How to Perform a Financial Checkup on Yourself

I could hardly believe it when I looked at the calendar and realized that the year is halfway over. This time of year is a perfect time for performing a financial checkup on yourself.

A financial checkup can help you pinpoint problems with your finances, and recognize issues that need attention. As you perform a checkup on your financial situation, here are a few things to keep in mind . . . .

Where Do You Stand?

Your first step is to figure out where you stand. A good way to get a snapshot of where you are right now is to use your net worth as a gauge. Your net worth can provide you with a benchmark for measurement. Are you better off than you were six months ago? Better off than you were a year ago? Look at your net worth for a basic idea of where you’re at.

It’s not just about net worth, though. You also need to acknowledge where you stand in other areas as well:

• Insurance: Review your insurance policies. Do you have adequate coverage? Are you getting the best deal? You might be able to save money if you are willing to shop around a little bit. You can even look at your health insurance policy. Even if you aren’t in open enrollment, you can evaluate your coverage now, and plan ahead for the possibility of making changes.
  
• Investments: Look at your investment portfolio. Does your asset allocation still match your target? Or do you need to make adjustments? Are you contributing as much as you can to retirement accounts? Find out whether or not you need to make changes to your investments in order to improve the situation.
• Bills: Go through your regular bills. Do you have recurring costs that are draining your finances? Figure out if you can shop around for a better deal, or if you can eliminate some bills altogether. This includes your mortgage. Perhaps you can better your financial situation if you are willing to refinance.
• Debt: What debts do you have? Consider how much progress you have been making in paying down your debt obligations, and try to figure out how you can avoid racking up more debt. If you don’t have a debt pay down plan already, now is the time to create one.
• Income: Don’t forget to review your income. Take a look at your income sources, and consider how stable they are. You can review the possibility of a raise, or of finding a way to diversify your income.

Once you have a handle on where you stand, you can figure out how to take the next steps toward improving your overall financial situation.

Upcoming Financial Issues

While you are performing your financial checkup, don’t forget to consider upcoming financial issues. What expenses will you have in the coming months? Will you owe money for a semi-annual insurance premium? Are you planning on going back to school? Do you want to buy a home in the next six months?

Think about what’s next, and how you will pay for it. Now is a good time to break down the actions you will need to take in order to reach your goals. Think about what needs to happen if you plan to improve your situation, and then create an action plan.

Your financial checkup offers you the perfect opportunity to learn about what you need to do next in order to succeed, and to let you know where you might be coming off track. Taking a little time to re-evaluate your situation, and tweak your finances a little bit, can be a great way to ensure that you are on the right path to a better financial future.

How did your financial checkup go? What improvements do you need to make? Leave a comment!

5 Ways to Pay Off Your Mortgage Early

Next to achieving a fully funded self-directed retirement account, paying off your mortgage early is probably the Holy Grail of personal finance success. As well it should be – once you’ve paid off your mortgage, your monthly living expenses take a dramatic drop. That opens up the opportunity to save even more money than you ever have in the past.

Since paying off your mortgage early is so desirable, what are some ways to do it without having to completely rearrange your finances?

1. Refinance the loan to a shorter term.

One of the most efficient ways to pay off your mortgage early is to refinance the loan to a shorter-term. Let’s say that you have 25 years remaining on what was originally a 30-year loan. By refinancing your mortgage to a 15-year term, you chop 10 years off the term with a single action.

This works especially well if you lack the discipline to use other methods to pay off your mortgage early. Since your new loan amount will be fixed, you’ll be forced to make a higher payment that will retire the loan in much less time.

The downsides of refinancing are that (a) you will have to pay closing costs in order to do it, and (b) it’s a strategy that won’t work if rates are higher than what they are on your original loan. In fact, you’ll probably be entirely unlikely to refinance if your interest rate will increase even a little above what you have now. In the right rate environment, refinancing will work well. But if rates are running against you, you may have look at other means.

2. Increase your mortgage payment by the same amount each month.

This is perhaps the simplest way to pay off your mortgage early. You simply increase your monthly mortgage payment by a specific amount that works well for you, and gradually chop years off the term of the loan by doing so. If you ever hit upon a cash flow problem, you can always revert back to the original payment.

Let’s say that you have a $200,000 mortgage for 30 years at 4%, and your monthly payment is $955. If you took the loan in 2013, it will be paid off in 2043. But look what happens if you add just $100 of extra principal each month: the loan will be paid off in 2038 – five years ahead of schedule.

If you add $200 in extra principal each month the loan will be paid off by 2034, or nine years ahead of schedule.

You can run different payment scenarios by using a mortgage amortization calculator. It will help you to find an extra payment amount that fits neatly within your budget.

3. Make one extra payment each year.

Using a biweekly mortgage payment plan is another way to pay off your mortgage sooner. Some mortgage lenders will allow you to set up such a plan on an existing loan, however others may require that you refinance specifically into a biweekly mortgage.

But you can achieve the same result without having to enter into a formal biweekly mortgage payment plan. The net effect of a biweekly mortgage is that you end up making approximately one extra monthly payment per year. You can do this on your own, simply by quite literally making one extra mortgage payment per year.

To show you how that works mathematically, with a biweekly mortgage, you’ll make 26 payments per year. If you divide the 26 payments by two, you get 13 monthly mortgage payments. You can make that 13th payment without having a biweekly mortgage.

Using the same mortgage example that we used above, if you make one extra mortgage payment per year – $955 – you’ll reduce your mortgage term by a full four years (2039 vs. 2043).

4. Pay it off in chunks.

If you don’t have the discipline to make additional monthly principal payments, you can also pay off your mortgage in chunks. Most of us have some extra cash come in on a fairly regular basis. If instead of spending extra money on other purposes you use them to prepay your mortgage, you’ll be well on your way toward paying off your mortgage early.

Using your tax refund is an excellent source. The average tax refund in the U.S. is a little bit higher than $3,000. But say that you redirect your refund into your mortgage each year. By doing so, instead of paying off your mortgage in 2043, you will pay off in 2033 – 10 years ahead of schedule. You’ll have effectively converted a 30-year mortgage into a 20-year mortgage without having to refinance, or make additional principal payments every month.

5. Set up a “sinking fund” to retire your mortgage.

If you are a saver by nature, this could be the preferred choice for you. You simply create a dedicated savings account for the purpose of paying off your mortgage early. Just as you would with any other savings plan, you will make monthly contributions to the account until you reach the point where the balance in the account is sufficient to payoff your mortgage completely.

Businesses and institutions use this method to retire bond issues. The strategy is referred to as a sinking fund in the business world.

This has at least two major advantages: It allows you to keep your mortgage interest tax deduction maximized until the day you pay off your mortgage, and it enables you to have control of the funds prior to payoff, which will give you options in the event that your plans or circumstances change.

You should be able to use at least one of these strategies to pay off your mortgage early. At least one of them should fit within your budget and your personal preferences.

Have you tried any of these strategies? What other methods can you suggest to pay off your mortgage early? Leave a comment!

4 Things You Can Learn from Your Mortgage Statement

Most of us, when we buy homes, use mortgages to make the purchase. However, it’s easy to lose track of how your mortgage payment breaks down, and what you’re really paying unless you look at your mortgage statement.

Here are some things you can learn from your mortgage statement:

1. How Much of Your Payment Goes Toward Interest

You might be surprised at how much of your payment is going toward interest, especially at the beginning of your loan. A look at your mortgage statement can help you see how much the principal has been reduced by, and how much of your payment is being spent just to finance your mortgage. Somehow it seems more real when you see how little equity you are building in the initial years of your home loan.

2. When You Can Stop Paying PMI

In a more indirect way, you can learn when you can stop paying PMI. When your loan-to-value ratio drops to 80%, you can stop paying PMI. Pay attention to your loan balance. While your lender should take the PMI off automatically, sometimes you need to be on top of things to make sure that you are saving the money you should be.

3. How Much is Being Held in Escrow

Part of many mortgages is an escrow account. Money that you pay each month is held in a special account that is used to pay property taxes and insurance. If part of your payment goes to escrow each month, you know that your lender is taking care of making property tax payments and insurance premiums when they come due.

At the end of the year, the account is often “settled up.” If you owe more, due to insurance premium increases or property tax hikes, you are sent a bill for the difference, and your monthly payment might go up. If your costs have decreased, you are sent a check for the difference.

4. Your Interest Rate

Don’t forget that you can learn your mortgage interest rate by looking at your mortgage statement. You can compare your rate to the national average, and decide whether or not you need to refinance. The general advice is to refinance if you can do so at a rate that is at least 1% lower than your current rate. Keep an eye on the situation so that you know how to proceed.

What’s Not on Your Mortgage Statement: Mortgage Pay Off Amount

You might think that the loan balance you see on your mortgage statement is the amount you pay off, but it’s not. In fact, most mortgage statements explicitly state that the amount shown is not the pay off amount. If you want to know your pay off amount, you need to ask for it.

Mortgage interest is paid in arrears, meaning that this month’s mortgage payment covers last month’s interest. When giving you a pay off amount, interest is often expressed on a per-day basis. So, you can see how much interest you owe each day if your pay off isn’t made by a certain date.

When requesting a mortgage pay off amount, make sure you look at the date in question. Most lenders will tell you the date through which the pay off is good for. Once you get beyond that date, interest is added to your total.

What have you learned from looking at your mortgage statement? Leave a comment!

Why Debt Consolidation May Not Be Right for You

Debt consolidation has become a favorite way to deal with high levels of debt, and this is especially true for credit card debt. The basic concept is simple: roll several high interest credit card debts over into a single, low interest consolidation loan. Generally, the monthly payment on the consolidation loan is substantially lower than the combined payments on the credit card balances. And the lower interest rate of the consolidation loan enables faster payoff of the entire debt.

So far, so good.

But there are a few flaws in the process, most of them relating to personal behavior.

1. You first need to demonstrate control of your finances.

Before you take a debt consolidation loan, you first have to recognize the fact that you got into debt because your living expenses exceeded your income. Unless you are able to get control of your budget (perhaps try Mint), consolidation will do little more than make your debt situation more tolerable.

There is sometimes the thought that once you have a debt consolidation loan you’ll be able to get control of your finances. That line of reasoning is seriously flawed. You need to have control of your finances before you take the debt consolidation. We’ll get a little deeper into the reasons for this in a little bit.

Once you have a debt consolidation loan, it’s absolutely critical that you have a plan to pay it off ahead of schedule. You can only do that by finding extra money in your budget that will allow for higher principal payments. You have to do this with a combination of increased income and lower expenses. Since both objectives usually take longer to achieve than you expect, you must have this process well under way before taking the loan. If not, you could very well get stuck in the business-as-usual rut.

2. Debt consolidation can become just one more debt.

If you have been living with high debt levels for long time, it has become part of your lifestyle. You probably have found that you are able to go on with your life, albeit with some struggle. A debt consolidation loan will not change this arrangement! It is simply debt by another name.

Since the debt consolidation loan will lower your monthly payments, it can actually make room for more borrowing. Your debt consolidation loan may be Loan #1, but it may soon be followed by Loan #2, Loan #3, and so on. Remember, you already have a history of juggling several loans the same time. It’s much easier to revert to this pattern than you think.

This is why it is so important that you fix your underlying financial issues before taking a debt consolidation loan. The last thing you need to have happen is for your debt consolidation loan to be the first in a succession of loans. The only way to avoid this fate is by creating extra breathing room in your budget. At least some of that breathing room should be allocated to a faster pay off of your new loan.

3. One consolidation loan can turn into another . . . and yet another.

Another big problem with debt consolidation loans is the revolving debt consolidation loan cycle. This starts with the first consolidation, and once a couple more loans are added to the pile, a second debt consolidation loan is done. Only this one is bigger because it includes the original consolidation plus any new debt you’ve taken on since.

Eventually you end up doing the mother of all debt consolidation loans, by taking a home equity line or second mortgage on your home, or even a cash out refinance of your first mortgage. When you do this, you’ll be converting your short-term debt into long-term debt that you’ll be paying off for decades.

Complicating this once cozy arrangement is the fact that declining home equity and tighter lending standards have made home equity and cash out mortgages more difficult to get. It may not even be an option.

4. Debt consolidation could become the easy way out of debt, or so you think.

We can think of this as being the “moral hazard” of debt consolidation loans. You build up credit card debt, and then clean it all up with a debt consolidation loan.

Problem solved, right?

Not at all. You will have succeeded in rolling your various credit card debts into a single neat package, but you still owe the same amount of money. Nothing will really have been accomplished other than the fact that the monthly payment will be easier to handle.

Since most people who are deep in debt are all about monthly payment, there’ll be a temptation to declare victory. If so, no lesson will be learned. The moral of the story is that debt is bad, and a lot of it is even worse. If the debt consolidation loan causes you to miss that lesson, you could be setting yourself up for bigger debt problems later.

Debt consolidation loans can work, but not until you are able to live beneath your means. If the value of frugality is not learned, then a debt consolidation loan will simply be a matter of moving your debts from one loan type to another.

Have you ever been tempted to use a debt consolidation loan to get control of your finances?

How to Use Lending Club to Pay Off Debt

If you’ve dug yourself into a hole in regards to your debt burden it can sometimes be impossible to dig out without filing bankruptcy. The minimum payments, late fees, and interest charges continue to rise to a point that you simply can’t earn enough money in a given month to pay everyone. Your credit score starts to dwindle and with it goes your ability to refinance some of your debt in order to lower your overall outgoing payments each month.

It’s ironic because under most situations, even when you’ve got too much debt, you are still getting offers to take on additional debt to help you juggle your balances through balance transfers and the like. But eventually the amount of debt you are carrying goes too high and no financial institution will throw you a lifeline.

All hope is not lost if you are in this situation. There is one potential lifeline left: peer-to-peer lending.

What is Peer-to-Peer Lending?

Peer-to-Peer lending (or P2P) is where a group of individuals, not a financial institution, lend money out to other individuals. One borrower might have 50 people they are repaying each month and each payment made is split back up amongst the individual lenders.

P2P lending isn’t free because the individuals loaning you the money expect a return on their investment. Yet the rates charged may be significantly lower than what a financing company would charge you. You can get a P2P loan through popular P2P lending websites like Lending Club. Lending Club helps connect people needing to borrow money with individuals looking to lend money for profit, and takes a small cut of the overall transaction.

How Can Lending Club Help You Get Out of Debt?

Since individuals have different risk profiles than financial organizations, you may be able to get a loan at a low enough interest rate to consolidate all of your payments back down to a level you can afford. Instead of owing three different credit card companies debts of 16%, 19% and 22%, you could get one loan through Lending Club at 11.5% and save thousands of dollars in interest.

Lending Club Prevents Adding to Your Debt

One of the benefits of using Lending Club to pay off your other debts is, if done correctly, it can prevent you from adding to your debt in the future.

Here’s how: You have three credit cards with balances of $5,000 (at 16%), $2,000 (at 18%), and $800 (at 22%). If you just pay the minimum payments you will be in debt for over 26 years and pay $12,965 in interest on top of the $7,800 in principal that you owe.

You get a Lending Club loan for $7,800 at 11.5% and use the proceeds to pay off your credit cards. This alone would drop your interest from $12,965 on the credit cards to $1,460 with the Lending Club loan. Your payments would increase from (assuming 2% minimum payments for the credit card) $156 in total to $257.21 with the Lending Club loan, but the extra you pay helps drastically reduce your total interest paid.

Here’s the kicker: your Lending Club loan will last 3 years. To make sure that you don’t add insult to injury by consolidating your debts and then getting new debts, you need to cut up your credit cards. You can keep your credit card accounts open for the health of your credit score if they don’t have annual fees, but you cannot use them. Cut up the cards or freeze them in a block of ice. This is the only way to keep yourself from compounding your debt problem by having new debt on top of old.

Have you used Lending Club to help you pay off debt? How did it work out? Leave a comment!

What is a Good Debt to Income Ratio?

A common question amongst potential home buyers is what a good debt to income ratio for the loan underwriting process. As important as this question is for home buyers (or those looking to refinance their loans) it isn’t just for this group of people. Everyone should know what a good debt to income ratio is for their personal finances.

What is Debt to Income Ratio?

To understand what a good debt to income ratio (also known as DTI) is we must first understand what this ratio calculates. You need to know two things to accurately calculate your debt to income ratio:

• Your total debt.
• Your total income for a given period of time.

When you are calculating your total debt you want to look at everything like a home mortgage, student loans, car loans, credit card debt, and medical debt. If you owe money to anyone or any financial institution, you need to account for that in your total debt number.

For the ratio’s purpose you’ll want to know what your debt payments are each month as well. This is the number you will compare to your income, but it is still good to know what your overall debt load is as well.

Your total income should be what you make in a month. This is gross income so don’t worry about what’s left after your health insurance, 401k, and taxes come out of the check. (Although if you want to calculate a debt to income ratio after all of this it certainly doesn’t hurt.)

An Example Debt to Income Ratio

Here’s an example to show you how to calculate the ratio.

An individual has the following debt:

• Home mortgage of $900 per month including escrow and taxes
• Car loan of $225 per month
• Student loan payments totaling $300 per month

Their total monthly debt payments come to $1,425.

The same individual makes $4,200 per month gross. That is equivalent to $50,400 over an entire year.

To calculate this person’s debt to income ratio, you simply divide the monthly debt payments by the monthly income ($1,425 divided by $4,200).

The result is 33.93%. This means that about 34% of every dollar that person makes must go to debt payment and that’s before taking into consideration taxes, health insurance, and retirement through their employer.

What is a Good Debt to Income Ratio?

Of course the best debt to income ratio is 0%. That would mean you are debt free and able to use every single dollar you earn toward your daily spending and savings goals like retirement.

However, we all know that getting to 0% debt is really difficult. So what do mortgage companies look for?

Ideally you want to be below 35% debt to income ratio. In the past you could get away with higher debt loads and get approved with a ratio in the 38% range, but that isn’t as common after the financial and housing crisis. Getting below 30% is really good, and getting under 25% is great.

Why Lenders Want a Lower Debt to Income Ratio

So why do lenders want to see less than 35% (or ideally less than 30-33%) on your debt to income ratio? Let’s go back to our example.

Our individual has $1,425 in debt payments per month and $4,200 in gross income. Let’s now take into consideration those other costs like tax and health insurance. Let’s roll taxes and health insurance together for an additional 25% taken out of your check plus another 5% toward retirement in a 401k.

Here’s how the math works:

• $4,200 in gross income
• ($1,050) in taxes and health insurance
• ($210) in retirement
• ($1,425) in debt payments
• Net: $1,515

So you have about $1,500 to handle all of your other expenses: groceries, gas, car insurance, eating out, entertainment. There’s enough money left over to cover those items.

Now let’s look at someone with a 50% debt to income ratio. The numbers are starkly different:

• $4,200 in gross income
• ($1,050) in taxes and health insurance
• ($210) in retirement
• ($2,100) in debt payments
• Net: $840

That’s a huge difference and likely unsustainable in the long run. This is exactly why lenders want to see as low a debt to income ratio as possible.

So while it might not be possible for you to get down to 0% debt to income, the lower the number the better off your finances are.

What’s your debt to income ratio? Are you happy with it? Leave a comment!

Example Letter to a Mortgage Company Requesting a Loan Modification

If continuing to pay on your mortgage has become a hardship, as it has for millions of homeowners, you have some choices. You can of course let the property go into foreclosure, or you can apply for a loan modification from your lender that will make your monthly payments fit better in your current budget.

If foreclosure looks like a reality, you should at least try working out a loan modification before letting it happen.

Hardship Options for Your Mortgage

The US government has a hardship program for certain homeowners called the Home Affordable Refinance Program, or HARP. The program is designed to allow “underwater homeowners” — those who owe more on their mortgages than the house is worth — to refinance even with negative equity. Under the program distressed homeowners can have their loans refinanced to lower rates and their payments reduced.

HARP is designed for homeowners who have Fannie Mae or Freddie Mac loans, but there are programs for other mortgage types as well. FHA has their own program, but many lenders have one as well. If you’re in a distress situation with your mortgage, you need to contact your lender to see what your options are and if a loan modification under one of these programs can be done.

Contacting Your Mortgage Lender

Sometimes that can be done with a phone call, but it often works better with a letter. With a letter, you’ll be better able to explain your circumstances and to provide any necessary documentation to back it up.

In many cases, even if you call your lender, they will instruct you to send a letter to open a case. This is often done because the department that handles loan modifications is in a different location. And whether or not you send a letter to open a case you’ll need to send one at some point in the process. By sending it up front, you get the process going quicker.

Even if you send documentation with your request, you should be fully prepared to follow up on future requests for even more information.

Typical Hardships that Could Lead to Loan Modification

Hardships in regard to mortgages are usually the result of a combination of factors. It could include any of the following:

1. Loss of a job or substantial decline in income
2. Disability or other significant medical event
3. You’re several months behind in your mortgage payments
4. The value of your home has dropped below the mortgage amount and can’t be sold
5. You’re unable to refinance your mortgage through the usual channels

There could be other factors not listed here, but you’ll have to have one or more of these situations playing out in order to have a legitimate hardship. Simply declaring a hardship because you’re underwater on your mortgage isn’t enough by itself.

A Sample Mortgage Loan Modification Request Letter

There’s no standard way to write a loan modification request letter, but if you’re looking for a format, try this:

(Your name)
(Your address, city, state and zip)
(Your home phone)
(Your cell phone)
(Your email address)

Regarding: (Your mortgage loan number)

(Mortgage lender name)
(Specific party or department)
(Mortgage lender address, city, state and zip)

To whom it may concern (it’s always better if you can get a specific name):

(I/We) have been struggling to make (my/our) house payment for (X months or years) and feel that (I/we) can no longer continue to do so at the current payment level. Though it has been difficult for (me/us) (I/we) truly wish to avoid losing the house in foreclosure. (I/we) wish to procede under any suitable loan modification that is available for someone in (my/our) situation.

We were fully qualified to make our house payments when we bought the home, and continued to do so for many years. But since (date of hardship) we have been unable to make our payments (regularly/fully) due to circumstances beyond our control.

(Use this paragraph do describe your hardship — job loss, income reduction, medical issues — whatever it is. Be specific, but limit it to a one or two paragraphs.)

(Use this paragraph to describe your own efforts to improve your situation — one or more refinance attempts, failed effort to sell the home. Be sure to mention that the home is worth less than the mortgage balance.)

Documents are enclosed to support both our hardship and our efforts to fix the problem.

We truly wish to keep our home and are willing to do what ever it takes to work with you to bring our mortgage up to date and to give us a fighting chance to keep it current in the future. Our current house payment is ($XXXX) but we feel certain we can continue to pay our loan if the monthly payment is reduced to ($XXXX).

We will appreciate any assistance you can provide in helping us to make this happen.

Sincerely,
(Your signature)
(Your typed name)

Documents to Include With Your Modification Request

With your letter you’ll want to include any significant documentation that will support your claim. If you attempted to sell your home unsuccessfully, include a copy of the listing agreement. If you applied for a refinance and were turned down, include a copy of the denial notice. If you lost your job, document the date of separation through unemployment records. If it was a medical issue, provide copies of relevant paperwork.

Make sure that you send only copies, never the original documents. You may need them in the future. Also, keep a copy of the letter and copies of specific documents that you sent with it, that way you’ll be able to know exactly what you sent should they call.

When you send the letter, be sure to do so either by certified mail or by overnight courier. It’s not just that you want to be sure that the lender gets the package, but also to minimize the risk that it might fall into the wrong hands. Loan documents and other personal information needs to be safeguarded at all times.

After a few days, follow up with a phone call, and be ready to cooperate in any way that you can.

Have you had an experience with a loan modification request? Do you have any advice to pass on to others?

What is a Good Credit Score for Buying a House?

Getting a mortgage today is still difficult. Guidelines are tight, and credit scores matter more than ever. Before applying for a mortgage, there are a few things you need to know about credit scores.

Acceptable Mortgage Credit Ranges

Believe it or not, there’s no single (or simple) answer here! The credit score range varies depending upon which mortgage agency is funding the loan, the type of loan you’re applying for, and also on specific lender guidelines.

On conventional fixed rate mortgages, the ones typically handled through either Fannie Mae or Freddie Mac, the minimum acceptable credit score is generally 620. On a conventional adjustable rate mortgage (ARM), it’s generally 640 as a minimum.

For loans insured by the Federal Housing Administration (FHA), the absolute minimum credit score is 500. You’ll need a minimum score of 580 in order to qualify for maximum financing (96.5% of the purchase price of the home). Between 500 and 579 you can qualify for a mortgage of up to 90% of the property value.

It’s important to remember that these are the minimum scores of the mortgage agencies. The individual lenders you’ll be working with may have credit score minimums that are set at higher levels.

Getting the Best Rates and Loan Terms

Mortgage lenders price loans using a matrix based on a mix of risk factors that includes loan-to-value ratio (mortgage loan amount divided by property value), credit scores, loan amount and debt-to-income ratios. They may even have different requirements based on geography.

Generally speaking, the higher your credit score, the more likely you’ll be to get approved and with the lowest interest rates and most flexible terms. There are thresholds above which your credit qualifies as “good”, “very good”, or “excellent”.

Depending on the lender and loan program, excellent credit scores can begin anywhere between 700 and 750. If you’re above those thresholds, you’ll generally get the best loan pricing available.

Refinances Can Be More Flexible

Largely due to the decline in property values in recent years, most lenders are offering “streamline refinances”, which are basically mortgages without so much of the usual documentation required. They generally work best for homeowners who are doing a simple rate and term refinance, so credit scores aren’t as much of a factor.

Not all refinances qualify as streamline refinances either, and that’s where credit score requirements re-enter the picture. For example, the game changes if you want to consolidate existing first and second mortgages into a new first mortgage. Another example is when you want to refinance a bank mortgage with a Fannie Mae or Freddie Mac loan. The usual credit score requirements are likely to apply in these cases.

Non-Traditional Credit

Some borrowers have no credit scores, and there are mortgages for them as well. It’s referred to as “non-traditional credit”, which is to say that it’s for people who either don’t have credit from the usual sources, like mortgages, installment loans or credit cards. Because there’s no credit, there are no credit scores.

Sometimes a non-traditional credit report can be ordered that will show your payment history (but no credit scores) from third parties, like utility and insurance companies. This option however is not available in all situations.

If not, you generally will have to produce evidence in the form of canceled checks for your rent and two or three other sources, like utilities or insurance payments. The canceled check requirement will typically call for you to provide evidence of on time payments for up to two years. If you go this route, be sure you have all 24 months worth of canceled checks. If you’re missing even one the lender may assume that you paid late that month.

An important note here is that non-traditional credit is not an option for borrowers with low credit scores. They’re strictly for people who have no credit scores at all.

Getting a Mortgage With a Lower Credit Score

Generally speaking, if you’re below the credit score minimum requirements you will not be able to get a mortgage. If you’re in the “fair” or “average” range (620-700 for conventional or 500-579 for FHA) you’ll most likely be able to get a loan, but it will have higher rates and less generous terms.

As mentioned above, FHA limits loan amounts to 90% of property value in the 500-579 range, but conventional loans have their own restrictions. You may similarly be restricted on your loan-to-value (90% or less) or your ability to take a second mortgage, but your interest rate will likely be higher as well. Lower credit scores may also restrict you to lower debt-to-income ratios, which will have the effect of decreasing the loan amount you can take.

There are two ways to get around the lower credit score issue. One is to work to improve your credit score, and the other is to have “compensating factors”.

Compensating factors is a mortgage industry term for components of your borrower profile that are strong enough to offset weaknesses in other areas. If your credit scores are below the most desirable range, you may not be able to improve your loan pricing, but compensating factors could mean the difference between an approval and a decline.

Typical compensating factors include:

• A large down payment (usually 20% or more)
• Cash reserves after closing, equal to six months or more of your new house payment
• Buying less house than you can afford (giving low debt-to-income ratios)

In today’s difficult mortgage lending environment, it’s usually best to do both — improve your credit score and have compensating factors. It’s a tall order, but one that will benefit you for many years in your home.

Have you recently had credit score issue with your mortgage application? Leave a comment!

The American Dream: A Fictional Story

Thanks to Danny Kofke, author of the book Live Wealthy With Little Money, for this portrayal of a family in debt.

Jim and Laura are a typical American couple. They just got married last year after dating for four years. Jim is a manager of a local department store and Laura is a school- teacher. They make a combined salary of $100,000 a year, and look forward to raises and increased incomes in their future. They have around $3,000 in their savings account— which seems ample since they are certain they’ll continue to make more money each year—and both drive new cars.

Spending Spree

Jim and Laura go shopping whenever they want and pretty much buy anything they like without thinking twice. In addition, they eat out most nights of the week but try to keep it cheap; they usually don’t spend more than $30 for these dinners.  

After renting an apartment for six months, they decide it’s time to buy a house.  Even though it’s just the two of them right now, they want at least a 2,000-square-foot house because children are on the horizon. Jim and Laura find the “perfect” house but it’s a little above the amount they wanted to spend.

Their Realtor® tells them that it’s not a problem. They can sign up for a five-year adjustable rate mortgage (ARM) and by the time it adjusts, they’ll have so much equity in their house they can just refinance. The housing market is strong and they’re confident their home will go up in value considering the prime neighborhood it’s in.

Both Jim’s and Laura’s parents live in much smaller homes but, after some talk, the couple feels they deserve this larger house because they work so hard and all their married friends are getting big houses too. Jim and Laura sign on the dotted line and their American Dream begins.

Never Enough Money

Fast-forward five years. Jim and Laura are now the proud parents of a little boy, James, and a girl, Sarah. After having James, Laura took eight weeks off from teaching to stay home and loved every minute of it. She wanted to stay home longer but they went through their savings on that 10-day Caribbean cruise before she got pregnant.

Laura began to feel very upset at having to send James to daycare but there was no way around it—they needed her check to pay the bills. Jim saw how unhappy she was and one night decided to have a talk.  It was very encouraging and they both agreed to make a change and start saving so Laura could eventually stay home.

This change lasted a few months before they started spending their entire paychecks again on things such as new clothes and dinners out.  Last year Laura had Sarah and was only able to stay home with her for four weeks before having to return to work. She now spends over half of her take-home pay on daycare expenses. Laura dreads going to work and hits the snooze button at least five times every morning because she hates getting up to face another day.

Jim is not doing much better. He’s had to lay off most of his salespeople. The raise he was promised every year did not happen. There are even rumors that his job might be the next to go. He’s started to look for other jobs but nobody seems to be hiring in his area of expertise.

Bad to Worse

To make a bad situation even worse, Jim and Laura’s five-year ARM is scheduled to adjust this year and their monthly mortgage payment will increase by $500.  The house has dropped greatly in value and Jim and Laura are underwater on their loan so they cannot refinance.

In addition, after James was born, Jim and Laura began to use their credit cards again with the promise of paying them off in full each month. That plan didn’t pan out and they now have $10,000 in credit card debt.

They both have a lot of trouble falling asleep at night and don’t feel optimistic about either their marriage or their future.  They have started arguing more and more—something they never did in the good old days—and these arguments usually concern their finances. What was supposed to have been their American Dream has turned into a scary nightmare!

Your Money

Not a pretty picture, is it? I hope your story is not like Jim and Laura’s but, unfortunately, I know a lot of people can relate to this couple in one way or another. The great news for Jim and Laura (and maybe you too) is that life allows us to learn and adapt and change.

Jim and Laura are obviously an example not to follow—but we can learn so much from them.  Many people don’t see the need to learn about money and how to manage it correctly. They bury their heads in the sand and don’t want to be worried about the true state of their finances because, if they did, they might have to change their spending habits.

The thing is, if you continue to make poor financial decisions, these actions will eventually come back to haunt you.  Even if you make $5 million a year but spend $6 million, you’ll wake up one day and find that you are broke. The great news is that it doesn’t have to be this way. We can educate ourselves, find examples to emulate, create goals and take action.

 

Editor’s Note: When Danny first contacted me I noticed he had already written one book “How to Survive on a Teacher’s Salary”.  So he’s definitely writing about an area where he has personal experience, trying to make ends meet on a small salary. 

My wife used to be an elementary teacher and it was interesting to see how teachers, making similar amounts of money, used that salary in different ways.  Some managed it well and never complained and some didn’t know how to handle their money and always seemed to be scraping the bottom of the barrel at the end of the month. 

So if you’re running dry at the end of the month and want a way to stretch your dollars farther, check out Danny’s book, Teach Yourself (and Your Kids) How to Live Wealthy with Little Money .

Home Mortgage Rates – 6 Key Factors

Home mortgage rates offered by your bank can vary from person to person; what determines the interest rate you’re eligible for? 

While the interest rates on 10 year Treasury notes have a major impact on whether mortgage rates rise or fall, there are many individual factors that go into determining your interest rate. Those individual factors are measurements banks can use to help calculate the amount of risk they take on if they give you a home loan.  Let’s take a look at six of the main factors that typically figure into your home mortgage rate.

1) Loan Amount: The bigger your loan amount, the larger the risk of default. A larger mortgage usually means bigger payments, and that means a bigger stress on your budget. If you are getting a jumbo mortgage, the increased risk can be reflected in a higher interest rate.

2) Amortization Schedule: When you borrow money, a schedule is created for repayment that’s known as an amortization schedule. It reflects how much of each payment goes toward interest and how much goes toward principal each month, in addition to determining when the loan will be paid off.

If you have a longer loan term, it means that you build equity (or ownership) in your home at a slower rate. A long mortgage term also means that you have more time to default. If you are willing to pay off your mortgage faster, you will likely see a lower interest rate.

3) Credit Score: You probably knew this was coming. Whether or not you think the credit scoring system is fair, the fact is that mortgage lenders use this system to evaluate your level of fiscal responsibility.

Your credit score is a reflection on your past behaviors related to borrowing money. A lower score means that there is a greater risk that you will default on the mortgage, or be late in paying. In order to make up for that, you will have to pay a higher mortgage rate. A good credit score can save you thousands of dollars (even tens of thousands of dollars) in interest charges.  You can read more on how your credit score affects interest rates.

4) Loan-to-Value Ratio: This number represents the amount of money you owe on your mortgage as compared to the value of the home. If you have a home that is worth $200,000 and owe $170,000, your loan-to-value ratio is 85%.

Many lenders consider a loan-to-value ratio of 80% or less to represent an more favorable situation, since it represents an amount of equity in the home that reduces the impact on the lender if your home ends up in foreclosure.

If you have a 20% down payment, you automatically get to the desired loan-to-value ratio, and can usually see a lower interest rate. When applying for a refinance or a home equity loan, a desirable loan-to-value ratio will also help you with a lower interest rate.

5) Loan Type: The type of loan you are getting matters as well. A variable rate loan, like an adjustable rate mortgage, generally starts out a little lower than a fixed rate loan, since the bank is hoping that interest rates will go up — meaning more money down the road.

A cash-out refinance loan generally carries a higher interest rate than a purchase mortgage, since a cash-out means you are taking more out against your home’s equity; this results in a greater risk for the lender.

A home equity line of credit that you tap repeatedly may have a variable rate, or a higher interest rate, as opposed to a fixed-rate home equity loan that is perceived as offering less risk.

6) Loan Program: Whether you’re borrowing using an FHA loan vs a conventional loan can affect your mortgage interest rate. An FHA loan, guaranteed by the government, often has a lower interest rate than a conventional loan. This is because the FHA insures the loan, reducing the risk to the lender. So, you might get a better rate than you would get under normal circumstance if you qualify for certain loan programs.

Lending Risk
In the end, the mortgage rate you end up with is all about the risk to the lender. A mortgage lender considers the facts of the loan, and then makes a decision on your interest rate based on how likely you are to default, and the amount of equity the home would have to cushion the costs associated with foreclosure. 

Your Interest Rate
These 6 factors aren’t the hard and fast rules for an interest rate calculator for every bank; each lender uses their own set of standards and these are some of the most common.  You can use them to estimate whether you’ll get a high or low interest rate relative to the market but the only real way to find out the mortage rate you can borrow money at is to fill out a mortgage application and get pre-approved for a specific loan amount.

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