Everything You Need to Know About Collateral Loans

Paper cut of model house with coins on wooden table.

You’re probably familiar with several types of collateral loans without being aware that’s what they’re called. If you’ve ever paid for a home over time or financed an automobile, you’ve probably used a collateral loan. In a typical mortgage, the home itself acts as security for the loan; if you don’t make your house payments, the lender may take it from you. A car or truck loan – especially on a new vehicle – is quite similar; if you miss enough payments, the dealer, bank, or credit union can take (or take back) the automobile in question.

Collateral Loans: What Are They and How They Work

At their most basic, collateral loans are any loans backed up by collateral – the stuff of value which lenders can take ownership of if the borrower is unwilling or unable to fully repay the loan in a timely manner.

Dollars Closeup ConceptIf that sounds somehow harsh or unfair, keep in mind that without collateral loans, most of us would never be able to afford those sorts of big ticket items. Our home buying options, for example, would be to (a) save up until we had enough to pay cash, or (b) live with our parents until they passed on and left us their house. Personally, I don’t find either of those particularly promising. Thanks to the modern mortgage structure, however, almost anyone can finance their home over a 15 or 30-year period. Lenders still care about your credit history and such, but they have the home itself as collateral as well, which allows the sorts of ridiculously low interest rates we’re currently experiencing in home loans.

Let’s Talk Terms (The Terminology of Collateral Loans)

Before we push ahead with different situations in which collateral loans might be a good option, it might be helpful to clarify a few of the terms I’m going to use or which you’re likely to encounter if you’re researching collateral loans for your own use.

Collateral / Collateralization

As you’ve no doubt picked up on by now, “collateral” refers to the home, car, or another item of value you offer as security for a loan. When you use your property or assets this way, they become “collateralized.” The term “collateralization” can be used in reference to the process itself or in reference to the loan or the items offered up as security. You will thus hear that the loan has been “collateralized” or remember that you can’t sell your truck because it’s “collateralized” for a small personal loan on which you’re still paying. You may also come across a reference to the “collateral value” of your property, referring to the amount it’s worth as collateral. This may be different than what you paid for it or how much it’s worth to you personally.

Secured Loans / Security

If your loan is backed up by collateral, it’s a “secured loan.” The term references the lower risk taken by the lender when an item of value is being offered as “security.” If you don’t make your payments, they take ownership of your collateral and sell it to recoup their losses. That’s not really what lenders want to do; they’re not looking to make a living selling used boats or whatever. What this does, however, is enable lenders to offer loans they might not otherwise, based on your credit score or credit history, and to extend better terms than they would even if they did approve the loan minus your collateral.

Unsecured Loans

If your loan is NOT backed up by collateral, it’s an “unsecured loan.” These rely entirely on your creditworthiness as indicated by your credit history and current credit score. Lenders may, to a lesser extent, factor in your current reliable income and job situation. Failure to make your payments on time, or to make them at all, will hurt your credit (making it even harder to borrow money on decent terms in the future) and may lead to collections or legal action, but it WON’T directly result in losing your home or car because those things haven’t been offered up as collateral. Because this means greater risk to the lender, expect lower loan limits and higher interest rates on most unsecured loans.

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Assets

Your “assets” are anything you own that has financial value and are thus might be used as collateral. Some assets, like your home or car (assuming you have enough “equity” in them – that you’ve paid enough on THEIR loans that you “own” part of their value) are fairly typical as collateral.

They’re easily converted into cash if necessary and have a fairly predictable value. Savings accounts or investments are also “assets.” Their value to lenders depends on how “liquid” they are (how easily they can be transferred and converted into cash) and the likelihood they’ll hold their value over the life of your “secured” loan. Atypical assets – your semi-rare comic book collection, those sacred mummy heads you inherited and are currently on loan to the local museum, that one-of-a-kind triple-neck 8-string guitar designed, built, and signed by Rick Nielsen of Cheap Trick – may be more difficult to use as collateral since their value is slightly more subjective and they’d be more difficult to convert to cash.

Equity

This is the “stored value” you own in various forms. If you’re halfway through paying off your car, and its current value is $12,000, you have around $6,000 worth equity in it. The same holds true for your home. If its market value is currently $195,000 and you owe $115,000, you have equity of about $80,000 to work with (although most lenders won’t advance more than 80% of the value of whatever you’re collateralizing). Savings accounts or investments are a bit easier to compute. If you have $7,341 dollars in savings, that’s equity worth $7,341.

NOTE: We’re using “assets” and “equity” more or less interchangeably here, but technically they’re not the same. In the most formal financial sense, “assets” tend to be things of value – tangible items – that have financial value. “Equity,” when having a very serious business-type discussion, refers to the cash value of everything you could convert to cash easily, minus existing liabilities. In other words, Equity = Assets – Debts/Obligations. This distinction is useful in some contexts, but for our purposes it’s like arguing about whether the U.S. is a “democracy” or a “republic.” It depends on who’s using the terms and what they’re using them for.

Liquidity

You’re no doubt aware that liquids easily change form to adapt to circumstances. Pour your drink into a tall, thin glass, and your drink fills up the tall, thin shape. Spill it on your keyboard, and it quickly fills in every crevice and finds its way into the inner workings of your computer. “Liquid Assets” are those easily converted into cash. “Liquidity” refers to how easy (or not) this conversion is. Used cars in good shape have great liquidity; rare books in ancient languages may be just as valuable, technically, but are harder to immediately turn into cash.

Interest

Interest is the primary cost of a loan. Figured as a percentage of the total borrowed. Interest rates tend to be higher if you have a limited credit history or a low credit score. Because the lender is assuming a greater risk by loaning you money and hoping you’ll repay. Greater risk means greater reward, at least in modern American capitalism. Interest rates are typically lower if you have a good credit score because the risk is less. The same is true if you’re able to offer up collateral of greater value than the loan amount. The same rate of interest can be computed in numerous ways (which we won’t go into here). So it’s important to pay attention to the details when rate shopping for your best loan options.

Default / Recourse

“Default” is a fancy word for “stopped paying” and “recourse” is a fancy word for what the lender has a right to do if you stop paying. If you still owe money on a loan and you stop paying for any reason, you’ll eventually be declared “in default.” Whether this is triggered at 30 days, 60 days, or longer, and what penalties are triggered once you’ve “defaulted” varies from loan to loan. This is the point, however, at which lenders can report you to a collection agency, take legal action, or seize control of whatever assets you collateralized to secure the loan.

So, to summarize, the reason you may be asked to offer part of your assets as collateral is so that the lender has recourse if you default. You agree because you wanted to secure a lower interest rate than you could get with an unsecured loan. And you know you have sufficient equity for adequate collateralization. (See how much fancier that sounds than “I had to sign a paper saying the bank will take my truck if I don’t make my loan payments”?)

Advantages of Collateral Loans

There are a wide variety of collateral loans, each with its own features and potential pitfalls.
If you’re thinking about finding a credible, trustworthy lender, Loanry can help you.

In general, however, there are a number of positives to collateralizing your assets in order to get the best terms on a secured loan. (I thought we might get more comfortable with all the fancy terms if we used them more.) What I’m saying is, there are reasons you might want to explore collateral loans for whatever your current needs might be.

Available for Poor Credit

If you have limited or poor credit, offering collateral might make the difference between getting a loan and being denied. Lenders have to make a reasonable profit – that’s how business works. In their case, that means two primary things have to happen with some regularity. First, they have to loan out money at interest (with interest being their profit), and second, they have to get repaid with a minimum of extra effort. If it costs them twice what they’re making in interest to track you down and force you to pay, the lender loses money in addition to your credit being damaged. That’s no fun for anyone. With collateral, there’s a better chance you’ll pay, and better protection for the lender if you don’t.

Lower Interest Rate

Offering collateral can secure you a better interest rate. This works for the same reasons we just discussed a loan approval. Lower risk means lenders can offer better terms – especially a lower interest rate. They don’t have to make a LOT on each loan if they’re relatively sure of repayment. Plus, lenders want you to be happy and say nice things about them. And come back to them for your future financial needs as well. Reputable lenders aren’t looking to “defeat” you; they want you both to come out OK on the other end because that’s what’s best for business.

Your Collateral Allows You to Take a Higher Amount

You may be able to borrow a larger amount if you have sufficient collateral. Let’s say you’re planning some major home renovation and remodeling. You’ve run the numbers, and it’s the best thing for your family now and the value of your home in the coming years. But the estimates you’ve gathered for getting the work done are higher than you’d hoped, and your credit is OK, but not great. Being able to use your home’s equity as collateral gives lenders the security they need to extend you the full amount. The risk is less for them but greater for you… if for some reason you’re unable to make your payments in the future, you could lose your nicely remodeled and renovated home.

Collateral Loans Provide “liquidity”

If your wealth is largely tied up on assets with low liquidity, it might make more sense to borrow against them than to convert them in order to finance whatever you need to do. This is more often the case with businesses than with personal collateral loans.

Collateral Loans are a Great Way to Build Credit

One of the realities of modern American life is that almost all of us need access to financing multiple times over the years. At some point, you’re going to want to buy a home, finance a car or truck, pay for a wedding, take a vacation, pay off medical bills, or start a small business. Each time you do, potential lenders will check your credit. The higher it is, the more flexibility you’ll have and the better the terms you’re likely to be offered. The lower it is, the more difficult it is to do, well… pretty much everything.

Collateral loans are also a good way to finance debt consolidation. If you’re ready to get serious about your household budget and take more effective control of your personal finances, collateral loans can act as a foundation for making that happen.

You are not your credit score. It’s not a reflection on you as a person. It is seriously inconvenient, however, and expensive over time. A few small collateral loans allow you to obtain credit. But just as importantly, as you pay them back, you’re building your credit history and raising your credit score. So that’s pretty awesome.

Potential Pitfalls of Collateral Loans

Well, there’s the biggie – if for any reason you’re unable to repay the loan in full, you can lose whatever you’ve put up as collateral. Even if the lender takes your collateral and sells it to recoup their investment, late or unpaid loans will still damage your credit substantially. As with ANY loan in ANY form for ANY reason, make sure you have a budget. And a good reason to borrow and a clear pathway to repayment before you even begin rate shopping.

There are a few minor inconveniences as well. Obviously you have to have an asset or assets of value in order to offer them up as security. There’s more paperwork than with an unsecured loan. Because lenders will require a formal valuation of the assets you’re offering as collateral. That means it may take a bit longer to get your loan as well.

Final Thoughts

We’re never going to tell you what the best choice for you or your family is when it’s time to borrow or refinance. What we will do is try to give you all of the information necessary for you to make an informed decision.

It probably won’t surprise you to know that we’re big fans of online lending around here. We don’t loan money ourselves, but we maintain a curated database of reputable online lenders who specialize in creative solutions and surprisingly competitive terms. And many of them, as it turns out, aren’t as quick to request collateral as traditional financial institutions. I’m not saying it never happens – just that you’d be surprised at the options you might have.

If you’re looking to borrow or refinance, consider all of your options before making your final decision. Collateral loans are ONE of those options, but they’re probably not the ONLY one.

Let us know if we can help.

How to End Your Mortgage PMI Payments Immediately?

Female hands holding small house, natural background

When you get a house mortgage with a down payment that is less than 20%, the lender will require you to buy private mortgage insurance. The same would be true if you refinanced with less than 20% equity. However, mortgage PMI payments can be expensive so it’s best to remove them as soon as you can.

Ways to Get Rid of Your Mortgage PMI Payments

There are different ways to get rid of your mortgage PMI payments, depending on your situation.

Pay Down Mortgage for Automatic Termination of PMI

This is not going to be the fastest way to get your mortgage PMI payments over with, but under the rules, mortgage lenders are required to drop PMI when your balance reaches 78% of the original purchase price, and you haven’t missed any payments and are in good standing. The lender also requires you to stop the PMI at the halfway point of your amortization schedule. For example, if you have a 30-year loan this midpoint is 15 years. The lender needs to cancel the PMI then, even if your balance hasn’t reached the percentage point. This is called final termination. Removing PMI in this manner works for those with traditional mortgages who have paid according to the payment schedule. Remember, you need to be up to date on payments.

Request PMI Cancelation When Your Balances Reaches 80%

Instead of just waiting for an automatic cancellation, a faster option is to ask the servicer to cancel PMI once the loan balance is at 80% of the home’s original value. If you are going to be making your payments as scheduled, you will be able to find this date on your PMI disclosure form. You can also request this from the servicer. If you have some cash on hand, you can get to this point faster by making some extra payments. You can also prepay the principal on the loan and reduce the balance. This will help you build some equity faster to get to this point and help you save on interest payments. Even something as small as an extra $50 a month can mean a big drop in your balance and interest over the term of the loan.

Some people decide to do a lump sum toward the principal or make just an extra mortgage payment every year. In order to estimate the amount, your balance needs to be eligible for cancellation, just multiply the original home price by 0.8. To cancel your PMI, you need to send a request to your lender in writing, be current on payments and have a good payment history. You may also need to meet other requirements for the lender, such as making sure there aren’t any liens on the home. You may also need to get a home appraisal. If, by chance, your home value has lowered, it’s possible you won’t be able to cancel PMI.

Refinance to Get Rid of Your Mortgage PMI Payments

If mortgage rates are low then you may want to consider a refinance for a number of benefits. Mortgage refinancing can save on interest costs or reduce your monthly payments. In addition to helping you save money, refinancing may enable you to get rid of your PMI. If your new mortgage balance is below 80% of the home value then you can get even more savings. In order for this refinancing strategy to work, your home needs to have gained value since the last time you got a mortgage. With refinancing, you want to weigh the closing costs against the potential savings from the new loan terms to see if it is worth it.

Refinancing is a strategy that works well in neighborhoods where home values are rising. If your home value has declined then refinancing may have the opposite effect. It’s possible that, if you want to refinance your mortgage, you may need to add PMI if your home equity has dropped. Refinancing to get rid of your mortgage PMI payments usually doesn’t work well for a new homeowner. Some loans have a requirement that makes you wait at least two years before you are able to refinance to get rid of these payments. If your loan is less than two years old then you can ask about this but it’s not possible that you will be guaranteed approval.

Get a Reappraisal if Your Home Has Gained Value

In an area where homes are increasing in value, your home equity could reach 20% ahead of the schedule.

If this is the case, you may find that it’s worth it to pay for a new appraisal. Let’s suppose you have owned your home for at least five years and the loan balance isn’t more than 80% of the new valuation then you can ask for PMI to be canceled. If you have owned the home for at least two years then the remaining mortgage balance can’t be any greater than 75%.

Appraisals can range between $450 and $600, depending on your area. Some lenders might be willing to accept a broker’s price opinion instead and this can be a much cheaper option for you. If this is the case for you, it’s best to speak with your lender about the potential to cancel your PMI requirement. If you have added some extra amenities or even renovated parts of your home then the home could have also increased in value, which also means more equity. Whether it’s a pool, common upgrades, or an extra room, check to see if it increases your value.

What to Know About Getting Rid of Mortgage PMI Payments

Whether you are paying PMI every month or as part of a lump sum, it’s not fun. However, you should be aware not to make your financial situation worse by trying too hard to get rid of PMI. Many financial experts will agree that it’s important to have some liquidity in case of an emergency. You don’t want to tap into your retirement funds or savings to reach that 20% equity mark. Speak with a financial advisor to make sure you are on the right track to reach it instead of tapping into savings.

As long as you aren’t taking on an FHA loan, you won’t be married to PMI. You are able to drop it once you get that 20% in equity. This means you may only be paying for a few years, depending on how fast your home appreciates. Don’t feel the need to use every last bit of your cash to make a bigger down payment that avoids PMI. You don’t want to be left in a situation that doesn’t provide you with financial flexibility, especially as you move into a new home.

Requirements to Cancel PMI

No matter how you are canceling your PMI, there will be different requirements. Any PMI cancellation must be done in writing. You need to have a good payment history and be current on your payments. You will need to make sure that you don’t have any liens on the home and have to prove this. For example, you can’t have a home equity line of credit. An appraisal can be helpful to demonstrate that the loan balance isn’t too high compared to the home’s current value.

How Does Mortgage Insurance Work?

While you may be paying mortgage insurance, it only covers the lender. There are different types of mortgage insurance and each will work a little differently, depending on your type of home buying options.

PMI for a Conventional Mortgage

Many lenders will still offer conventional mortgages with low down payment requirements and some are as low as 3%. A lender will require that you pay for this private mortgage insurance, also known as PMI if you have a down payment that is less than 20%. Before you buy a home, it’s best to use a PMI calculator in order to estimate the cost of your PMI. This will vary according to the size of the loan, your credit score, and some other factors. Typically, this will be added to your monthly mortgage payment.

FHA Mortgage Insurance Premiums

FHA loans are insured by the Federal Housing Administration. And these loans have down payments as low as 3.5% and there are easier credit qualifications when compared to conventional loans. This loan requires you to pay mortgage insurance upfront and an annual payment, regardless of what you have for a down payment. The upfront premium will be 1.75% of the loan amount. The annual premiums can range from 0.45% to 1.05% of the outstanding balance. You will pay this for the life of the FHA loan.

USDA Mortgage Insurance

USDA loans, backed by the U.S. Department of Agriculture, usually are 0% down loans for suburban and rural homebuyers. There can be two different charges for mortgage insurance, including an upfront guarantee fee paid in the beginning and an annual fee you need to pay for the life of the loan. The federal government will evaluate the fee each fiscal year and can change it. However, your fee doesn’t fluctuate and they are fixed when the loan closes.

VA Mortgage Insurance

VA loans, similar to other government-backed loans, don’t have any down payments and feature low-interest rates for retired, disabled, and active military members. While these loans don’t require mortgage insurance, many borrowers will pay a funding fee that is between 1.25% and 3.3% of the loan amount. This fee will depend on a variety of different factors, including whether or not you have applied for a loan before and how big your down payment is.

What Does Mortgage Insurance Do?

Mortgage insurance is designed to reimburse the lender if you default on your home loan. You, as the borrower, are responsible for paying the mortgage PMI payments. When a company sells the insurance it’s known as private mortgage insurance. However, the government does sell mortgage insurance as well. This means PMI doesn’t apply to all mortgages with down payments below 20%. For example, government-backed VA and FHA loans with low down payment requirements have different rules. There may also be private lenders that sometimes offer conventional loans with a small down payment option that also don’t need PMI. There can usually be other higher interest costs.

How much your mortgage PMI payments are will depend on your credit score and your down payment.

Can You Avoid Mortgage Insurance?

The main way to avoid mortgage PMI payments is to make a down payment that equals 20%, or one-fifth, of the purchase price of the home. For example, if the home costs $180,000 then you would need to pay at least $36,000 to avoid paying PMI. While it’s the easiest way to avoid mortgage insurance, a down payment of this size may not be a feasible option.

Another option to avoid paying this is for qualified borrowers to get a piggyback mortgage. A home equity loan or second mortgage is taken out at the same time as the first mortgage. This means that 80% of the purchase price is then covered by the first mortgage, 10% is covered by the second loan, and then the final 10% is covered by the down payment. This will eliminate the need for PMI. With a home valued at $180,000, the first mortgage would be $144,000, the second mortgage would be about $18,000, and your down payment would be $18,000. This may be a more feasible option when saving.

A final option is the option of lender paid mortgage insurance where the cost of PMI is included in your interest rate for the life of the loan. While you are technically avoiding PMI payments, this means you are paying more in interest over the life of the loan.

Know Your Rights about Mortgage PMI Payments

Those who are making mortgage PMI payments should be aware of their rights under the Homeowners Protection Act. This is a federal law that will protect you from excessive PMI charges. This means you have the right to get rid of your payments once you have built up a certain amount of equity in the home. Lenders will all have different rules for canceling PMI but they have to let you do so. Before you get a mortgage with PMI, ask for an explanation of PMI rules and the schedule and make sure you understand it. This will help you actually track progress toward ending the payment. If you feel like your lender isn’t following the rules for getting rid of PMI, you can report the situation to the Consumer Financial Protection Bureau.

Reasons to Avoid PMI

There are plenty of reasons to avoid PMI and to get rid of mortgage PMI payments as soon as you can.

Cost

PMI will cost you on the entire amount yearly. You could pay up to $1,000 a year on a $100,000 loan, depending on your PMI fee.

No Longer Deductible

PMI used to be deductible on taxes, but only for certain people. This is no longer the case and it’s not deductible for anyone.

Heirs Get Nothing

Homeowners may hear the word “insurance” and think that their kids or spouse will get some money if they die, which is not the case at all. The lending institution is the only one that benefits from this policy. And the proceeds are paid directly to the lender. If you want to protect your heirs then you need to get a separate insurance policy.

Giving Away Money

You are going to have to pay PMI until your equity reaches 20%. This can take a while and the mount of money you are paying is equivalent to giving it away. If you take the money you are spending on PMI and invest it, you can easily grow the money.

Hard to Cancel

While there are different ways to get rid of your mortgage PMI payments, sometimes it can be hard to eliminate. You can’t just not send in the payment once you get your equity to 20%. You need to draft a formal letter and have a formal appraisal before you are able to cancel it. This could take a while, depending on the lender. And during the time you are working on this, you still have to make the payments.

Payment Can Go On and On

Some lenders will require you to maintain the PMI for a predetermined period of time. This means that even after you have met the required equity, you are still going to have to keep paying for the mortgage insurance. In order to prevent this from happening to you, you need to read the fine print on your PMI contact carefully.

In Conclusion

There are some ways to avoid PMI but in many instances, it isn’t feasible for a borrower. This is why a borrower may be looking for a way to end mortgage PMI payments immediately. There are four different ways to do this, depending on your financial situation and the type of loan you have. There are reasons to avoid PMI so it’s best to get to the point where you can cancel it as soon as possible, as long as you aren’t getting into worse financial shape by doing so.


What Factors do Mortgage Lenders Use During the Loan Process?

A real estate agent with a key. Red roof house.

The purchase of a home is one of the biggest purchases you’ll ever make. As such, securing adequate financing through mortgage lenders to make the purchase is essential for most homeowners. Some consumers are concerned about whether they will be eligible for a mortgage loan.

If you’re not sure whether you’ll be approved, you need to do your research. The more you know about possibilities and resources, the easier it will be to buy a home. You need to understand what a mortgage loan is and how it works. One of the most important things to know is what factors mortgage lenders are looking at.

Getting ready to buy a home is exciting. It can also feel overwhelming as well. There is a lot of information to process. Your primary concern should be finding mortgage lenders who will approve you. Acquiring financing is generally the biggest obstacle to overcome. However, you should be able to find a mortgage loan appropriate for your needs and budget with persistence.

What is Important About Your Finance Status to the Mortgage Lenders

All this information is no doubt helpful. However, what you’re probably most interested in is whether you qualify for a mortgage loan. To determine whether you’ll qualify, you need to know what lenders look at. All mortgage lenders look at certain factors when deciding on a loan application.

Knowing what factors lenders look at helps you to know what to expect. You want to be prepared when you apply. You also don’t want to apply if there is very little chance you’ll be approved. Therefore, you should know that the following six factors help determine your mortgage loan worthiness.

Your Income

Your income is an important factor. The lender wants to see that you’re earning enough to keep up with mortgage payments. You’ll need to provide details on how much you make per year. You’ll also need to provide information on how long you’ve been at the same job.

The lender doesn’t just want to know you’re making money. The lender also wants to know that your income is reliable and will continue throughout the life of your mortgage. If you’ve been at the same job for several years, mortgage lenders consider your income reliable. If you’ve just started your first job, it may be more difficult to be approved.

Your Savings

Mortgage lenders will probably want to know what’s in your savings accounts. Having extensive savings shows that you are financially stable. Not having a lot of money saved up doesn’t necessarily mean you won’t qualify. However, large savings accounts certainly give the lender greater peace of mind. Anyone who is interested in purchasing a home in the near future should start growing their savings.

Your Credit History

Your credit history is one of the number one considerations to consider. Obviously, lenders will not want to lend to you if you’ve defaulted in the recent past. Also, lenders will be less inclined to approve you if you have a history of missing payments.

Lenders want to know that you’re reliable as a borrower. You need to show that through your performance with your credit accounts. You need to start and nurture a strong credit history. If you have never had a credit card or loan before, you have no credit history. Lenders might be less inclined to lend to someone with no credit history than someone with a lower credit score. Having no credit history means mortgage lenders can’t really know what kind of borrower you will be.

Your Down Payment

The larger your down payment, the better it looks to lenders. When you make a large down payment, you’ve got some skin in the game regarding your home purchase. Lenders know that keeping up with payments will be all the more important for you when you’ve already made a significant investment in the property.

Making a larger down payment doesn’t just make you more attractive to lenders. It also minimizes your interest costs. You don’t have to pay interest on your down payment. The more your down payment is, the less of your home purchase price you have to pay interest on.

Your Current Debt Load

Mortgage lenders will want to look into how much you already owe. If you’re currently dealing with a heavy debt load, lenders will consider that taking on more debt is not a good idea. Every debt you have means an additional expense each month.

Lenders don’t just look at the total amount you owe. They also look at how much you owe in relation to how much available credit you have. If all your credit cards are maxed out, then you’re already using most of your available credit. If your debt load is heavy, you might want to take time to pay it down before buying a home.

The Home You’re Buying

Lenders don’t want to lend money for a home purchase that is overpriced. They also don’t want to provide a loan for the purchase of a run-down house. The house you purchase is basically collateral on your loan. The lender will repossess the home if you fail to make payments. However, the lender won’t be able to recuperate the loan money if they can’t sell the property to cover the outstanding loan balance.

Mortgage lenders often want to inspect the home that the borrower is purchasing. They want to make sure that the property is a good investment. Therefore, the home you want to buy could influence the decision lenders to make on offering you a mortgage loan.

Understanding Mortgages

A mortgage loan is much like any other type of loan. It is an agreement where a lender agrees to loan you the money you’ll use to buy a property. You’ll gradually pay the lender back the loan money. As you pay your mortgage loan, you build up equity in your home. Once you finish paying your mortgage, you own your home outright. However, the lender can repossess your property if you fall behind on payments.

You have to pay interest on your mortgage loan. That’s how mortgage lenders make money. The lower the interest rate on the loan, the less expensive it is. You need to understand all your home buying options before taking out a mortgage.

Choosing to take out a mortgage is a big decision. You don’t want to take out a mortgage that is going to be hard on your budget. Your credit will be severely damaged if you default on your mortgage loan. Make sure you plan your budget carefully. While owning a home may be your goal, you still need to protect yourself financially. Be careful you’re not getting in over your head with an excessively large monthly mortgage payment.

Going to a Banker or a Broker?

Both mortgage bankers and brokers offer mortgage loans. If you’re buying a home, you can choose between working with a banker or broker. There are advantages to each method of acquiring a mortgage loan.

Working with a mortgage banker means you go directly to a bank or credit union. Then, you inquire about their available mortgage loan products. You’re only going to be considering mortgages available through that particular financial institution.

When you borrow through a mortgage broker, your broker can analyze your unique situation. Your broker has more resources at his or her disposal than a banker might. The broker can compare mortgage loans from a variety of different financial institutions. This means greater customization of services.

A broker may be able to pinpoint the perfect mortgage for you. However, you’ll have to pay a broker fee if you work with a broker. Borrowing directly from a bank also tends to be a little more reliable and predictable. Mortgage brokers are independent professionals while bankers are working for large and established financial institutions.

Types of Mortgages to Consider

You need to consider mortgage type in addition to considering whether to work with a banker or a broker. Those who buy a home for the first time are often surprised by the variety of mortgages. There are quite a few different types to consider.

Here are some of the basic mortgage types to look into.

Fixed-rate Mortgage

A fixed-rate mortgage is among the most basic mortgage types. With a fixed-rate mortgage, the interest rate doesn’t change throughout the life of the loan. Also, the amount that’s paid on the loan each month doesn’t change. There are options for different term lengths with a fixed-rate mortgage. You can pay off the mortgage in only 10 years. You could also opt for a longer loan term of 30 or 40 years.

Fixed-rate mortgages are especially advantageous if interest rates are low when you purchase your home. This way, you know your interest rate won’t go up with fluctuations in the market.

Adjustable-rate Mortgage

Adjustable-rate mortgages are another common type of mortgage loan. Unlike fixed-rate mortgages, adjustable-rate mortgages experience changes in the interest rate depending on the economy.

There are numerous possible arrangements for an adjustable-rate mortgage. One common option is a 5/1 adjustable-rate mortgage. With this setup, the interest rate will not change until five years have gone by. Afterward, the interest rate can fluctuate with the market.

You need to be careful with adjustable-rate mortgages. If your monthly payment and interest rate gets too high, you could struggle to keep up with payments.

Interest-only Mortgage

When you take out an interest-only mortgage, you focus on paying the interest off right away. You pay the interest on the mortgage off during the first few years. This can help minimize interest costs. Once all the interest is paid, you pay the remaining balance off. This balance is then paid off much like a fixed-rate mortgage would be.

FHA Loans

FHA loans are government-subsidized loans. The Federal Housing Administration guarantees these loans. This makes FHA loans a little easier to qualify for. If you have a low credit score, you might want to look into FHA loans. FHA loans aren’t just more flexible when it comes to credit score. They’re also more flexible regarding income. You might not make enough money to qualify for a traditional loan. However, you might find that you can be approved for an FHA loan thanks to more lax underwriting.

VA Loans

If you are a veteran, you may be able to take advantage of a VA loan. These loans are made available to those who have served in the armed forces. One big advantage of VA loans is that you don’t have to put a down payment on the home. VA loans also generally offer great terms and flexible options.

Balloon

A balloon mortgage arrangement requires you to pay off the interest first. Once the interest is paid, you’ll be expected to pay off the entire principal of the loan.

Subprime Mortgage Loan

If you don’t have the best credit, you’ll be shopping for the subprime mortgage loan market. Mortgage lenders are often willing to lend to those with poor credit. However, they will charge higher interest rates on subprime loans.

Dealing with subprime mortgage loans can be tough. You need to be reasonable and avoid excessive mortgage costs. If you’re looking at subprime offers that are expensive, you might want to wait and improve your credit before buying.

How the Process Works

The process of applying for a mortgage loan is similar to the process of applying for any loan type. The lender will ask you to fill out an application. You’ll provide information about your identity. You’ll also provide information about your employment situation. The lender will want to know how much money you’re making. The lender will ask you for your social security number and run a credit check.

Every lender is a little different. The way mortgage lenders process and evaluate applications varies. Generally, you should know quickly whether you’re approved.

Research and Getting Quotes

You shouldn’t just jump into applying for a mortgage loan right away. There is some important research to do first. This research involves first looking into your options. Evaluate your credit and income situation. Find mortgage lenders who are likely to be willing to work with you.

Some lenders might offer a loan estimate when you’re shopping for a mortgage. This allows you to see how much you can qualify for without actually applying. Once you’ve found some lenders who you think may approve you, it’s time to apply.

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Applying

Filling out mortgage loan applications is generally fairly simple. Most of the information you’re asked on the application will be things you know off the top of your head. Some mortgage lenders allow prospective borrowers to apply online for pre-approval. Others might require a paper application.

When it comes to applying, you’ll generally be looking for pre-approval. Usually, with home shopping, you don’t officially apply until you’ve found a home that you’re interested in buying. You’ll, therefore, seek out pre-approval as an important step in the mortgage loan process.

Closing the Sale

Once you’re pre-approved for a mortgage, you can start home shopping in earnest. Then, you can make an offer on the right home. If your offer is accepted, you’ll take the next steps with your mortgage loan. Your mortgage lender might want to do some research on the property you’re buying.

When you and the seller are ready to close, the mortgage loan funds will go right to the seller. You will probably have to pay closing fees, mortgage insurance premiums, and a commission for the real estate agent in addition to paying for the sale value of your new home.

In Conclusion

Now that you’ve done some research on mortgage loan shopping, it’s time to get started. You should start improving your qualifications for a mortgage loan right away. Focus on the factors mortgage lenders looks at mentioned above. You want to make yourself more attractive as a borrower.

Analyze your financial situation and determine what you need to work on. If you’re carrying a heavy debt load, pay down your debt. If you have missed payments, focus on making all your payment due dates from here on out. Don’t feel discouraged. Your credit score changes over time. In fact, you can bring your credit score up quickly with effort. Patience and persistence pay off. Make sure you choose a mortgage loan offering reasonable terms. Your mortgage loan will affect your finances for years to come. This means you need to stay away from mortgage loans with excessively high-interest rates.

How Much Should You Have in the Bank to Buy a Home?

House model and money on weight scale with out of focus home.

Buying a home is going to require that you have some money in the bank. There are many expenses you will need to save up for beyond just the down payment.

How Much Money do You Need For the Expenses When Buying a House

Before you buy a home, it’s important to note how much you can afford. There is not should be any space for mistakes when it comes to your home buying. Your house is going to be your biggest purchase so this is an important first step.

Begin the budget by figuring out how much you and your co-buyer, if you are having one, earn each month. Be sure to include all revenue streams, such as investment profits and alimony.

List housing costs and your total down payment. This should include the annual property taxes, estimated mortgage rate, loan terms, and homeowner’s costs.

Tally up the total expenses. This is the money that you will need on a monthly basis. It’s important to be accurate about how much you spend as this dictates what you can reasonably afford. Then use a home affordability calculator to get a better idea of your home budget.

One way to be smart about how much home you can afford when you buy a home is to follow the 28/36% rule. If you max out your income to buy your dream home, it can put you in a bad spot financially. There should still be room in your budget for emergencies, retirement and other expenses. This rule of thumb says that you shouldn’t spend more than 28% of your gross monthly income on housing expenses and then no more than 36% on debt, which includes housing and other debt, such as credit card payments, car expenses, and student loans.

Depending on where you live, it’s possible that your annual income could be enough to cover the mortgage or, in some cases, it may fall short. Knowing what you can afford will help you decide how much you should have in the bank when you go to buy a home.

Expenses at Closing to Buy a Home

In order to buy a home, you need cash for the down payment and even more. There is a lot that you will need to bring to the closing and one of the big shocks of buying a house is finding out you need more to close on the home than just your down payment. It can be hard enough to save for the down payment and then to find out more can be disheartening.

The Down Payment

This is the part that is the most obvious to home buyers. It’s usually a percentage of the price of purchase. How much you will need for a down payment will depend. With many lenders, if you want to avoid having to pay private mortgage insurance then you will want 20% down. Coming up with this amount can be hard for a lot of first-time buyers so there are other options if you qualify for certain types of loans.

Closing Costs

Closing costs can run at 2% to 3% of the loan amount. The costs do vary from one state to another. This is because of the differences in either the real estate transfer tax or the mortgage stamps. They can also vary based on the different rates charged for attorneys, title insurance, and appraisals. Not only can the closing costs vary by state but also by the lender, due to the many home buying options there are. Each lender charges an application fee that can vary. Some lenders also charge points.

Prepaid Expenses

This is a confusing charge for many homebuyers but it is also necessary. With many mortgages, the lender puts real estate taxes and the homeowner’s insurance in escrow. This means that charges are included in the monthly payment and then paid by your lender when due. For this to happen successfully, the lender needs to collect amounts upfront to make sure funds are going to be available when they need to be paid. Depending on where you live, these prepaid expenses can come to as much as 2% of the loan. An option is to decline this escrow arrangement but in order to do this, you need to have 20% down.

Utility Adjustments

These adjustments can be a large number of charges but they aren’t usually more than a few hundred dollars. These charges represent utility costs paid by the seller in advance. For example, if the seller fills a heating oil tank before the closing then you need to reimburse the seller for the unused oil. This will happen during the closing. Another expense that may need an adjustment is a homeowners association fee. In some neighborhoods, fees are paid on a yearly basis. If the seller pays for these for a full year then you need to reimburse the seller for the months of fees that you are living in the house instead. Since these are usually direct expenses, the seller often doesn’t pay them.

Lender Required Cash Reserves

While this isn’t a closing expense, it can take some homebuyers by surprise. Lenders require that you have some cash left in savings after the closing costs are paid. The lender doesn’t want you to end up in early term default and so this requirement makes sure that you are able to make the payments during the first two months. The most usual cash reserve is two months. This means you will have to have sufficient reserves to cover the first two months of your payments. These funds aren’t going to be deposited with the lender. The lender will verify that you have these funds available. This can include verifying a checking account, savings account, or money market fund balance. You aren’t supposed to have these funds in a retirement account since it’s not a liquid source.

There are two alternatives that can reduce or even eliminate closing costs. You can negotiate with the seller to help pay your closing costs. This is only allowed in areas where this is common. You can also negotiate a price with the lender. This is where you then pay a higher interest rate on your mortgage in exchange for the lender paying the closing costs.

Determining the Cost of Moving

Besides what you need to bring to the closing table, you also need to consider the cost of moving when you go to buy a home. Moving costs can be a shock to some people. Moving can cost as much as $6,000 just for the movers. This also doesn’t take into consideration moving supplies, moving a car, and other heavy items. If you are moving out of state, the costs can be even more.

Figure out how much it costs to hire a moving company in your location and how much it could cost on your own, whether you are moving locally or farther away. Even if you aren’t going to pay for movers, you will still need to consider the cost of a DIY move. Figure out the average cost of renting a truck for a day and the cost of truck insurance for the rental. If you need help with the move, you want to save for the cost of having a POD at the home. Research the most expensive time of year to move. Moving companies may not have a lot of business during winter months since many people may not want to move then. If it works for you, consider moving during a non-peak season to save money.

Ongoing Homeowners Expenses

It’s not just closing costs you need to prepare for when you buy a home but also the ongoing expenses.

Mortgage Payments

Process gettinng a mortgageIt’s important to comparison shop when you are going to buy a home. Your interest rate is going to make a big difference in how much your payment is each month so finding a lender that will give you the lowest interest rate will be important. Monthly payments are the easiest cost associated with buying a house mortgage to predict. However, one mistake that some first-time homebuyers make is thinking that the mortgage is the total sum they will owe each month, just like rent payments, but that’s not the case.

Property Taxes

Taxes are usually paid twice a year but the laws and policies vary by county and state. A real estate agent can give you a rundown before you buy it. Local governments raise taxes in order to cover municipal expenses or projects so you can’t assume that this will stay steady. Increases in the home’s assessed value, whether it’s due to renovations or market conditions, can also cause taxes to rise, which can increase your payment if you have an escrow account with your lender.

Homeowners Insurance

Homeowners insurance can be built into your payment, just like property taxes. You will be required to have this insurance by your lender and the costs are based on a number of things. You can usually lower the cost if you bundle this policy with other insurance policies, such as life or auto.

Mortgage Insurance

If you have a down payment that is less than 20% then you will need to have mortgage insurance. The premium protects the lender in case you default. You can pay this upfront or have the premiums due each month in your mortgage payment. You can cancel this insurance when the remaining principal dips below 80% but for now, it will be an extra cost in your budget.

HOA or Condo Fees

If you are buying a condo or in a planned development that has shared spaces then you will have an extra monthly assessment on top of the mortgage payment. This pays for improvements to the complex or shared amenities, such as painting or landscaping. In a pricy urban area, a condo assessment can almost rival a mortgage payment so it’s important to pay attention to these costs.

Utilities

Once you have finished buying a home you may think you are done with financial hurdles. However, there are utilities, maintenance, and the occasional emergency. Some of these expenses you can budget for while others might surprise you. You may want to pad a homeownership rainy day fund so you have money to cover these problems, such as a water heater breaking. Having money set aside will prevent you from having to take on credit card debt. It’s best to have at least 1% of your home’s value in savings for maintenance and repairs.

Preparing to Buy a Home

If you have decided that you want to buy a home then you also need to convince a lender. This means that your credit will need to be in good shape and you don’t have a lot of debt. Lenders are looking for a variety of different metrics to see if you are too much of a risk to get home. How much you owe compared to how much you earn will also play a role in the approval process. In order to prepare for the mortgage process, you want to check your credit score and take a look at your debt. Do you have a credit card with a lingering balance that you are able to pay off? Little improvements you can make can boost your credit score and allow you to have a better interest rate and save money.

Also, try to do good lender research before you purchase a home. Make sure you are choosing the best option. You can always look for help here, on Loanry! By putting in your information below, you may find out if you qualify for any of the suggested, trustworthy lenders:


Getting the Best Interest Rate

A lower interest rate can save you a lot of money over the life of the loan so it’s best to get the lowest rate you can.

  • Credit Score: If you have found mistakes on your credit report then fix these. If you have time to work on your score then you should since this is a big factor in your interest rate.
  • Debt-to-Income Ratio: Start lowering the debt you have to make it easier to have room in your budget for a mortgage payment. When you pay off debt, you are in a better position to manage your budget and have resources in case you need them for emergency expenses.
  • Down Payment: A bigger down payment means you will get a better interest rate since it shows lenders that you are less risky. If you don’t have a large down payment now but are ready to buy, you may want to consider refinancing in the future. The faster you are able to lock in a lower rate, the more you will save on mortgage costs.

Are You Ready to Buy a Home?

Not only do you need to be financially ready to buy a home but you should be emotionally ready as well. There are some things you need to think about before you buy a home. Does your career mean that you need to have some mobility? Depending on where you live, it can take up to four years to break even and if you have career advancement or promotion in the next five years, will you have to relocate? If you plan on starting a family then you may outgrow your starter home before you know it. You might want to consider something big and look in a good school district.

When you are ready to buy a home, you need to determine the shelf life. How long do you think you will be there? Does your starter home make a good rental property that you can use for passive income in the future? Determine your life’s readiness. Do you have the time to handle maintenance, such as repairs and yard work?

Saving for a Down Payment and Closing Costs

One of the best ways to save for a down payment and the other costs it takes to buy a home is to transfer a fixed amount into special savings account each month. The next step would be to get on a budget and lower expenses as much as you can. Reducing high-interest debt will allow you to reduce your debt-to-income ratio, which helps your credit score and will enable you to put more toward your savings goals. Besides reducing expenses, you may also need extra income, which you can get through a second job or by looking into a side hustle.

There are different down payment assistance programs that you can use if it is just not possible for you to save enough for a down payment. There are other types of loans that don’t require you to save as much for a down payment but you do still need to pay for some of the closing costs so you will still need some money in the bank. While it’s not recommended, you can borrow from retirement in a pinch.

Conclusion

When saving enough for your new home, you need to consider a few things about buying a home. You will need to bring more to the closing table than just a down payment and some of the expenses may catch you by surprise if you aren’t prepared for them. Once you have enough in the bank for closing costs and a down payment then you also need to consider your other monthly home expenses, such as your mortgage payment and insurance. How much you need for your home will depend on different factors, including where you live and what lender you decide to go with for your mortgage.