Category Archives: Credit Advice

5 Ways to Eliminate Debt and Qualify for a Mortgage

cash-on-wood

Some home buyers don’t know the negative effect debt can have on a mortgage application. You don’t have to be debt-free to purchase a home, but excessive debt can reduce purchasing power or result in a higher mortgage rate.

When applying for a home loan, your lender pulls your credit report and credit score, and evaluates how much you owe on credit cards, auto loans, student loans, and more. When compared to your income, this information gives lenders an idea of how much you can spend on housing.

As a rule, your mortgage payment cannot exceed 28 to 30 percent of your gross monthly income. Your total monthly debt payments, which also include the new mortgage payment, shouldn’t exceed 36 to 43 percent of your gross monthly income. This maximum depends on whether you receive a conventional or an FHA home loan.

Although you’re allowed to spend up to 30 percent of your gross monthly income on housing, this doesn’t mean a bank will approve any amount up to this percentage. For example, if your loan or credit card payments take a chunk of your monthly income, a lender may say you only qualify for a mortgage with a payment up to 25 percent of your gross monthly income, which limits your options. Therefore, you should eliminate as much debt as possible before applying for a mortgage.

This not only increases affordability, less debt makes it easier to adjust to home ownership and new expenses. Debt elimination is easier said than done and it can take months or years to pay down balances. But there are ways to help wipe the slate clean faster.

1. Temporarily Downsize

Temporarily downsizing can provide extra cash to pay off debt. Once you finish paying off debt, begin saving for mortgage-related expenses, such as a down payment and closing costs. Average down payment minimums range from 3.5 to 5 percent, and closing costs can range from 2 to 5 percent of the loan balance. Consider getting a roommate to share expenses with, moving into a cheaper home on a temporary basis, or moving in with your parents to save money.

2. Sell Unused Items

It might be difficult to get rid of treasured belongings. However, if you focus on the big picture and think about your future home, it’ll be easier to unload stuff you don’t need and don’t use on a regular basis. The more you have, the more you have to maintain. Decluttering can put cash in your pocket and simplify your life. Make a list of items you no longer use. Plan a yard sale, list items for sale online, or work with a local consignment shop.

3. Pay Off Debt with Free Money

Some people get free money throughout the year, whether it’s an end-of-the-year work bonus, a sizable tax return, or cash as a gift. Planning a vacation or shopping spree is fun. A smarter approach, however, is using unexpected money to pay off credit cards and other loans. By doing so, you can eliminate your debt months sooner.

4. Consolidate to a Lower Interest Rate

Credit card debt is one of the hardest debts to erase because of high interest rates. See if you qualify for a 0% interest balance transfer credit card. These cards typically offer 0% interest for the first six to 18 months. Transfer all your balances to the new card. You’ll simplify your finances, and with no interest charges, one hundred percent of your monthly payments will go toward reducing the principal.

As you pay down your credit card balance, your credit utilization ratio improves. This can raise your credit score and help you qualify for a lower interest rate when you’re ready to get a mortgage.

5. Find a Second Income Stream

How much time do you spend watching TV or surfing the Internet every week? If you’re serious about paying down debt and getting a mortgage, get a part-time job a few days a week or think of a side businesses you can do. If you can earn an extra $150 a week, that’s an extra $600 a month or $7,200 a year. This can pay off your debt and help build a down payment fund.

Are Mortgage Discount Points Worth the Cost?

house-cash-piggy-bank

Most borrowers want the lowest possible mortgage interest rate. This is why they work to improve their credit scores before applying for a home loan and comparison shop. But these aren’t the only ways to find the most favorable rate – borrowers can also reduce their mortgage rate by paying discount points.

Discount points are optional, but offer a practical way to reduce the interest rate on a home loan. A cheap rate lowers the amount of interest paid over the life of a home loan, plus borrowers can enjoy a lower monthly payment. Although discount points are helpful, buying points isn’t the right choice for everyone.

Each borrower has to count the cost and then decide whether discount points makes sense for their situation.

What is a Discount Point and How Does It Work?

A discount point is a type of upfront prepaid interest paid to a mortgage lender in exchange for a lower mortgage rate.

For every discount point you buy, you receive (on average) .25% on your interest rate. If you apply for a home loan and the lender quotes a rate of 4%, paying two discount points can reduce your interest rate to 3.50%.

Paying discount points is attractive, especially if you need a lower interest rate and a lower monthly payment. But discount points aren’t cheap – and certainly aren’t free. Each discount point costs 1% of the loan balance, and this fee is included in your closing costs. Let’s say you’re financing $200,000 for a home purchase and you want to buy two discount points. In this scenario, you’ll pay $4,000 upfront.

Some lenders wrap closing costs into the mortgage loan, which means you don’t have to pay out-of-pocket for discount points. But even if you’re not shelling out money at the closing table, you have to do the math to determine whether discount points make sense from a financial standpoint.

To decide whether you should or shouldn’t purchase discount points, there are three factors to take into consideration: how much you’ll save monthly with a lower interest rate, how much you’ll pay for each discount point, and how long you plan to live in the home.

If you’re borrowing $200,000 and you buy two discount points to reduce your interest rate from 4% to 3.50%, you’ll pay an extra $4,000 in closing costs. If you have a 30-year fixed-rate mortgage, the difference in your mortgage payment at 4% and 3.50% is approximately $55 a month.

For discount points to make sense, you’ll have to live in the house long enough to break even or recoup the cost of buying the discount points. Since a cheaper interest rate saves $55 a month and you paid $4,000 for two discount points, you’ll have to live in the home for a minimum of 72 months (or six years) to justify the extra expense.

It’s difficult to predict where you’ll live in the next few years. As a rule of thumb, if you don’t foresee living in the property long-term, it might be cost-effective to skip discount points. On the other hand, if you know you’ll live in the home long-term, paying discount points can result in significant savings over the life of the loan.

Why You Should Check Your Credit Before Buying a Home

shutterstock_280796339

It’s become harder to qualify for a home loan in recent years. Therefore, it is important to understand what banks look for in an applicant. Getting a mortgage typically requires a down payment and consistent employment, and you have to meet the lender’s credit requirements. However, some applicants never check their credit file before meeting with a mortgage lender.

 If you’re thinking about a home purchase, here are four reasons to check your credit beforehand.

1. Your credit score could be lower than you realize

 Some applicants assume their credit is good, so they don’t check their score or reports prior to applying for a mortgage. But even if you pay your bills on time and have a seemingly good relationship with your creditors, your credit score may not be high enough to qualify for the most favorable interest rates.

 There is no way to know where you stand credit-wise until you order your credit report and credit score. You can qualify for a conventional mortgage with a credit score as low as 620 and an FHA mortgage with a credit score as low as 500 to 580. But if you want an excellent interest rate, you need a credit score in the upper 700 or 800 range.

 Checking your credit ahead of applying for a mortgage also gives an idea of the loan programs you qualify for; and if your credit needs improving, you can take steps to raise your score. Paying down debt and paying your bills on time helps fix a low credit score.

2. Your creditors may report erroneous information

 Checking your credit helps you identify mistakes on your credit file. Creditors may update your credit report with erroneous information that damages your credit score, such as higher account balances or late payments. Mortgage lenders put a lot of emphasis on payment history, and having one or two late payments on your report within the past 12-months can hurt your chances of getting approved for a mortgage. Therefore, it’s important to check your report for accuracy, and then contact your creditors to fix any mistakes you find. If your creditor is unwilling to assist, you can file a dispute with the credit bureaus.

3. You might be a victim of identity theft

 If you never check your credit history or credit score, you could be a victim of identity theft without realizing it. Identity theft can include someone applying for loans and credit accounts in your name and accumulating debt in your name. This type of theft can damage your credit reputation, to the point where you may not qualify for a mortgage. It doesn’t matter if you are innocent and a victim of fraud, a mortgage lender will not approve your application until the issue has been resolved and derogatory items are deleted from your credit report.

 Order your credit report from AnnualCreditReport.com, or request your reports by contacting the three major bureaus (Experian, Equifax and TransUnion). If you’re a victim of identity theft, notify your creditors and the credit bureaus, and then file a police report. You can also report identity theft to the Federal Trade Commission.

Three Ways Bad Credit Affects Home Loan Terms

shutterstock_199958969

A low credit score doesn’t necessarily mean you can’t get a mortgage loan, but at the same time, you shouldn’t expect the most favorable loan terms. Several mortgage products are available to borrowers with low credit scores. You only need a 620 credit score to qualify for a conventional mortgage, and you can get an FHA mortgage with a credit score as low as 500. But while you might have options, it is important to understand how bad credit affects your home loan terms.

Higher Mortgage Interest Rates

Although mortgage lenders have relaxed their guidelines and will approve borrowers who have low credit scores, this doesn’t mean “everyone” with bad credit qualifies for a home loan. The lender will check your credit history and review your income. If you have more than one to two late payments in the past 24 months, you may not qualify. There are also rules for qualifying for a mortgage after a bankruptcy and foreclosure. In the case of a foreclosure, you have to wait at least three years to get approved for an FHA home loan, and seven years for a conventional home loan.

But even if your recent performance demonstrates good credit habits and you’re approved for a loan, getting a mortgage with a low credit score means you’ll pay a higher interest rate than an applicant with good credit. For example, a borrower with an 800 credit score may qualify for an interest rate of 3.8%, whereas a borrower with a 640 credit score qualifies for an interest rate of 4.6%. If you’re looking to buy a home at $200,000 with a 30-year term, that’s a monthly difference of $93.

Bigger Down Payment Requirements

Down payments are required with a conventional mortgage and an FHA mortgage. Both loans feature a low-down payment option which lets you purchase without a 20% down payment, but some banks will require a larger down payment depending on your credit score.

FHA mortgage loans only require a 3.5% down payment if you have a credit score of at least 580. If your credit score is between 500 and 579, the down payment increases to 10% of the purchase price. Conventional loans require a minimum down payment of 5%, but your lender may require 10% if you’ve had a bankruptcy, foreclosure or short sale within the past seven years.

Higher Private Mortgage Insurance Premiums

Private mortgage insurance (PMI) is a type of mortgage insurance with conventional loans. You’re required to pay this insurance if you purchase a home with less than a 20% down payment.

Some borrowers don’t understand how credit scores affect private mortgage insurance premiums. With an FHA home loan, mortgage insurance is 0.85% of the loan balance regardless of a borrower’s credit score. PMI premiums with a conventional loan vary and range between 0.5% and 1% of the loan balance. Conventional lenders take into account different factors when determining the cost of PMI, such as the mortgage balance, the size of your down payment and your credit score.

PMI protects lenders in case a borrower defaults on his mortgage. Since borrowers with low credit scores have a higher default risk, they typically pay higher mortgage insurance premiums than borrowers with excellent credit.

How to Get Your Credit Mortgage-Ready

shutterstock_130170536

You may be financially ready to purchase a home, but buying a house requires more than income. You also need acceptable credit.

Your credit score tells a lender a lot about your credit habits and, unfortunately, a bank isn’t going to give you a mortgage if you have unresolved credit problems. The good news is that you can fix your credit. So, while you may not qualify for a mortgage today, you can qualify in the future!

Here are three strategies to get your credit mortgage-ready.
Continue reading →