Home Financing Tips & Advice
If you're going to buy or remodel a home and don't have the cash to put on the barrelhead, you'll need to finance the cost. Usually, this is with a mortgage or other borrowing agreement with a lending institution. Many different businesses lend money, but banks are the most common. Secondary to banks are businesses specializing in loans without the other services offered by banks.
Buying A Home
There are many different things to consider when you're looking to borrow money to buy a house. First, you must decide what amount you're comfortable paying each month. If your budget for a mortgage payment is $1,000, then you'll have to design the loan with that in mind. It doesn't matter if you can get a better rate if achieving that rate comes with a $1,500 monthly price tag. After that, choose the length of term and decide the maximum rate of interest you're willing to accept. Generally, the rule of thumb is that longer terms have higher interest rates. The last thing to consider is incidental costs, such as closing costs, hiring a lawyer, if necessary and paying for appraisals and inspection.
Many lending institutions hide the long-term costs of a loan within high closing costs. At the same time, they advertise extremely low rates. Remember, unless you plan to bring a check to the closing, the cost of the closing will be rolled into the loan. You also have to consider the amount you owe as compared to the value of the home. This is called loan to value, and most lending institutions protect themselves by keeping this value below 80 percent. There are government programs that assist home buyers with loans to value higher than that. Let's look at an example:
You put down $50,000 on a house valued at $150,000 and the bank charges a closing cost of $389. Let's assume the interest rate is 6 percent for 15 years. That mortgage payment each month would be $844. Now, let's assume another lending institution will give you 5.25 percent for the same term but charges $500 for the appraisal and $3,000 in closing costs. The payment for the second institution is $848 a month. As you can see, accepting the better rate means you'd be paying slightly more a month.
In cases of refinancing, the most common way to save money is in cutting down the number of years. For example, if you pay $450 a month on a 30 year mortgage with 27 years left and have the option to pay $575 a month for 15 years, you will save $42,300 over those 15 years even though you'd be paying $125 more a month. As long as you could afford the payment, it would make great sense to change to the 15 years mortgage.
Renovating A Home:
Cash-Out Refinancing For Home Improvements
Your house is a potentially large source of ready money if you are willing to sacrifice some of your equity in return for liquidity. Cash-out mortgage refinancing is one way to access this cash.
What is Cash-Out Mortgage Refinancing?
Cash-out refinancing involves refinancing your mortgage for more than you currently owe and pocketing the difference. If you have been paying down your mortgage for some time, then the principal is likely to be substantially lower than what it was when you first took out your mortgage. That build-up of equity will allow you to take out a loan that covers what you currently owe -- and then some.
For example, say you owe $90,000 on a $180,000 house and want $30,000 to add a family room. You could refinance your mortgage for $120,000, and the bank will then hand over a check for the difference of $30,000.
You can use the cash for home renovations, debt repayment or anything else that needs a significant amount of cash. What's more, you may be able to get a more favorable interest rate for your refinanced mortgage.
However, if the interest rate offered for your refinanced mortgage is higher than your current rate, this probably isn't a sensible choice. A home equity loan or line of credit (HELOC) might be a better idea.
Typically, homeowners are allowed to refinance up to 100 percent of their property's value. However, if you borrow more than 80 percent of your home's value, you may have to pay private mortgage insurance, or pay a higher interest rate. Again, this might make a home equity loan or a HELOC a better choice.
Cash-Out Refinancing vs. Home Equity Loans
Homeowners sometimes confuse these two pools of home-financed cash. They are quite different. Cash-out refinancing is a replacement of your first mortgage; home equity loans are separate loans on top of your existing mortgage. In other words, with refinancing you get a new mortgage, not a second loan against the equity in your home.
Refinancing often makes sense when there has been a drop in interest rates and you want to lock in a new mortgage at a lower rate for a longer term than your existing mortgage. It can also benefit those who want to refinance their mortgages for a longer term to lower their monthly payments. In other instances where you need a short-term cash infusion, a home equity loan is often a better choice.
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Home Equity Loan vs. Line of Credit:
If you're renovating your home, you can borrow against the value of your house through either a home equity line of credit (often called a HELOC or a line) or a home equity loan (often called a HEL or loan). Both are essentially a second mortgage.
What's the Difference?
A HELOC is a form of revolving credit similar to a credit card. It allows you to draw funds, up to a predetermined limit, whenever you need money. There is generally a minimum payment due each month, with the option to pay off as much of the line as you want. With a HEL, you receive a lump sum of money and have a fixed monthly payment that you pay off over a predetermined time period. In each case, the amount you can borrow is based on factors such as your income, debts, the value of your home, how much you still owe on your mortgage and your credit history.
The appeal of both of these types of loans is their interest rates, which are almost always lower than those of credit cards or conventional bank loans because they are secured against your home. In addition, the interest you pay on a home equity line or loan is often tax deductible (consult a tax advisor about your particular situation).
Which is Best for You?
Generally, a HELOC is a good choice to meet ongoing cash needs, such as college tuition payments or medical bills. A HEL is more suitable when you need money for a specific, one-time purpose, such as buying a car or a major renovation.
Comparing the Costs
Both HELOCs and HELs usually carry a higher interest rate than that of a first mortgage. With a HEL, you may choose either an adjustable rate that fluctuates according to variations in the prime lending rate, or you may opt for a fixed rate. A fixed rate enables you to budget a set payment monthly without worrying about increasing costs should interest rates rise. With a HEL, there are also closing costs that you should consider.
A HELOC usually carries a lower initial interest rate than a HEL, but its rate fluctuates according to the prime rate, so there is more interest rate risk. Unlike a HEL, where your monthly payments are a set amount, a HELOC enables you to borrow funds as needed and repay as little as interest only each month. In addition, there are generally no closing costs when you open a HELOC.
Keep in mind, your home is the collateral for both a HELOC and a HEL. If a HELOC's easy access to cash tempts you to run up more debt than you can repay, or if you fail to make your payments, you risk losing your house.
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