An FHA loan is one of the tools available if you want to buy a home but don’t have much money for a down payment. I actually bought my home with the help of a FHA loan. However, it is important to consider the pros and cons of a FHA loan before jumping in.

What is an FHA Loan?
The FHA loan is backed by the Federal Housing Administration. With a FHA loan, the government guarantees the loan, so that a lender is at a lower risk should you default. FHA loans were not terribly popular before the financial crisis of 2008, since it was possible to get 0% down home loans fairly easily.

Now, though, with many mortgage lenders tightening requirements, the 3.5% down payment requirement for a FHA loan seems attractive to many. It is important to note that the 3.5% down payment option is only available to those who have a credit score of at least 580. If your credit score is between 500 and 579, you will need a 10% down payment. FHA loans are not available to those with credit scores are less than 500.

You do need to show sufficient income to be approved for a FHA loan, and some of the guidelines are stricter than what was available prior to the financial crisis.

Private Mortgage Insurance
When you borrow for a mortgage that’s not an FHA loan, banks and other lenders ask for at least 20% down on the home to protect themselves against a default.  If you don’t have enough money to make a 20% down payment, they may still lend you the money but you’re required to buy private mortgage insurance.

Private mortgage insurance (PMI) usually amounts to between 0.5% and 1% of the entire loan amount each year. If you have a $200,000 loan, and the PMI is 0.75%, you will pay $125 a month each year until your loan to value ratio drops to 80%.  Although the existence of PMI does extend home ownership as an option to many that might not be able to afford it, that monthly fee can add up to a big expense for the homeowner.

PMI vs FHA Insurance Premiums
If you borrow money with an FHA loan, you don’t pay PMI but you do have to pay into a fund that guarantees FHA loans.  This fund is an escrow account setup by the U.S. Treasury Department.  Lenders are still exposed to the risk of default (even more so since the down payment is so small) but the Federal Housing Administration is agreeing to back the loan with the escrowed funds paid into by FHA borrowers.

When you have a FHA loan, you will need to pay 1% of the loan amount up front (Upfront Mortgage Insurance Premium), and then an annual premium depending on the term of the loan and how much you put down. (You can add the 1% up front premium to the loan amount.) You have to pay the premium for at least five years, and you stop paying the premium once your loan to value ratio reaches 78%.

The table below is based on the rates on the FHA website for new loans after April of 2011.  The table shows the annual premium for an FHA loan according to the length of the loan and the size of your down payment.

		Loan Term
		<= 15 Years	> 15 Years
	< 5%	0.50%	1.15%
Down Payment	>= 5%	0.50%	1.10%
	< 10%	0.50%	1.10%
	>= 10%	0.25%	1.10%

 

So, to figure out how much mortgage insurance you’d pay with a conventional loan vs FHA loan you’d first figure out your monthly premium based on your loan term and the size of your down payment.  Multiply that times the number of months it would take you to pay down the loan to less than 78% loan to value ratio.  Then add that number to the amount of your Upfront Mortgage Insurance Premium and you’ll have the total cost of insurance for your FHA loan.

There are many variables involved in this decision.  In addition to the term of your loan and the amount you have to put down, you also have to factor in what the appraised value of the property will be.  In terms of determining if you can afford the monthly payments, you’ll also need to know what interest rate you’ll pay.  The combination of the interest rate and the term of the loan will determine what your monthly payments will be – which you need to know in order to figure out how long it will take you to pay down your loan to the point where you have at least 20% equity in your home. I haven’t seen a good calculator that compares a conventional loan vs an FHA loan but if I find one I’ll be sure to write about it.

Saving Up for a Down Payment

Right now, with tighter lending standards, a FHA loan can be quite tempting. You have a lower down payment requirement — and a lower credit score requirement. However, you might end up paying more. A bigger down payment can save you money in the long run, since you will be financing less, and paying mortgage insurance premiums for a shorter period of time.

What you decide depends on your priorities: Do you want to buy now and long in a lower home price and lower interest rate? Or do you want to save up for a down payment and borrow less? In the end, it depends on whether you want the home now, without saving up, or whether you want to wait until you have a bigger down payment.

The Fear of Mistakes

Remembering back to our experiences of buying a house I can recall that in the back of our mind the whole time we were worrying that we would make a big mistake.  If you only buy one or a few houses in your lifetime you don’t go through the process very often and a rookie mistake could end up costing you thousands of dollars.

It’s not just the potential cost of a mistake that sets you on edge, it’s also the fact that you’re making one of the biggest commitments of your life and making decisions that may live with you for the next 20 or 30 years – or even longer.

Buying a House With Less Stress

It was no surprise to me that when I asked what kept you up at night one of the big things was finding a house you liked and could afford.  So as a result over the last few weeks you’ve seen the series of articles on home buying topics.  I tried to focus them on common problems you might struggle with: finding money to buy a house, finding a house that won’t break your budget, getting a home loan at the lowest cost, and how to handle a big mortgage after you buy.

Here’s a summary of everything we covered, let me know if there are things we didn’t touch on that you’d like included. 

Finding Money to Buy a House

Unless you’ve saved up enough money to pay for your house with cash, you’ll have to borrow funds to buy a house.  You’ll have to figure out how much you’re eligible to borrow and how much you’ll expect to pay based on your financial situation. 

If you’ve struggled with finances in the past and have bad credit or a history of bankruptcy or foreclosure that makes it more difficult and we touch on that in one of the articles. Also remember that how much you’re able to borrow usually isn’t the same as how much you should borrow.  You may be approved for a loan amount that’s actually higher than what you can afford.  But we’ll get to that in the next section.

• How to Improve Your Credit & Buy a House
• 12 Steps to Improve Your Credit Score
• Mortage Pre-Approval When Buying a House
• Down Payments and Private Mortgage Insurance

Buying a House You Can Afford

As I mentioned earlier, buying a house is probably of the biggest financial commitments you’ll ever make.  You want to find something that meets your needs but also a home that won’t put you in the poor house for decades to come.  So here’s a look at figuring out how much you can afford and some ways to help stretch your dollars to get more house for less.

• 3 Ways to Buy More House for Less Money
• How to Buy a House in an Expensive Market
• How Much House Can You Afford?

Financing Your Home 

Decisions about financing your house can potentially save you or cost you tens of thousands of dollars over the life of a home loan.  If that’s not enough to stress you out, picking the wrong type of loan could even mean the difference between being able to make your payments or facing foreclosure.  Here’s a look at the implications of the different loan options and ways to keep your borrowing costs down.

• 30 Year Mortgage vs 15 Year Mortgage
• FHA Loans vs Conventional Loans
• How to Use a Mortgage Calculator to Compare Home Loans
• 6 Key Factors for Home Mortgage Rates
• Finding the Best Mortgage Rates
• Home Loan Closing Costs

Paying for Your House

Once you finally find the right house and the right loan and get moved in your house payment is due every month for the length of your loan. If it turns out that bill is more than you can handle or is just higher than you’d like here are a few things you can do to help ease the pain of a monthly mortgage.

• What To Do If You Can’t Pay Your Mortgage
• How to Sell Your House Without a Realtor
• 5 Ways to Pay Off Your House Early

I hope these articles help take some of the uncertainty and stress out of the process of buying a home. Next up on the list of things that keep you up at night is a series that covers investing your money, stay tuned!

Paying it Off

For most homeowners your mortgage represents the largest outflow of cash from your budget every month. We like to think about all the things we could do in life if we didn’t have to pay to keep a roof over our head. Imagine how fast you could ramp up your retirement savings, build a college fund, or save up for a big vacation. In addition to the increased cashflow, having your house paid off also comes with a sense of security, that you own your home and not the bank.

One tax note to be aware of on your quest to pay off your mortgage.  For many of us homeowners the interest we pay on our mortgage is what enables us to itemize our deductions.  If you pay off that loan you might have to start taking the standard deduction. 

5 Ways to Pay Off Your Mortgage Early

Here are five ways you can pay off your mortgage early and reap financial benefits from not having that payment.

1) Extra Principal Payments

The easiest way to pay off your mortgage faster than normal is to simply include additional money on every payment you send in. The additional money will go straight toward the principal of your loan rather than to paying the bank interest. Over time this will slowly pay down your mortgage faster than your original financing term.

Check with your lender to see how they treat additional payments.  Most banks automatically apply additional payments to any outstanding fees.  How they handle extra payments after that can vary so be sure to note on your extra payment that it should be applied to your principal.

2) Bi-weekly Mortgage Payments

A second way to send in additional payments is to coincide your mortgage payment with your pay cycle. Since many people are paid bi-weekly you simply send in half of a mortgage payment on each pay day.

This doesn’t seem like it would save you any money, but you’ll end up paying an extra month’s worth of payment every year. This is due to how the calendar year plays out. Most people know there are 4 weeks in a month, but over 12 months that is just 48 weeks. That means throughout the year there are a couple of times where you will get a 3rd check in that month even though you’re paid bi-weekly. If you send a half payment in on those pay days you’ll end up making two additional half payments (to bring us up to 52 weeks in a year). It’s an easy way to “trick” yourself into paying off your mortgage faster.

3) Refinance to a Shorter Mortgage Term

Another way to pay your mortgage down faster is to refinance to a shorter mortgage term. If you’re three years into a 30 year mortgage and refinance to a 15 year mortgage you’ll save money over the life of the loan. Granted your payments will be higher every month, but the shorter term combined with the higher principal payments will save you a lot of money in comparison to your previous mortgage.

4) Refinance to a Lower Interest Rate

Even if you don’t change the length of your mortgage in terms of the number of years you are still better off if you refinance to a significantly lower interest rate. If you bought a house 4 or 5 years ago your interest rate was probably in the 6% range. With rates in the high 4% to low 5% range today you are likely to save a ton of money by refinancing – even if you keep your mortgage at a 30 year term. The lower interest over the life of the loan will pay for any refinancing costs you have out of pocket and still save you thousands of dollars in interest.

5) Recast Your Mortgage

In contrast to paying a little extra each month, a mortgage recast is usually used to payoff a big chunk of your loan at once.  When you recast your mortgage your bank actually reamortizes your loan based on the remaining term left on your loan and the new loan balance.  Your interest rate remains the same but because you’re paying interest on a lower balance, the amount of overall interest you pay goes down. 

If you’ll remember from the amortization tables in the mortgage calculator post, since you’re paying less interest your monthly payment will drop. Ideally this will free up money each month you can use to make extra principal payments. Another benefit of a recast is that it can help you get rid of private mortgage insurance (PMI) if the lump sum you pay puts you over 20% down on the value of your property.

There are some limitations on this strategy. Not all banks are willing to recast a mortgage so if your’s doesn’t allow it then it won’t work for you.  Most banks will have a minimum amount that you can recast and typically they’ll charge a several hundred dollar recast fee.  Some banks have limits on the number of times they’ll recast your mortgage.

Steps to Take If You Can’t Pay

It is of little comfort to know that if you are in this situation that you are not alone. Although it feels overwhelming, try to remain focused. Here are some things to do if you can’t pay your mortgage:

Notify the Loan Servicer

Honesty is the best policy. Being honest with yourself during tough times is hard, not to mention to a financial institution you owe thousands of dollars to.  Let your lender know you intend on paying what you owe but have hit a rough spot.  See if they’re willing to work with you  Perhaps in a few months you’ll be back on your feet and able to pay again.  It’s better to be in contact with the bank than to stop making payments and ignore them.

Apply for a Home Modification

The federal government funded a large home mortgage modification program called Making Home Affordable. You need to apply for a HAMP modification (HAMP stands for Home Affordable Modification Program). There are specific requirements you must meet to be eligible for a modification. If you don’t meet the qualifications don’t cling to hope that you will still be able to modify your mortgage. The government program isn’t going to change to suit you.

Ask for Forbearance

A forbearance is a period of time the bank allows you to, essentially, get your life together in order to get back on track paying the mortgage note. With a forbearance the loan servicer may reduce or completely eliminate your payment for a specific period of time. If you’ve lost your job but anticipate getting back to work soon this can be beneficial. You can save on costs today, get your income back, and continue to make payments to the bank. You’ll owe either higher payments or a lump sum at some point to make up for the payments and interest you avoided during the forbearance.

Sell Your Home at a Loss

If you can’t get a modification or a forbearance it is time to consider selling your home, even at a loss. Many banks are covered up in foreclosure proceedings and you might be able to get away with living in your home “rent” free for a while. But eventually the bank will catch up with you.

Find an Experienced Agent

Obviously it’s best if you can avoid getting to this point. Try and find an agent who’s dealt with other homeowners in your same situation.  They should have a general feel for a realistic selling price and help you price the home for a quick sale.  Since so many people have been hit by the economic downturn, there are many realtors that have worked to sell homes that are facing foreclosure.  The benefit of working with one of these agents is that they know the system and what your options are.

One thing to watch out for is that people in your situation may feel desperate to sell and crooked agents may try and exploit your situation.  So be sure to screen the agent well and check their references.

Short Sales

One option to consider is doing a short sale – but you will need the bank’s approval. A short sale is where you sell the home for less than what is owed on the mortgage. The bank has to agree to this and approve any offer that you accept – which can slow the process down.  Going through a short sale is preferred over foreclosure but be aware that it still does damage your credit and will make getting a loan in the near future more difficult.

If you’ve been in this situation before, are there any other tips that you’d add?

Bankruptcies and Foreclosures

If you have a low credit score, with no bankruptcy or foreclosure, you might be able to purchase a home now. You will have to pay a higher interest rate, and you might not get the best loan terms, but you probably won’t have to wait — as long as you have a large down payment and a credit score above 500. (If you have a small down payment, you might not be able to get a bad credit mortgage with a score below 580.)

Waiting periods apply if you have had a bankruptcy or foreclosure. Most lenders won’t offer you better rates until a bankruptcy is four years behind you and it has been at least two since a foreclosure. In order to qualify for a FHA loan, you have to be at least two years away from a foreclosure, and you can get a loan with as little as a 3.5% down payment.

Improving Your Credit to Buy a Home

So what should you do if you don’t have any recent bankruptcies or foreclosures and would like to buy a home but have bad credit?  Your first move should be to try and improve your credit score. Here are three ways to begin improving your credit score:

1. Make your payments on time and in full.
2. Pay down your debt, reducing your debt to income ratio.
3. Avoid applying for very much new credit.

One way to build a history of making regular payments is with a credit card, but you may not qualify for one if you have bad credit.  One option is to open a secured credit card, where lenders are willing to give you a credit card if you provide collateral in case you don’t make your payments.

As long as you use it responsibly, making regular purchases and paying down the balance each month, this can be a fast way to help your credit score.

Other things that can help you improve your qualifications for a home loan include:

Earn a regular wage. Self-employment offers a different challenge. If you are self-employed, you should be able to show tax documentation of regular earnings. However, self-employment income isn’t going to be viewed by lenders as favorably as a salary. Show that you have been steadily employed for at least a year or two.

Save up for a down payment. If you have poor credit, you can improve your chances with a down payment of at least 10%. If your credit score is lower, approaching 600 or below, you might need 20% down. If you have a credit score of less than 500, there is a good chance that you will need a 35% down payment to qualify.

Letter of explanation: If you have a compelling explanation for your low credit score, a letter of explanation might be required. You can explain extenuating circumstances (such as job loss or medical catastrophe) that led to your poor credit. You can also describe what you are doing to improve your financial situation.

When you have bad credit, it is still possible to buy a house. However, you will need to work hard to improve your credit score at least a little, and you may have a couple other hoops to jump through.

“Would you like a fifteen year or a thirty year mortgage”? You are sitting in a tiny chair with an anxious mortgage broker staring back at you, visibly impatient and waiting for an answer. For you it’s a major decision, but to the broker your just another customer in a long day at work.

So, what will it be? 15 years or 30 years? In some ways it seems like such an arbitrary decision. Yet deep down you know this is the rare decision that is powerful enough to make or break your financial future. So, what factors should you consider when determining what is the best mortgage length to choose? Thanks to contributor Chris Thomas for this article.

There are several factors to consider when selecting the best mortgage length. The major factor everyone tends to focus on is the monthly price differential between a 15 year or 30 year mortgage. For instance, if you are purchasing a $260,000 home, your monthly minimum payments might be something like: $1,800 for a 15 year mortgage and $1,450 for a 30 year mortgage. To be sure, the monthly payment probably is the biggest factor for the average person to consider when selecting a mortgage term. However, the analysis should not end there, for there are a number of other factors to consider when selecting a mortgage length.

Factors for Comparing Mortgages

1) Job Security and Predicted Future Income Levels
At the time you apply for a mortgage, the bank is looking at your finances at a static point in time. However, your financial reality is in fact much more of a moving picture than the snapshot photo the lenders are using. For instance, when my wife and I recently purchased our house, our financial profile “snapshot” was as follows: a young couple with decent jobs, a decent amount of money in the bank, but an even larger amount of student loan debt. That was an accurate portrayal of our current financial reality at the time we applied for our mortgage.

However, as we only recently received our graduate degrees, the hope is that we will with time earn much higher salaries. That is one of the reasons we went with a 15 year mortgage. Although nobody can predict the future, many of us possess an inherent knowledge as to our own job security and expected earnings, both in the near and long-term future. Your age, the amount of years you wish to continue working, and your health should also be considerations when choosing a mortgage length.

2) Future Plans for the House
How much work does the home need? Is it a money pit waiting to happen? How about just your ordinary everyday fixer upper? On the contrary, perhaps the house looks to be completely sound and you do not anticipate many repairs other than basic upkeep for the foreseeable future. These are factors you will have to consider when choosing a mortgage length, because they go to disposable income available, and may dictate which type of mortgage length would be best for you to choose.

To be sure, your expected disposable income/money must be examined in its entirety along with debts/investments as a whole. Simulated budgets reflecting the various monthly payments would also be a smart tool to utilize in determining the proper mortgage length. Finally, you will want to consider how much money you have saved should illness, a job loss, or any other unanticipated issue arise.

3) Interest Rates
Along with the monthly minimum payments, the interest rate is probably the biggest mortgage length factor to consider. If you can swing a 15 year mortgage at a 4.0% interest rate rather than a 30 year mortgage at a 4.8% interest rate, then the amount of money you could save in interest over the life of the loan might be well-worth the extra monies you would have to pay each year. In some cases, you might actually be surprised by how close the monthly payments are as and between a fifteen year v. a thirty year mortgage.

4) Budgetary v. Long-Term Monetary Freedom
If you go with the 30 year mortgage you will likely have more breathing room in your budget each month. At the same time, if you force yourself to instead choose the 15 year mortgage, you will in theory halve the amount of time you carry a mortgage. This will provide you the chance to do things like take on more investment opportunities, to start your own business, or to purchase an investment/vacation property in the future.

Although there generally is no penalty for paying down a mortgage faster than its specific term, you will still miss out on the lower interest rate a fifteen year mortgage offers. Also, despite your best intentions, if you are not careful you may very well find yourself slipping into only paying the minimum mortgage amount each month. Weighing the present budgetary freedom with the long-term freedom of owning 100% of your house sooner is a big consideration.

5) Taxes
You will have to factor in the property taxes (as well as utilities, etc), in determining just how much mortgage you can afford each month. On top of that, there are tax benefits to owning a home. Although the tax code is always subject to change, at the present moment the longstanding federal income code home mortgage tax deduction is perhaps the most powerful deduction offered to the average American.

I know several people that have said this home mortgage tax deduction is the reason why they have not paid off their mortgage in full, even though they could. For me, I would rather have the mortgage paid off. Moreover, I note that the math is challenging at best to try and prove that more money is saved by putting off full repayment of a mortgage note. That said, it is a factor that must be considered in the overall mortgage length landscape.

6) Private Mortage Insurance
This type of insurance protects the mortgage company (note holder) if you default on your loan and the house goes into foreclosure. It is generally required if your down payment is below 20%. However, sometimes there are exceptions depending upon whether you are utilizing a 15 year or a 30 year loan.

For instance, FHA loans generally waive the PMI costs if you take on a loan that is 15 years or less and put down 10% or more. That means that the same 10% down payment on a 30 year FHA loan would likely trigger the requirement of PMI insurance. By the way, if you’re not familiar with it, PMI insurance can run pretty steep.

Additionally, this could mean that between the extra monthly PMI payments and the extra interest, the initial monthly payments on a 15 year FHA loan may not be noticeably different from that of the 30 year mortgage note.

7) Time Value of Money, Economic Outlook, & Inflation
I offer here a sort of a “mixed bag” of other factors you may want to consider when determining the best mortgage length for you and your family. The “time value of money” principle basically says that money is worth more now than in the future. This is due, among other reasons, the magic of compounding interest and the historical trend towards inflation. So, if you select the 30 year mortgage and then turn around and invest the extra money in your budget each month, it could cut down on the extra amount of interest you might pay.

At some historical mortgage interest levels this argument might be much weaker, but now that the interest rates on a house are 1-3% points lower than the traditionally “low interest” federal student loans, this argument might now have some traction. Just like nobody can time the market, nobody really knows whether the long-term global/national economic outlook is favorable or not to a 15 year v. a 30 year mortgage.

Even economic experts disagree on whether we are entering an era of rapid inflation, stagflation, or deflation. However, there are various charts and economic trends you may want to consider prior to making a mortgage length decision.

Conclusion

So, hopefully by now you have a better idea of what factors to consider when choosing the best mortgage length for you and your family. It is not an easy decision because so many of these factors are outside of our control. That said, it is important to look beyond just the monthly payments and to also consider other factors such as those addressed in this article.

By looking at this decision globally, you will have a better chance to make the best decision for you. Although this list is by no means exhaustive, it does provide a solid basis of some of the more important factors to consider in determining the proper mortgage length. As with anything, seeking the help of a proper financial expert may be necessary. Keeping all of these factors in mind is difficult, and ultimately is a decision you will have to make on your own (or with the help of a relevant expert).

So, what mortgage length do you think is best for you? Can you think of other factors that should be considered in determining a proper mortgage length? Did you know that some banks/lenders now offer 40 year mortgages?

Mortgage rates are pretty low these days but not all mortgages are created equal.  It’s possible that you could get a low interest rate but still end up paying more than you planned due to additional fees.  To help you find the best financing deals around, start out a mortgage calculator to screen the options and make sure you read the fine print of the loan offering very carefully.

Screening Home Loans
To get started let’s find a mortgage. For a decent list of banks offering financing in your area you can check out Bankrate’s mortgage finder.  Here’s an example of listings it gives me for a 30 year mortgage in Knoxville, TN.

You should notice pretty quickly that the first listed loan available isn’t the lowest interest rate. Even if it were the total cost is what matters. Thankfully Bankrate includes a lot of information for you to make an informed decision:

• Mortgage amount - how much you are borrowing. If you’re paying 20% of the home’s value as a down payment then this should be 80% or less of the home’s value. This is the principal balance that you will be paying off over the life of the loan.
• APR - the compound total interest rate you’ll pay over the year
• Rate (with any listed points) - how much borrowing the mortgage balance is costing you
• Fees in APR – any rolled in fees (origination fees, points, etc.) in the mortgage
• Estimated monthly payment – your estimated total monthly outflow to the bank, not including taxes or insurance

A loan could have a great rate, but also have a lot of fees tied up in the APR. What you want is a listing of the total cost, and the monthly payment is a great equalizer when it comes to understanding the total cost.

Check Monthly Loan Costs
If you don’t have the luxury of seeing all the fees that are being rolled into your loan simply take the loan’s interest rate and plug it into a mortgage calculator. One of my favorite calculators is DrCalculator’s Mortgage Calculator – note: you’ll need a newer browser to use it .

This gives you a bunch of different options to include as you look at your mortgage. Variables like principal amount, interest rate, length of mortgage, and then insurance and property tax information for the home you are buying. You can usually look up approximate property tax costs for a house online and add that cost into the calculations.

On the calculator it will also show the total interest over the life of the loan. This can be handy when comparing two different loans or types of loans.

Compare Mortgages Using Amortization Tables
As you are looking at mortgages and deciding to go with a 15 or 30 year fixed mortgage you’ll want to compare the total cost and monthly cost for each. An amortization table shows you how much of each payment of a loan will be interest and how much will be principal.

Here’s a monthly amortization schedule for a $250,000 loan with a 5% interest rate.

The total interest on the loan is $233,141. Now let’s compare to a 15 year loan at 4.5%:

You’ll notice the interest is about $100 lower per month (to start), but the principal payment is a whopping $675 more per month to make up the for the 15 years worth of payments you won’t be making. The total interest on this loan is only $94,247.

Doing comparisons like this — 15 year to 30 year, different interest rates for the same mortgage length, etc. — will show you how much money you could save for a different mortgage.

However, it is important to remember that although you’re not making payments a reverse mortgage is a loan and at some point it will have to be paid back — along with fees and interest.

How Does a Reverse Mortgage Work?

Applying for a reverse mortgage is similar to getting other types of loans, but your credit and income don’t matter because you’re borrowing against home equity.  Lenders look at your age, interest rates, and how much equity you have in the home (as well as the market value of the home) when considering applications for a reverse mortgage. Since the reverse mortgage is intended primarily for retirees, income levels are a moot point.

A mortgage lender will get an appraisal to determine the market value of your home and how much you are eligible to borrow.  Then you can decide how you want to receive your money; as a single lump sum, as a line of credit, or in the form of regular payments.

Reverse Mortgage Payments

How you elect to receive the money depends on what you use the money for. Some people take out a reverse mortgage and use a lump sum to pay some major expense. Others are looking to make up for a shortfall in their monthly cash flow, and choose to receive payments monthly.

Reverse Mortgage Fees

Lenders will charge you an origination fee, mortgage insurance, and closing costs to process a reverse mortgage.  This can be a lot to pay if you’re on fixed income so many lenders will let you roll these costs into the loan. When the Federal Housing Administration (FHA) defined the reverse mortgage product they created a cap on the origination fee. The fee can’t be more 2% of the first $200,000 and 1% thereafter, with an overall cap of $6000.

Reverse Mortgage Eligibility

Since the FHA insures reverse mortgages, they set following criteria about who qualifies for a reverse mortgage.  You must:

• Be at least 62 years old. (Some lenders will offer non-FHA reverse mortgages to those who are younger.)
• Own the property, or have a small balance remaining on your original mortgage.
• Have no federal debt delinquencies.
• Meet with a counselor about the reverse mortgage.

Repaying a Reverse Mortgage

As long as you live in your home as your primary residence, you do not need to make payments on your reverse mortgage (although you can). Once you have not been living in the home for a year, though, the reverse mortgage comes due. For many, this happens when long-term care is needed, or upon death.

The reverse mortgage is repaid with funds from the sale of the home. This is why the market value of the home, and the equity in the home, are such important considerations when getting a reverse mortgage. Unless the estate or heirs pay of the reverse mortgage, the home will have to be sold to repay the obligation.

Reverse Mortgage Insurance

It is important to note that a FHA reverse mortgage cannot be repaid for more than the amount of the home’s market value. This means that if home values plunge after the reverse mortgage is made, the lender can only take the amount the home is now worth — even if more is owed on the home.  This is why you’re required to buy mortgage insurance on a reverse mortgage.

The FHa offers two different types of reverse mortgages, the Home Equity Conversion Mortgage (HECM) and the HECM Saver.  The HECM Saver reduces the amount of mortgage insurance you pay up front at closing but also puts a lower limit on the amount you can borrow relative to the value of your home.

Bottom Line

It is important to research the pros and cons of reverse mortgages before making the decision to borrow against your home.  You should read more about the benefits of reverse mortgages for seniors as well as reverse mortgage disadvantages.

Thinking about mortgage refinancing?  You’re not alone, with some of the best mortgage rates available in history many people are debating whether they should spend the money and refinance. 

The benefit of refinancing comes from borrowing at a lower mortgage rate so you can either lower your payments or reduce your loan term, either way saving thousands of dollars over the life of your home loan.

However, there are some pitfalls to watch out for; here are some of the mortgage refinancing mistakes you want to avoid:

Paying High Closing Costs

When you refinance, you are essential getting a new mortgage to replace your old mortgage. This means fees; origination fees, administrative fees and other closing expenses. 

Many people simply pay them, adding them to the cost of the loan and reducing the savings benefit of refinancing your home. Instead, shop around and compare costs between various banks and credit unions. Check out this article on how to lower your home loan closing costs.

Not Getting a Big Enough Discount on the Rate

Many people refinance because rates have dropped but then find that the difference in the interest rate wasn’t big enough to really save them money. If there is only a small difference, the closing costs can erode the savings you are getting.

If you don’t stay in your house for five to seven years after you refinance, this small difference can actually result in you losing out over all. The generally accepted rule of thumb is that the new rate should be at least a full percent lower than your current rate, and you should be planning to stay in your home for a few years.

Waiting Too Long for a Good Rate

It is tricky trying to predict how low mortgage rates will go. In some cases, you might wait too long, and then find that you missed your opportunity. At this point, mortgage rates are unlikely to drop very dramatically again in the near the future. Waiting for even lower rates could mean that you miss out altogether.

Look at the current rates, and then look at your mortgage rate. If you will be saving more than one percent, it might be worth it to just go ahead and refinance now. Rates are not likely to head another full percent lower, but if they head higher, you will have missed out.

Cash Out Refinance

One of the biggest mistakes that people make with mortgage refinancing is to get a cash out loan. In this type of refinance, you get a loan for more than you owe. For instance, if you owe $170,000 on your home, but it is worth $205,000, you might refinance for $180,000. You pocket the $10,000 difference between what you actually owe and what you borrowed. (Of course, closing costs can erode what you actually end up with.)

Cash out refinances can be an issue for several reasons. First of all, you are adding to your debt. Another concern is that your cash out finance could put you above the 80% loan to value ratio, and result in the necessity of paying private mortgage insurance, which adds to your costs. Some people like to do a cash out refinance and pay off consumer debt, but if you are not careful, this could land you in even more trouble — especially if you just run up the balances on your newly paid credit cards.

In the end, it’s better to avoid a cash out refinance if you can, and just stick to refinancing what you actually owe on your home mortgage.

I had never heard of mortgage protection insurance so I figured other potential home buyers would be interested in discovering what it’s all about before all those letters start hitting your mailbox.

Private Mortgage Insurance vs Mortgage Protection Insurance

Many of you are probably familiar with private mortgage insurance or PMI. Although the names are similar PMI is completely different than mortgage protection insurance.

Private mortgage insurance is almost always required by banks when you buy a house with less than 20% down payment. (Your only other option is a second mortgage at a higher rate than the first mortgage). PMI protects the bank’s investment, if you default on the mortgage loan the insurance kicks in and pays the bank what you owe them. PMI is basically a premium you pay for having a small down payment and it helps insure the bank’s money.

Mortgage protection insurance is an extra level of insurance you can buy whose purpose is to protect against unforseen life events (becoming disabled, losing your job, or death) that make it difficult or impossible for you to make your mortgage payments.

Mortgage Protection Insurance Coverage

MPI will pay your mortgage for you if your circumstances meet the criteria of your policy. Many policies have a limit on the amount the policy pays or length of time it will pay for you. (Some limit both.)

So when does it kick in?  As I mention it depends on the policy but in general, if you:

• become disabled and unable to work
• lose your job and lack income to make mortgage payments
• die (these policies usually pay off the loan)

Mortgage Protection Insurance Alternatives

Let’s address each of the above issues.

Disability – One option is to buy a disability insurance policy. With this policy you’ll get a monthly check to replace your lost income. That’s income that you can use for anything — not just your mortgage like with MPI.

Unemployment – One common suggestion to guard your finances against losing your job is to build an emergency fund. An emergency fund can be used to fight not only unexpected unemployment but also any big financial issues like a car dying or unplanned medial bills.

Death – A term life insurance policy would be a good alternative to mortgage proection insurance.  The benefit of life insurance is that your family can use the money as they see fit, they wouldn’t have to use it to pay off the house like mortgage protection insurance would do.

Where to Buy Mortgage Protection Insurance

Let’s start with two places to not buy mortgage protection insurance. You should not buy a policy from your bank or anyone your bank recommends simply because it is your bank. I’m not saying you shouldn’t consider these policies, just be sure to watch out for conflicts of interest.

Along the same lines, I would be wary about buying mortgage protection insurance based only on a direct mail advertisement.  Not that you should rule a company out simply because they sent you an ad in the mail but make sure you research the company and the policy they offer.  For example, The Hartford is a reputable insurance company and they sent me information about the product but I wouldn’t automatically use them simply because of their reputation.  I would find out the terms and details of their policy before signing anything or paying any money.

If you’re considering mortgage protection insurance the best thing to do is probably consult with an insurance agent that specializes in the product. An alternative to an in-person meeting with an agent would be to do a lot of research of companies online. (But I wouldn’t buy this type of insurance online unless I was very, very sure of the company and website I was purchasing from.)

Comparing Mortgage Protection Plans

As with any insurance product there are a lot of factors to consider before you make a purchase decision. Here’s a quick run down.

• Cost/Benefit Ratio - How much is the policy going to charge on a monthly basis?
• Policy Cancellations – Are there a lot of “catches”? Do you have to pay a fee to get out of the policy?
• Health Factors - Do health risks increase the chances you might need need this insurance?
• High-Risk Occupations – Do you work in industries that are more likely to lead to death or disability (loggers, oil rig work, etc.)?
• Financial Situation – Can you afford the insurance and have you run the numbers on the alternatives?

The last factor to consider is the actual insurance you are purchasing. You pay a flat fee for a slowly less valuable payoff. If you use the insurance one year into owning your home then the insurance company will be paying you the full amount of the insurance.

The flip side is if you use the insurance with one year left to pay off your mortgage your benefit will be significantly reduced.

Is MPI for you? I prefer having insurance products and savings that cover me in a multitude of financial situations, but some people may find value in mortgage protection insurance.