually lasting between 5 and 15 years. They often have a fixed interest rate as well, though adjustable rate versions are available.

HELOC. A home equity line of credit, or HELOC, is an ongoing line of credit that’s backed by your home’s equity — think of it a bit like a credit card. Your bank will authorize a certain dollar amount (similar to a credit card’s credit limit) and period of time during which you can access the line of credit, known as the draw period. Within this time, you borrow only what you need as you need it, though some banks do set a minimum withdrawal. You can make interest-only payments only on the amount you choose to borrow or pay more to start contributing towards the principle.

Next comes the repayment period, where you can’t take out any new funds and need to start repaying the amount you’ve borrowed, if you have not already. Interest rates on HELOCs are variable and often pegged to the prime interest rate.

Comparing home equity loans and lines of credit

 

HELOC

Home equity loan

Interest rate

Variable

Fixed, but sometimes variable

Funds access

Withdraw funds as needed

Lump-sum disbursement

Funds use

No restrictions

No restrictions

Monthly payments

Varies, based on how much you withdraw and interest rate at the time

Fixed for the life of the loan

Closing costs

Yes, but not always

Yes

Collateral

Home equity

Home equity

The two types of borrowing do have two major things in common: They are backed by the equity in your home, and there are no restrictions on what you can do with the cash.

With both home equity loans and HELOCs, the maximum amount you can borrow varies depending on your credit and the lender, but generally tops out at 80% to 95% of the your home equity. To calculate your home equity, start with the valueof your house (from an appraisal, if available) and subtract the amount remaining on your loan. You can also use LendingTree’s home equity calculator to estimate how much you can borrow. (Disclosure: LendingTree is the parent company of MagnifyMoney.)

Since the loans are backed by your home equity, the interest rates are usually lower than for unsecured forms of credit like credit cards or personal loans.

It’s up to you what you do with the money from either type of loan. You can make improvements to your home, pay for a vacation or put your kids through college.

However, Brett Anderson, a certified financial planner and president of St. Croix Advisors, said it’s important to think carefully about borrowing against your home equity, which is likely one of your largest assets.

“Remember these are loans that need to be paid back. A home equity loan isn’t free money, even with these low interest rates,” he said.

Tax changes’ impact home equity loans and HELOCs

New laws have changed tax deductions related to home equity loans and HELOCs. From the 2018 tax year until 2026, the IRS says borrowers cannot deduct interest payments on these types of loans, “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”

In addition, starting in 2018, taxpayers may only deduct interest on $750,000 of qualified loans, or $375,000 for a married taxpayer filing separately. If you have a HELOC or a home equity loan and a regular mortgage, this limit applies to the combined amount of both loans. This limit is lower than it was previously.

So for example, if you take a $100,000 home equity loan and spend $75,000 on a kitchen renovation and $25,000 paying off credit card debt, only 75% of your interest payments is tax-deductible.

Randy Key, home loan specialist at Churchill Mortgage, told MagnifyMoney he’s seen interest in home equity loans and HELOCs drop after the tax changes.

Benefits and risks of a home equity loan

Given the current economic environment of rising interest rates, one of the main benefits of a home equity loan is having a fixed interest rate for the term of the loan — you get a lump sum upfront and have the same steady payment, even if the Federal Reserve continues to hike rates. That makes a home equity loan easier to budget for, said Anderson.

A home equity loan does have some drawbacks. If you already have a mortgage, you’ll have to keep track of two loans and make two seperate payments every month. A home equity loan also has the same sort of closing costs as a regular mortgage. Those costs can take their toll, especially if you aren’t looking to borrow that much money, Key said.

The rate the lender offers you for a home equity loan depends on your credit score. If your score is under 700, you’ll pay a higher rate to compensate for the risk the bank feels it’s taking on, Key said.

Benefits and risks of a HELOC

A big advantage of a HELOC is the flexibility. You get to withdraw the cash when you need it and only pay interest on the amount you use — however, be aware that most lenders require a minimum withdrawal at the closing.

HELOCs can have lower upfront costs than home equity loans, with some lenders offering to pay for closing costs. Key said if you are willing to base your line of credit off the tax appraisal value of your house, most lenders will do a HELOC without a new appraisal.

The major downside of HELOCs is that they use a variable interest rate pegged to the prime rate, which is set to go even higher this year. This means if you have a HELOC, your interest payments are going to get bigger. You’ll also need a strong credit score to qualify; according to Key, a score around 650 is often required, though it depends on the lender.

Equifax data shows that interest in HELOCs is going down, which Key attributed to both the tax changes and the rising interest rates. He said many of his customers are choosing to refinance to combine an existing first mortgage with a HELOC into one loan.

“With a rising rate market, people are seeing that HELOC rate could be 1% higher next year and thinking, ‘I have to do something about this,’” he said.

Which loan type is right for you?

When choosing between a HELOC or a home equity loan, experts say it is important to consider why you need the money: Is it a set project or a variable need?

Going with a home equity loan instead of a line of credit is usually the best choice to pay for a specific plan, like remodeling a kitchen or buying a vacation house.

“[If] you have a purpose for these dollars today, and you know the amount you’ll need, a home equity loan might be a better alternative,” Anderson said.

A HELOC is generally a better choice if you need some added cash but not a fixed amount or fixed timeline. Key recommends them for customers looking to cover “a tight month in the budget or maybe they are investors who want to be able to tap money quickly.”

The third option: a cash-out refinance

If you are considering a home equity loan or a HELOC, you might want to look at a third option: a cash-out refinance.

A cash-out refinance is designed to improve on the terms of an existing mortgage and provide additional cash at the same time. You’ll be refinancing and taking equity out your home at the same time, leading to one new loan with a larger balance than your previous one.

A cash-out refinance is a good option if you need money and at the same time want to improve the terms of your current mortgage by securing a better interest rate or converting an adjustable-rate mortgage to a fixed-rate one. But be mindful of the fees involved, which can be high depending on the circumstances.

Key has recommended these to a lot of borrowers at the moment who need big chunk of cash for a project like a renovation or putting a pool. With interest rates heading higher, he said, if a borrower needs $100,000 to $300,000, “a HELOC is not a good place to park that much in debt.”

Closing thoughts

Any decision to borrow against the equity in your home should not be taken lightly. The overall volume of both home equity loans and HELOCs has declined since the 2008 financial crisis, when falling property prices burned some borrowers who had borrowed too much against the equity of their homes.

If you need cash and choose to use your home as collateral, a home equity loan is generally the best choice for financing a project with a set cost. A HELOC provides more flexible access to money, but rising interest rates will make these a more expensive choice in the coming year. It’s also worth considering a cash-out refinance, which could potentially improve the terms of your current mortgage while also giving you extra cash to spend.

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

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.

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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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How to Qualify for a Home Equity Loan

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.

Buying a house is an investment, one that can open opportunities in numerous areas of your life. Not only does it become a home for you and your family, you can also borrow money against the property, creating financial flexibility for a wide range of goals.You can access that flexibility is through a home equity loan (HEL) or home equity line of credit (HELOC).

When you take out a home equity loan, you receive a lump sum that you repay at a fixed interest rate.

With a home equity line of credit, you’re approved to borrow a certain amount, but you don’t need to use it all right away.

If you’re approved for $100,000, you might borrow in increments of $15,000 or $20,000, depending on your needs. Unlike HELs, HELOCs typically come with adjustable interest rates, though there are variations in the product terms you’ll want to compare to ensure you’re getting the best deal for your circumstances.

What it takes to qualify for a home equity loan

There are three key factors that impact your chances of being approved for a HEL or HELOC.

Decent credit. The first is your credit score. Because some lenders are more conservative than others, each will have different credit thresholds for approval.

“Getting a home equity is very similar to getting a mortgage,” Kelly Kockos, senior vice president in home equity product management at Wells Fargo, told MagnifyMoney. Borrowers will likely need at least fair to good credit to qualify for a home equity product, she says.

Substantial equity. The second element that needs to be in place is your available equity, which is determined by your existing mortgage balance and the total value of your home. If you’re approved for a loan or line of credit, the lender will decide how much of your equity you can borrow against. Depending how their products are structured, they may allow you to borrow up to 85% of your available equity. Most lenders won’t go above 85%, according to the Federal Trade Commission.

Tendayi Kapfidze, chief economist at LendingTree, says a good rule of thumb is to have a loan-to-value ratio that’s well below 80% before applying for a home equity product (Disclosure: LendingTree is the parent company of MagnifyMoney). He suggests that if a home is worth $100,000, a mortgage balance of $50,000 would be a healthy ratio for taking out a home equity loan or line of credit. Assuming a lender allows you to borrow up to 80% of your home value and that you meet all other criteria, you might be approved for up to $30,000 to use as you see fit.

Kapfidze says the percentage for which you’ll be approved depends on the lender’s criteria and the relationship you have with them. If you hold other assets with them, they may feel comfortable offering a higher loan or line of credit, he says. But regardless of where you apply, equity below 80% will provide enough of a gap between your remaining mortgage and your home’s value to borrow the money you need.

Low debt. Finally, lenders will take your debt-to-income ratio into account. As with other credit decisions, they’ll look at how much you pay each month on your mortgage, student loans, car payments and credit cards, Kockos says. Keeping these as low as possible will boost your chances of approval because a high debt-to-income ratio may raise red flags about your ability to manage another significant payment.

“If your debt is over 43% of your income, then it’s probably not a good thing for you to take on more debt,” Kockos said.

The benefits of home equity loans and lines of credit

Both HELs and HELOCs provide access to funds and offer a means to cover important expenses.

Kapfidze says that because home equity products are backed by your house as collateral, you’ll often secure better interest rates than you would through a personal loan or credit card. That’s why some consumers will use home equity to purchase cars or pay off student loans, because they’re able to secure better interest rates that way.

Whether you choose a home equity loan or line of credit depends on your particular circumstances.

Depending on how you use your loan, you may qualify for a tax deduction. You may choose to limit your home equity spending based on new tax limitations as well. The Tax Cuts and Jobs Act stipulates that you can only deduct interest paid on a home equity loan or line of credit if you use the funds to renovate, build or purchase the house that secures the loan, according to the IRS.

Who home equity loans are best for: Kockos says that home equity loans make sense for consumers who know they need a set amount of cash right away. If you’re facing a major expense with a set dollar amount — a medical procedure or a roof replacement, for instance — you may want to take out a loan for the exact amount you want to borrow. You can then lock it in at a fixed interest rate and you’ll know what your monthly payments will be for the duration of the loan.

Who HELOCs are best for: A home equity line of credit may make more sense if you want access to a certain amount of money but don’t necessarily want to use it all immediately. Unlike with an HEL, you’ll only pay on what you’ve already drawn from a HELOC. Kockos offers the example of using a HELOC to cover home remodeling expenses. You might be approved for $100,000 but you may not pay all of your contractors at once. Instead, you might pay $25,000 to one vendor this month and $10,000 to another next month. If that’s the case, you’d use your credit line as each expense comes up, and you only pay interest on the funds you’ve already drawn.

David Gorman, a division executive at Bank of America, says a home equity line of credit has become increasingly popular among both lenders and borrowers. “You very rarely see home equity loans anymore,” he said.

He attributes this shift to the flexibility of HELOCs. Even consumers who want to lock in a fixed rate can do so on their lines of credit, he explains. If you spend $30,000 of an $80,000 line of credit on roof repairs, you can lock in that $30,000 at a fixed rate to avoid significant interest increases during repayment. This provides some of the security of a home equity loan without sacrificing the benefits of the HELOC.

“It acts almost the same, and they don’t have to take it all out upfront,” Gorman said. “It provides you significant flexibility.”

The risks of home equity loans

The number one risk you must be aware of when you apply for a home equity product is that you’re borrowing against your home, and your lender can foreclose on it if you don’t make your payments.

“You’re risking your house, whereas with other types of loans, you may pay a higher interest rate but you’re not putting your house ‘on the line,’” Kapfidze said. Consumers should be well aware of that risk when applying for a home equity product, he added, but if they go into it with a full understanding of the terms, they’ll find that they are likely to get the best rates through these options.

Knowing that your house is at stake makes it vitally important to think carefully about how you spend your home equity funds. You can use the money however you choose, whether that’s to repair your basement after a flood or take a second honeymoon. However, paying for nonessential renovations or family vacations leaves you with less money to cover emergencies, not to mention with potentially significant debt that could become difficult to repay. Gorman says that Bank of America doesn’t advise borrowers on how to spend their money, but he says that misuse of funds is one of the biggest pitfalls that ensnare consumers.

“Should they actually need the equity in their house for other things down the road, they may no longer have it,” he said.

Shopping for a home equity loan

Look beyond the interest rate. The obvious comparison point when comparing HEL and HELOC offers is the interest rate. However, there are several other factors to consider as well. One is the fee — how much is the lender charging on top of your monthly interest payment? Another is whether there are rate caps in place to protect you against future interest rate spikes. Kockos recommends looking at annual and lifetime rate caps to determine which offers provide the best protection features throughout the life of the loan.

Compare flexibility. Kockos also suggests comparing product flexibility among HELOCs. Some lenders will offer lock and unlock features for their home equity lines of credit. This allows you to secure a portion of your spending at current interest rates but unlock it later if rates drop and you want to secure those instead. If your lender offers a lock and unlock option, be sure to ask how many times a year you’re allowed to use that feature so you’ll know how agile you can be based on rate volatility. Kockos notes that some lenders will offer promotions or discounts on fixed-rate home equity loans, so it’s worth inquiring about those as well.

Consider closing costs. Jorge Davila, vice president of sales, consumer direct and digital mortgage lending at Flagstar Bank, says it’s important to compare post-closing services as well. He recommends comparing when and how you’ll be able to access funds, whether there are mobile management options and whether there are prepayment penalties for your loan or line of credit. Factoring in servicing features along with rates and protections will give you a full picture of what you can expect from working with a lender.

What to do if you don’t qualify for home equity products

From a lender’s perspective, issuing a home equity loan or line of credit is riskier than giving someone a mortgage. Kapfidze explains that the mortgage lender has the first lien, meaning that they’ll be repaid first if you default on your loans. Because the home equity lender has the second lien and therefore carries more risk, their approval thresholds are likely higher. This means that your chances of qualifying for a home equity product may be lower.

However, if you still need access to a large sum of money, you may qualify for a cash-out refinance. In this case, you would refinance your current mortgage for a higher dollar amount that includes the remaining balance on the loan plus additional funds you can use for renovations and other needs. The difference between the two is what’s available for spending. Kapfidze notes that consumers can see higher interest rates on their refinanced mortgages than on their existing mortgages, so it’s important to be aware of the additional costs you’ll incur before pursuing this option.

Making the right home equity decision

The first step in applying for a home equity loan or line of credit is meeting with lenders. They can explain the qualification process so you’ll know exactly what to expect. But you’ll also want to dig into the specifics of their offers and get a sense of what it will be like to work with them. As with a mortgage, you may be repaying this loan over decades, so you want to make sure their terms and support options work for your needs. The right lender can help you determine how much to borrow and how to maximize the opportunities associated with home equity borrowing.

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The Importance of Getting Preapproved for a Mortgage

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It’s a challenging time for homebuyers. Demand for housing is on the rise as the economy continues to soar and job opportunities increase. At the same time, housing supply is down in many parts of the country and mortgage rates are at a seven-year-high, averaging at 4.62% for a 30-year fixed loan as of June 18, 2018.

If you can get preapproved for a mortgage before you put in an offer on a home, it will give you an edge, especially if you are in a highly competitive market.

“A preapproval makes your offer stronger and more attractive to the person selling the house,” said Tendayi Kapfidze, chief economist at LendingTree, the parent company of MagnifyMoney.

In this post, we’ll explain what it means to get preapproved for a mortgage, and how you can do it the right way.

What is a mortgage preapproval?

A mortgage preapproval is essentially when a lender looks at some of your financial information, credit history and employment record, and determines you are eligible for a loan of a certain amount.

They will tell you how much you have been preapproved for and also what your mortgage rate will be. At this point, you can choose to lock in your mortgage rate, or wait to compare their offer with preapprovals from other lenders.

When you have a preapproval, a lender is telling you they are almost certainly going to qualify you for a loan. And when you are competing against other buyers for the same home, that document tells the home seller that you are a reliable candidate. It gives them an incentive to go with your offer, because you’ve been preapproved and it’s likely you’re going to be able to get a mortgage without any issues.

A preapproval can also be helpful to you and your real estate agent. The lender will preapprove you for a certain loan amount, so you will know exactly what you can afford. Your real estate agent then has a good idea of what properties to show you based on your affordability and preferences. In fact, some real estate agents will ask if you’ve been preapproved for a mortgage loan before they even agree to take you house hunting.

There is no guarantee that the borrower will get a final approval. There are plenty of things later in the mortgage process that could derail your application, such as a poor home inspection or a home price that is higher than the home’s appraised value.

How to get a preapproved for a home loan

Identify at least three potential lenders.You should plan on getting preapprovals from at least three different lenders to be sure you’re getting the best rate possible. Even a small difference in mortgage rate can add tens of thousands of dollars to your total loan costs, so that’s why we recommend comparing offers to secure the lowest rate possible. Start with your current bank and check offers from a credit union and online lenders as well.

Of course, if you are merely looking to obtain preapproval to bolster your initial offer on a home, it’s fine to get just one lender preapproval. That will be enough to satisfy any home seller or their agent. But once you are really ready to lock in a lender, that’s when it’s crucial to get offers from other lenders as well. Before there is a property attached to your preapproval, Kapfidze said, you can always switch to another lender.

Get your documents ready to go. Many lenders today will ask for documents electronically and you may even be able to upload documents directly through their website. If you get all your documents organized on your computer, you’ll be sure to have them all ready to go. Different lenders ask for different sets of paperwork, but most lenders require the following documents:

  • Your ID
  • Two months of bank statements
  • Verification of employment, usually in the form of your pay stubs from the last 30 days or W-2s from the past two years (1099s for those who are self-employed)
  • Documentation for other sources of income, if applicable
  • Social Security number and address

Expect an answer within 24 hours. Most lenders can process a preapproval within 24 hours if the borrower submits all the paperwork on time, said Doug Crouse, a mortgage loan originator with UMB Bank in Kansas City, Mo. However, that also depends on how quickly lenders move and how timely borrowers provide the needed information. In some cases, the preapproval process could take up to 10 days.

If you are preapproved for a mortgage, a lender will issue a letter stating the estimated loan amount and mortgage rate you qualify for based on your financial conditions. Once you have a preapproval letter in hand, you can start searching for homes within your price range.

How preapprovals impact your credit

Getting preapproved will result in a hard pull on your credit, which could make a minor dent in your score. This shouldn’t deter you from shopping around and comparing multiple offers, however. If you get multiple mortgage applications in a short period of time — 14 to 45 days usually — it will only count as one hard inquiry on your credit file and should not damage your score significantly at at all.

If you’re denied for preapproval, it could be for a number of reasons, such as a low credit score, high debt-to-income ratio or a small down payment, Kapfidze said. According to a recent study by LendingTree, the most common cause of mortgage denials was a tie between the borrower’s credit history and their debt-to-income ratio. Your debt-to-income ratio (DTI) is how lenders determine what percentage of your monthly income is going to be needed to cover your monthly debt obligations, including your potential mortgage payment.

You don’t need perfect credit to get a mortgage. To get the best possible rate, you’ll need a credit score of at least 760, but a credit score of 620 can generally qualify you for a conventional home loan. It will just come with a higher mortgage rate and cost you more money over the lifetime of the loan in interest charges. Do all that you can to improve your credit score before applying for a mortgage.

There are other mortgage options that accept a lower credit score. For instance, someone with a score of 500 may qualify for an FHA loan. We have a list of loan options for borrowers with poor credit here.

Really, the preapproval process is more straightforward than it sounds, and it’s a lot more simple than the actual loan application process — lenders are simply looking for signs indicating that you will be able to repay the loan at this stage.

Preapproval vs. pre-qualification

These terms are often used interchangeably in the mortgage business but they can mean very different things.

Pre-qualification is typically a prerequisite of a preapproval. Lenders may ask prospective borrowers to fill out a pre-qualification form, where a loan officer will gather a few details from you face to face or online, including your income, assets, debts and credit. Based on the preliminary information, they estimate the size of a loan they may qualify you for.

Because at this stage lenders will not verify any information about you, there is typically no hard credit pull required. It’s a good first step in that it helps you gauge how big a home you can afford.

Lenders may issue a pre-qualification letter indicating what your home purchase limit is. If you’re casually shopping for a mortgage or you’re just curious how much you might qualify for, a pre-qualification quote is a good first step for that reason. There’s no risk that you’ll ding your credit score for nothing.

However, pre-qualification is not as serious as a preapproval, and many home sellers will want to see a preapproval when they review your offer. If you’re truly serious about putting a bid on a home, get a mortgage preapproval first.

In a tight housing market, a buyer with proof of preapproval can get a competitive advantage than those who don’t have it — sellers are more likely to take the offer from a buyer who’s preapproved for a loan. This is why preapproval should be done before house hunting.

Benefits of shopping around for mortgage offers

Just like buying anything else, you would want to shop around for a mortgage, because the first offer may not be the best offer.

According to LendingTree’s recent Mortgage Rate Competition Index, borrowers could save 0.62% in interest rate by shopping around. On a 30-year mortgage, a borrower could potentially save $28,890 on a $300,000 loan. That’s almost 10% of the entire loan amount. (Note: MagnifyMoney is owned by LendingTree)

Crouse recommended borrowers check with two or three lenders to make sure they are getting the best deal in rate and costs. Once you’ve shopped around and received quotes from different lenders, then you can go forward with the one that you feel most comfortable with.

Alternatively, you can use this online tool, which will match you with multiple mortgage lenders, to compare quotes before applying for a preapproval.

Advertiser Disclosure: The card offers that appear on this site are 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 card companies or all card offers available in the marketplace.

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Shen Lu is a writer at MagnifyMoney. You can email Shen Lu at shenlu@magnifymoney.com

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How Long Does It Take to Refinance a House?

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Refinancing a home is very similar to getting a mortgage, but you might be wondering how long the process might take. If you have time-sensitive goals, knowing average refinance timeline for each stage could help you with planning. (Note: MagnifyMoney is owned by LendingTree)

How long does it take to refinance a house?

According to a recent report by Ellie Mae, the time to close on a home refinance has decreased significantly over the last few months.

As of February 2018, the average time to close on a home refinance loan was 37 days, down from 50 days in October 2016. Granted, closing times vary by loan type (i.e. FHA, conventional VA, etc.) but the average is coming down across all home refinance loans, Ellie Mae found.

Jason Lerner, area development manager and mortgage broker at George Mason Mortgage, LLC, said that refinancing could be even faster if there are no delays or complications.

There are many variables that come into play that could affect the timeline for your home refinance.

One variable in the timeline will be how responsive you, as the loan applicant, are with providing and verifying information as requested by the lender. The other variable is how responsive your lender is and whether or not there are issues or complications with your application.

The good news is that you can control your level of responsiveness and communication to help the process go as smoothly as possible while minimizing delays. However, you cannot control how the bank handles their internal processes.

That’s why it’s a good idea to review lenders who have a good track record of proving the best home refinance rates and customer service. Often, the best place to start is with your current lender, especially if you are a fan of their customer service, but always compare their offer with other lenders as well to be sure you’re getting the best deal.

The mortgage refinance process — from start to finish

It’s good to know about all the steps of the refinance process. This way, you can anticipate what’s needed and be prepared for the closing table that much quicker.

Here are the steps involved in most home refinance loans, along with how long you can expect them to take (barring delays, problems or issues). Some of these stages can overlap or occur simultaneously.

Figure out why you want to refinance

Preparing to refinance your home loan comes down to knowing your objective so you can narrow down a loan type, amount and potential repayment schedule. This is an important step.

Without being clear on exactly why you are refinancing your home, you could end up choosing a loan that doesn’t suit your needs, or even end up overextending yourself financially, which could put your home in jeopardy.

Refinancing your home just because you can is not a good idea. Create a list of financial goals, amount of money it will take to reach them along with a budget that includes your refinance scenario.

Common goals for refinancing a home could include:

  • Having a lower monthly payment
  • Consolidation of other debt
  • Get a lower interest rate
  • Pay off the loan quicker (with a shorter term, lower rate or both)

Home refinance costs (more below) should also be considered in this equation. Though the equity in your home is yours, accessing it still costs money. If possible, fare on the conservative side when it comes to determining the loan amount and type for your home refinance.

Choose the right refi loan

Now that you have an idea of what you’ll use your loan for and what you can afford, it’s time to determine the best type of home refinance loan.

There are many options when it comes to refinancing your home. You should become familiar with each so you can choose the best one for your needs.

Here are some loan types you could research:

  • 30-year fixed: A fixed interest rate loan amortized over 360 months
  • 15-year fixed: A fixed interest rate loan amortized over 180 months
  • Adjustable rate mortgage (varying types and terms): Interest rate resets periodically
  • Interest only: Borrowers pay interest on the loan, then principal
  • Payment option: Adjustable rate mortgage with multiple payment options
  • Balloon: Lower payments during loan term with a large payment at the end of the term

Next, you’ll want to explore different options offered under FHA, VA, USDA or conventional home refinance loans. There are ups and downs for each kind of mortgage, but ultimately, you need to choose the product that will help you meet your financial goals.

Compare offers from lenders

Now that you have a sense of the best type of home refinance loan, it’s time to research lenders who can offer you the best home refinance deal possible. Shopping for the best refinance rates can save you thousands of dollars, so don’t skip this step!

The terms offered will be based on a few things like how much your home is appraised for, the maximum loan-to-value a lender will offer, current market interest rates and your personal credit profile.

If you are especially concerned with how long it will take to refinance your home, you can make this a part of your research. Dan Green, former mortgage loan officer and owner of mortgage-literacy website Growella said, “Homeowners — especially homeowners working on a deadline — should ask about time-to-close as part of the lender comparison process.”

Understand the fees and additional costs

As mentioned before, financing your home is no small feat and it does come with a price tag. You should know upfront about the fees and costs related to a home refinance, as it should help you determine whether or not this is a move you actually want to make.

Think about how much you paid to close on your original mortgage loan to anticipate your closing costs this time around.

You can use a home refinance calculator so you can see the impact of refinancing your home when it comes to interest, monthly payments, tax deductions, total mortgage cost, etc.

Here are some home refinance costs you should know about:

  • Mortgage application fee
  • Home appraisal
  • Loan origination fee
  • Document preparation fee
  • Title search fee
  • Recording fee
  • Flood certification fee
  • Inspection fee
  • Attorney fee
  • Survey fee

Costs could vary by state and lender, so compare these fees on your Loan Estimate (see below) as you look at multiples lenders.

Submit your refi application to various lenders

Most lenders will allow you to apply for your home refinance online. To streamline your application process and get the best rates, you can apply to several lenders at once. This way, you can explore the best rates available while having lenders compete for your business.

If all of your refinance applications are made within a 30-day time period, the inquiries will not affect your score while you are shopping for rates.

Be prepared to provide demographic information about yourself and co-borrower, along with information about your property, original loan and more. Your lender will also eventually ask for additional proof to support the information you provide in the application. This would be a good time to start gathering this documentation up.

Get a loan estimate

Once the lender has processed your application and verified your information, they will provide what is called a Loan Estimate (LE.) By law, they must submit this loan estimate to you within three business days of receiving your completed loan application.

The Loan Estimate form is a standardized template that clearly outlines the home refinance terms the bank expects to offer you, should you decide to go forward. The bank has not yet approved (or denied) your refinance loan at this point, and they may ask you to sign the LE as a record of receipt on your end.

Again, you’ll want to use this Loan Estimate to compare multiple offers from various lenders.

Lock in your rate

Prevailing rates for mortgages can change from day to day and even from hour to hour, so it’s a good safety measure to lock in your rate. A rate lock means your lender will “lock” in your interest rate until closing.

Some lenders may lock your rate as part of issuing the Loan Estimate, but this is not always the case. You can check the top of your Loan Estimate document on the first page to find out if your interest rate is locked, along with when this rate will expire.

Submit required documents for loan processing

Among the supporting documentation you’ll be asked to provide may include:

  • Pay stubs
  • Tax returns, W-2s and/or 1099s
  • Credit report
  • Bank statements
  • Proof of any supplemental income

Note: It’s a good idea to check your credit report regularly in case there’s inaccurate information that needs to be addressed. You don’t want anything to prevent (or delay) the bank from processing your application or extending a refinance loan to you.

Once this information is provided, the processor will go on to order your credit report, home appraisal and payoff amount from current lender.

Appraisal

This is where an appraiser will come to your home and determine its value. They will be dispatched by the bank and come view the property, look up comparable properties nearby and furnish a report with their findings. The amount you’ll be able to refinance will be based on this appraisal report.

Underwriting

At this stage, the lender is putting all the pieces together — the appraised value of your home, your personal financial situation along with your predicted ability to repay the loan on time and as agreed. This risk analysis can take time and may require additional information.

You should be ready to provide additional information to your loan processor, if needed. Also, your employer could be contacted to verify your salary and employment status during the underwriting phase.

Commitment letter

This letter states that the bank agrees to lend you money, but there could be additional requirements, such as providing more information or clarifying information you’ve already provided. The bank can rescind this offer if there is an significant change in your personal financial situation as well.
However, once you meet the conditions set forth in the commitment letter, the underwriting department will issue a “clear to close.” Your loan officer will let you know via email or phone call that the bank will soon communicate the next steps for your closing date.

Closing disclosures

At least three days prior to closing, you’ll be issued a Closing Disclosure. It will outline the final terms of your refinance loan.

This three-day timeline is designed to give you enough time to compare rates and ask your lender questions about your loan. For example, if your closing disclosure varies greatly from your Loan Estimate, this is time to get clarification as to why.

You can also ask to review your closing documents before you get to the closing table. Your lender should be able to provide an electronic version so you are aware of what you would be signing at closing. The Consumer Financial Protection Bureau (CFPB) offers examples of closing forms along with instructions on how to interpret the information.

If you need help staying organized throughout this process, you can use a closing checklist to help you keep track of each stage of the closing process.

Closing

At this stage, you will sign all the required documentation to complete your home refinance. You should bring your Closing Disclosure with you to make sure your the terms you were quoted are on par with this document.

Sometimes your loan closing will be at an office with a closing agent (from a title company) that facilitates the entire process. According to Rafael Reyes, producing branch manager at loanDepot, “Most often, the lender will send either a representative from the title company or a lawyer to your home for the closing.”

He added, “The borrower doesn’t need a lawyer on their side for the closing, but they could hire legal representation at their discretion.”

At closing, you’ll sign your promissory note, mortgage, initial escrow disclosure and “right to cancel” form. You should bring proper identification because there may be a notary present who requires a valid ID to notarize your signature.

How you can speed things up

If you’re refinancing your home with the idea of saving money, you probably want to start saving sooner than later. You can start capturing those savings as soon as your refinance is complete and funds are disbursed.

To speed up the refinance process, you’ll want to stay on top of all the documentation requested by your lender. Even better — collect everything before you begin the loan application process so everything is ready, even at a moment’s notice.

You will also need to be responsive when it comes to requests for information. Though there are a number of variables that can influence the refinance timeline, your responsiveness and preparedness will help move things along much faster.

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How to Use Airbnb Income on Your Mortgage Refinance Application

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.

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Airbnb hosts, here’s one more way renting out your spare bedroom can give you extra cash. U.S. hosts are now able to include Airbnb income when refinancing their home mortgage loan with participating lenders Better Mortgage, Citizens Bank and Quicken Loans thanks to an initiative between Airbnb and Fannie Mae. Read on to find out how it works, benefits of the partnership versus other lenders and what you need to do if you’re considering refinancing your mortgage.

How it works

Here’s who’s eligible for the new partnership: U.S. Airbnb hosts who list their primary residence and are interested in refinancing an existing conforming loan on that home. For anyone who has been denied refinancing in the past, this may provide the boost you’ve been needing. Of course, it always pays to compare interest rates and other costs — if you can afford to wait, other lenders may join in with even better offers.

John Moffatt, head of loan origination at Better Mortgage, says borrowers who have at least one year of Airbnb income claimed on their tax return and proof of income from Airbnb qualify. You may also be asked to submit utility bills.“Think of this partnership as a step toward more forward thinking in how people earn income,” he said. “It’s showing some good initiative in how Fannie Mae is helping borrowers by accepting alternative forms of income.”

Applying through Better Mortgage, Citizens Bank or Quicken Loans is similar to any refinance application. Each lender has its own underwriting and approval process, so you’ll need to refer to them for any specific questions. “At Better Mortgage, you can go through the entire application online. After you lock in your interest rate, we will then request your tax return, proof of income and any additional documents during the closing process,” Moffatt said. “I’ve heard anecdotally where customers have come to us with [a] high interest rate and just haven’t been able to refinance. It’s great we’re able to help people potentially save thousands of dollars in the long run.”

The rates through Better Mortgage, Citizens Bank and Quicken Loans are comparable with its competitors. Of course, the actual rate you get depends on a number of factors including your credit history, debt-to-income ratio and loan term.

What this partnership means for other lenders

While the three lenders mentioned above accept Airbnb rental income, that doesn’t necessarily rule out other mortgage companies. While Fannie Mae’s requirements for rental income don’t specifically address short-term rentals, Freddie Mac’s guidelines have been updated to help lenders qualify income from short-term rentals. Borrowers must show a two-year history of rental income on their Schedule E.  Reminder: Fannie Mae and Freddie Mac are government-sponsored enterprises that buy and sell residential mortgages. Better Mortgage, Citizens Bank and Quicken Loans have their own agreement with Fannie Mae so they accept a shorter history of rental income.

Cassidy Cain, a mortgage loan officer with US Mortgage, says the partnership with Airbnb could be beneficial to hosts. “The truth is that every lender out there is going to follow the guidelines presented to them by places like Fannie Mae and Freddie Mac,” she said. “However, some may be overly cautious about accepting [Airbnb rental income].”

In other words, other lenders could accept Airbnb income but may be cautious as to how much weight they give it when considering someone for a refinance. These companies may also require two years’ worth of rental income history as required by Freddie Mac, so that could put new hosts at a disadvantage.

Cain says Airbnb income may make a dent in your debt-to-income ratio. “If there’s enough income to significantly reduce your debt-to-income ratio, then you could have a shot at refinancing,” she said. “You’ll also need to make sure you meet all other requirements, such as your creditworthiness.”

Bottom line

This new partnership may work to your advantage if Airbnb income is the factor that puts you over the refinancing finish line, assuming you’re considered creditworthy and can fulfill other lender requirements.

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Which Is Better: Cash-Out Refinance vs. HELOC?

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When you need cash but don’t want to raid your emergency fund, it’s only natural to consider tapping into what could be your greatest source of wealth — your home equity.

It’s entirely up to you how you use it, but many consumers use home equity to remodel their homes, consolidate debt or cover expensive bills, such as college tuition. It’s your equity to use how you please, so the options are endless.

But because there’s more than one way to access your home equity, it’s wise to compare available options to find the right fit. Two of the most popular ways are a home equity line of credit (HELOC) and a cash-out refinance. Both of these loans can work if you want to access your home equity, but they do work rather differently.

Cash-out refinancing: How does it work?

Cash-out refinancing involves replacing your current home loan with a new one. The “cashing out” part of the equation requires you to take out a larger home loan than you currently have so you can receive the difference as a lump sum. Like HELOCs, this strategy works for people who have equity in their homes due to paying down their mortgage balances or appreciation of their property.

To qualify for a cash-out refinance, you need to meet similar requirements as you would if you were applying for a first mortgage. This typically means having a credit score of 620 or above, a debt-to-income ratio of 50% or less (i.e. the sum of all your debt payments, including housing, divided by your gross monthly income), and a loan-to-value ratio on your home of 80% or less after the cash out refinance is complete.

The equity part of the equation can be a roadblock since you need to have a lot of equity in your home to qualify for a cash-out refinance. Let’s say your home has a value of $300,000 and you want to take cash out. In that case, you could only borrow up to $240,000 through a cash-out refinance. If you owe that much or more on your home already, you wouldn’t qualify.

Like any other loan, you’ll need to prove your employment status via recent pay stubs and gather other documentation such as W-2 tax forms, two months of recent bank statements and two years of tax returns.

Cash-out refinance pros and cons

Pros:

  • You can use the money from a cash-out refinance for anything you want, including home upgrades, college tuition, a vacation or debt consolidation.
  • If rates have gone down or your credit has improved since you took out your original home loan, you could refinance your mortgage into a new loan with a lower interest rate.
  • You can choose from different types of loans for your refinance, with various terms and fixed or variable rates available.
  • Interest on your first mortgage may be tax-deductible.
  • Interest rates on first mortgages tend to be lower than other options, such as home equity loans or HELOCs.

Cons:

  • You may face substantial closing costs for a cash-out refinance, which typically work out to 2% to 6% of the loan amount.
  • If interest rates have gone up since you purchased your home, you could be trading your mortgage for a higher interest loan that will be more expensive.
  • Refinancing your home to take cash out may leave you in mortgage debt longer.
  • You won’t qualify for a cash-out refinance unless you have at least 80% equity in your home after the process is complete.
  • Refinancing your home to take cash out could leave you with a larger monthly mortgage payment.

Home equity line of credit (HELOC): How does it work?

While a cash-out refinance requires you to replace your current mortgage with a new one, a HELOC lets you keep your first mortgage exactly how it is. Acting as a second mortgage, a HELOC lets you borrow against your home equity via a line of credit. This strategy allows you to withdraw the money you want when you want it, then repay only the amounts you borrow.

To qualify for a HELOC, you need to have equity in your home. The Federal Trade Commission (FTC) notes that, depending on your creditworthiness and how much debt you have, you may be able to borrow up to 85% of the appraised value of your home after you subtract the balance of your first mortgage.

For example, let’s say your home is worth $300,000 and the balance on your mortgage is currently $200,000. A HELOC could make it possible for you to borrow up to $255,000, because you would still retain 85% equity after accounting for your first mortgage and your HELOC.

Generally speaking, HELOCs work a lot like a credit card. You typically have a “draw period” during which you can take out money to use for any purpose. Once that period ends, you may have the option to repay the loan amount over a specific amount of time or you might be required to repay the balance in full. You may also have the option to renew your draw period at that time. All these factors can vary, so make sure to ask your HELOC lender about specifics before you move forward.

Like credit cards, HELOCs also tend to come with variable interest rates. This can be a good thing when rates are low, but you have to be prepared for your rates to rise.

To qualify for a HELOC, you must be able to borrow the money you need and still maintain 15% equity in your home. Having a credit score of 680 or above can also help the process along, although some lenders offer home equity loans to borrowers with scores as low as 620.

Generally speaking, you also need to have a debt-to-income ratio of less than 43%, including your first mortgage and your HELOC payment. The Consumer Financial Protection Bureau (CFPB) reports that lenders implement this “43% rule” based on the idea that borrowers with higher levels of debt often have trouble keeping up with their housing payments.

HELOC pros and cons

Pros:

  • Applying for a HELOC allows you to maintain the terms of your original mortgage, which can be an advantage if your rate is low.
  • You can use money from a HELOC for anything you want, and you only have to repay amounts you borrow.
  • HELOCs tend to come with lower closing costs than traditional mortgages and home equity loans.
  • Interest may be tax-deductible if you use the funds to improve your property. Make sure to check with your accountant.

Cons:

  • Taking out a HELOC means you’ll need to make two housing payments every month — your first mortgage payment and your HELOC payment.
  • Interest on a HELOC is no longer tax-deductible, unless the funds are used for acquisition or updating your home.
  • Since you only repay what you borrow and the interest rate on HELOCs is typically variable, you may not be able to anticipate what your monthly payment will be. Your monthly payment could also be interest only at first, meaning your payment won’t go toward the principal or help pay down the balance of your loan.
  • The interest rate on HELOCs tends to be higher than first mortgages, and their variable rates can seem riskier. You may also be required to pay a balloon payment at the end of your loan, so make sure to read and understand the terms and conditions.
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At a glance: Cash-out refinancing and HELOCs

At the end of the day, either borrowing option can get you what you need — access to the equity in your home. But, one option can easily be better than the other, depending on your situation.

Before you choose between a HELOC or a cash-out refinance, here are all the details you should consider:

 

Cash-out refinance

HELOC

Loan term

You get to select the loan term when you go through a cash-out refinance. Among other options, you can get a fixed-rate mortgage with a 15-year or 30-year term.

Most HELOCS come with a draw period of up to 10 years. After that, you will have a repayment period that varies by lender.

Borrowing limits

You can borrow up to 80% of your home’s value.

HELOCs allow you borrow up to 85% of your home’s value, including your first mortgage.

How long it takes to get the money

The average refinance takes between 20 and 45 days, and you’ll get a lump sum for the amount you borrow at closing.

The average HELOC can close in less than 30 days, at which point you’ll have access to your new line of credit.

Credit score

You need a credit score of 620 or higher to qualify for a cash out refinance.

You need a credit score of 620 or higher to qualify for a HELOC.

Equity requirements

You need to have at least 20% equity in your home after the cash-out refinance is complete.

HELOCs require you to maintain at least 15% equity after borrowing.

Interest rates

Mortgage rates can be fixed or adjustable, with rates ranging from 3.75% to 4.25%.

HELOC interest rates are variable, currently ranging from 4% to 5.87%.

Closing costs

Closing costs for a traditional mortgage range from 2% to 6% of the loan amount.

HELOCs tend to have little or no closing costs.

Risks

Since you’re using your home as collateral, you run the risk of losing your home if you default. If you extend your repayment timeline, you will also spend more time in debt.

HELOCs require a lower amount of equity (15%) in your home, which means you can borrow more. However, you could lose your home if you default, because you’re using the property as collateral.

Which choice is right for you?

Before you decide between a HELOC or a cash-out refinance, it helps to take a holistic look at your personal finances and your goals.

A cash-out refinance may work better if:

  • Your current home loan has a higher rate than you could qualify for now, so refinancing could help you save on interest
  • You prefer the stability of a fixed monthly payment or only want to make one mortgage payment every month
  • You have high-interest debts and want to consolidate them at the same rate as your new mortgage
  • What you save by refinancing — such as savings from a lower interest rate — outweighs the fees that come with refinancing

A HELOC may work better if:

  • You are happy with your first mortgage and don’t want to trade it for a new loan
  • Your first mortgage has a lower interest rate than you can qualify for with today’s rates
  • You aren’t sure how much money you need, so you prefer the flexibility of having a line of credit you can borrow against
  • You want to be able to borrow up to 85% of your home’s value versus the 80% you can borrow with a cash-out refinance

In addition to these options, you can also consider a home equity loan. While HELOCs come with variable rates and work as a line of credit, a home equity loan comes with a fixed rate and fixed monthly payment.

Whatever you decide, make sure to compare lenders, interest rates and terms to get the best deal possible when accessing your home equity.

Advertiser Disclosure: The card offers that appear on this site are 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 card companies or all card offers available in the marketplace.

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