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What are the Major Factors Affecting Interest Rates?

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If there’s one factor about a mortgage that most people worry about, it’s the mortgage interest rate. This little factor affects not only your monthly payment, but also how much interest you pay over the life of the loan. It could mean the difference between an affordable and unaffordable mortgage.

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So what determines which interest rate a lender gives you? There are many factors that when all put together, like a puzzle, the lender uses to provide you with a quote.

Keep reading to see what you need to watch in order to get the lowest interest rate for your loan.

What’s Your Credit History?

The very first thing most lenders look at is your credit report and for good reason. It lets them know how financially responsible you are, or aren’t. They use your credit score and history as a measure of your likelihood to pay back the loan you want to borrow.

As a general rule, the higher your credit score, the lower your interest rate. The lower your credit score, the higher your interest rate. It’s all about risk. If you have a high credit score, you pose a lower risk to the lender. In exchange, they can charge you less interest because it’s pretty likely that you’ll pay your mortgage back in full and on time.

If, however, you have a low credit score, you are a higher risk to the lender. The chances aren’t as good that you will make your mortgage payments on time. You may even default on your loan. The lender will likely charge a higher interest rate in order to make more money while you do make payments, in the event that you do default.

How Much are you Investing?

Another factor in your risk level is the amount of money you invest in the home. In other words, how much are you putting down? The more you invest, the more skin you have in the game. In other words, you have more of a vested interest to make your payments on time. If you don’t, you stand to lose a large portion of your own money.

As a general rule, 20% is the key when it comes to getting the best mortgage interest rate, but it’s not always necessary. Just putting down more than the minimum required makes you look better in the lender’s eye. Because they don’t focus on one factor, but all of them together, you want as many positive factors as you can.

For example, combining a higher than minimum requirement down payment with a high credit score shows the lender you are a good risk. However, a high down payment with a lower credit score shows good faith effort in offsetting your risky factor – the lower credit score.

How Much are You Borrowing?

Large loans obviously are a much higher risk than small loans, but that doesn’t mean you’ll automatically get a lower rate with a smaller loan. In fact, if the loan is too small, the lender will charge a higher rate just to make sure they make some money on your loan.

If, however, you borrow more than the conforming loan limit, you may pay an elevated rate because as your loan amount increases, your risk increases too. This will depend on the lender and the other factors of your loan application. In general, though, average size loans under the $453,100 conforming limit, but higher than $100,000 provide the lowest interest rates.

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How Long are you Borrowing the Money?

Generally, the less time you keep the bank’s money, the less interest they will charge you. Specifically, a 30-year term usually has a higher interest rate than a 15-year term. The bank knows they will have their money back in 15 years, so they keep the interest rate down. They will have their money back sooner so they can lend to another borrower.

A 30-year term ties up the bank’s money for a much longer period. While they won’t charge monstrous rates, they will be higher than the 15-year term just because of the higher level of risk. You double the amount of time that you will take to pay the bank back their money.

What Type of Interest Rate do You Want?

Finally, you must determine the type of interest rate. You can choose between a fixed rate and adjustable rate. Looks may be deceiving when it comes to the adjustable rate, though, so be careful. The adjustable rate is often much lower than the fixed rate. The tradeoff, though, is that it will adjust after the introductory period ends.

For example, let’s say you take out a 3/1 ARM. The interest rate is 3.0%. This means for the first three years of the loan, the rate will be 3%; it will not change. After those three years, though, the rate can adjust annually. This is where the catch starts. You’ll pay the index rate plus a predetermined margin. There’s no way to know today what the index (chosen by the lender) will be in three years. Your rate could go up or down quite a bit and you won’t know until you are closer to the adjustment date.

A fixed rate, on the other hand, never changes. It remains the same for the entire term. Because of this predictability, the lender charges a slightly higher rate than the introductory rate of the ARM.

Lenders take all of the pieces of the puzzle and put them together to come up with the perfect interest rate for you. Chances are that if you ask three different lenders for a rate quote, you’ll get three different answers. Each lender has their own threshold for risk and their own requirements. They will use those requirements to determine the right mortgage interest rate for you. The best thing you can do is shop around. If you apply with different lenders within a 30-day window, your credit doesn’t get hit for more than one inquiry. The credit bureaus recognize the need to talk with different lenders and get the interest rate that is most affordable for you.

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What are the Benefits of a Fixed Rate Mortgage?

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If there’s one type of mortgage that is the most popular, it’s the fixed-rate mortgage. Perhaps it’s because of its predictability or because it’s the loan most people know about. Either way, you need to decide if it’s the right choice for you.

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Learn the pros and cons of this type of mortgage to help you make your decision.

The Pros of the Fixed-Rate Mortgage

  • Predictability – This goes without saying. Your interest rate never changes. You know from day one how much you will owe in principal and interest. The only amount that may change is your escrow payment. Real estate taxes and homeowner’s insurance costs may change, which could alter your mortgage payment slightly.
  • Simple comparison shopping – If you shop around with different lenders (which we recommend), it’s easy to compare apples-to-apples. You look at the two interest rates for the same terms and see which one is higher. You don’t have any calculations to perform or other factors to consider.
  • No worrying – You don’t have to watch the market during the months leading up to your adjustment rate to predict what your interest rate will do. No matter what happens in the market, your fixed-rate stays the same.
  • A variety of terms – Fixed-rate mortgages come in a variety of terms compared to other mortgage options, such as the ARM. You may be able to choose between the 10, 15, 20, 25, and 30 year term. This allows you to play with the payments a little to determine which one suits your budget the best.

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The Cons of the Fixed-Rate Mortgage

  • Higher starting rate – The adjustable rate mortgage often has an introductory rate that is lower than the fixed-rate loan. In exchange for the predictability, you may pay more interest on your loan for a few years. But, you don’t have the worry of an increasing rate down the road.
  • Pressure when locking the rate – Locking in your interest rate for a purchase or refinance is stressful. You have to choose just the right time, but that can be impossible. You cannot predict if rates will go up or down within the next hour let alone the next few weeks. This could leave you with buyer’s remorse if you lock in a rate and then rates fall.
  • Must refinance to lower rate – If rates fall and your friends with ARMs start to enjoy lower rates, you’ll still be paying your higher fixed rate. The only way out of it is to refinance, which costs money and isn’t always in your best interest, depending on the situation.

Choosing the Right Program

The best way to determine if the fixed-rate mortgage is for you is to compare all of your options. Ask several lenders which loan programs you qualify to receive. Then you can figure out which one works best for you. Don’t look at just the interest rate, though. That is deceiving. Instead, look at the big picture.

Lay out the quotes from each lender and compare closing costs, interest rates, and closing fees. An easy way to do it is to look at the APR. This gives you the breakdown of the cost of the loan over its entirety including all costs. This way you’ll have a better idea of which one suits you the most.

Of course, only you know what you can afford and what you are comfortable with taking. For example, if you have a stable job with a known income, taking a fluctuating ARM might not be the end of the world. If, however, you have a less stable job or you work on commission, you might want the predictability that a fixed-rate mortgage offers.

Consider all of the pros and cons and all of your options before making your decision.

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Pros and Cons of Homeownership

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Homeownership can be expensive, there’s no doubt about it. Dealing with repairs or just regular maintenance can be downright costly. Sometimes it might feel like you are constantly paying out without gaining any benefits in return.

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While you probably won’t see the financial benefits of being a homeowner right away, in time, they will be very apparent. Following are the most common benefits you’ll see.

Natural Appreciation

Even if you don’t make any changes to your home, but you keep it well maintained, your house may appreciate over time. It may not be a lot and it may even fall from time-to-time, but eventually the values usually come full circle. We saw this with the housing crisis. So many homeowners lost tremendous value in their homes. But, those that stuck it out are seeing those values come back again.

If you are in your home for the long haul, chances are you will see a return on your investment just with natural appreciation.

Building Equity With Monthly Payments

Every time you write that large mortgage payment check, you build equity in your home. Just how much depends on many factors including your interest rate and the term of your loan. Every payment, however, gets you that much closer to owning your home free and clear.

You can look at your amortization table from your closing documents to see just how much of your payment goes towards the principal and how much goes to interest. No matter how much goes towards the principal, though, you make gains with every mortgage payment you make. In other words, your investment gets larger with every passing month.

An Emergency Savings Plan

While we don’t recommend using your home’s equity as your emergency savings plan, it could work in a pinch. Because you reduce your principal with each payment you make, you increase your investment. Once you hit the point where you owe at least 20% of the home, if not more, you can tap into it with a cash-out refinance. If you end up in a serious situation where you don’t have the money to pay for, the equity in your home can be your ‘back up’ plan.

Tax Deductions

Many homeowners enjoy the tax benefits of owning a home. While you do have a lot of expenses as a homeowner, many of them can reduce your tax liability including:

  • Interest paid on the loan
  • Interest on a home equity loan (up to the first $100,000)
  • Real estate taxes
  • Points paid on your loan

You can often use these deductions if you itemize your tax deductions each year. The interest deduction alone could be a rather large deduction for you, as could your real estate taxes depending on where you live.

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Capital Gains go Untaxed

Usually capital gains are the first thing you worry about when paying taxes. You want to avoid too much of a profit as you know it will get eaten up by taxes. With your primary residence, though, this isn’t the case. If you are single, you can keep up to $250,000 profit from the sale of your home tax-free. The only stipulation is that you must live in the home for 2 years in order to qualify.

If you are married, you get an even larger profit as you can make up to $500,000 before being taxed on your capital gains. Again, however, you must live in the home for at least 2 years as your primary residence.

Homeownership Can Increase Your Credit Score

You might think even think of the ramifications of your mortgage on your credit score, but if you pay it on time, it can help in a big way. Credit scores are comprised of many factors including timely payments, the type of debt, and the age of the debt.

If you keep the same mortgage for many years and make regular payments on it, it could help improve your credit score. In the same respect, though, if you miss payments or default on the loan, it could have a drastic negative effect on your credit score. The best thing to do is only take a loan that you know you can afford to avoid anything negative from occurring.

There are many financial benefits of homeownership, and each person is different. Even if your home’s value drops or you don’t see your home appreciate fast, it will. Investing in real estate is meant as a long-term investment. It’s not going to have a quick turnaround or make you a quick profit. In time, though, it can be one of the most lucrative investments you make in your lifetime.

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Buying a House With Low Income

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If you have low income, you may think you can’t buy a home. Lenders look at your income, assets, and debt ratio, right? So how would you ever qualify if you don’t make top dollar for your area?

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Luckily, there are programs out there catering to borrowers with a small income. In fact, the USDA program is only for those borrowers with low monthly income. You can actually make too much money and not qualify for that particular program.

Keep reading and we’ll teach you how to take advantage of the programs available for borrowers with little income.

What Does Low Income Mean?

First, we must discuss what low income actually means. No one will be able to secure a mortgage if they don’t make enough to afford the payments. You must have enough income that you can cover the mortgage and your existing debts. You should still have some money left over too. Lenders verify this fact by looking at your debt ratios.

Each loan program has its own debt ratio requirements. They are as follows:

  • Conventional loans – 28% front-end ratio and 36% back-end ratio
  • FHA loans – 31% front-end ratio and 43% back-end ratio
  • VA loans – 43% back-end ratio
  • USDA loans – 29% front-end ratio and 41% back-end ratio

As you can see, each program differs in their requirements. You’ll even find different requirements between lenders regarding the same loan program. Lenders must use the program’s guidelines at a minimum. But, they are free to add to those requirements if they want to tighten up the restrictions on the loans they write.

Low income in this case, means a small income for your area, but enough to cover the debts you must cover.

The USDA Loan for Low Income Borrowers

The most common low income loan is the USDA loan. In order to be eligible for this loan, you must buy/refinance a home in a rural area. The USDA sets the rural boundaries, though. You may be surprised to see which areas qualify, as we may not consider them rural.

You must also have a total household income that is less than the allowed amount for the area. Every adult in your household that makes an income must disclose the amount they make. You then total this amount and deduct any of the following allowances that apply to you:

  • $480 for each child under 18 or over 18 and in school full-time
  • $480 for each disabled relative living with you
  • $400 for each elderly person living with you

If after deducting the allowances your income fits within the guidelines for your area, you may be eligible for the program.

Once you are eligible, you must qualify for the loan. This pertains only to the borrower and co-borrower now. You must be able to prove you have the income to cover the proposed housing payment, with a debt ratio no higher than 29%. You must also prove that your total debt ratio doesn’t exceed 41%.

If you meet these requirements and the house meets the USDA appraisal requirements, you are well on your well to securing a USDA loan.

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The VA Loan for Veterans

The VA provides 100% financing to veterans of the military, including those serving in the National Guard or Reserves. You do not need a down payment for this program and the VA doesn’t focus on your debt ratio.

Instead, the VA looks at your disposable monthly income. You have left this money after paying your monthly bills, such as the mortgage, installment loans, and credit card bills. Each area has a specific amount of disposable income required based on your family size.

As long as you have the income to cover your housing payment and existing monthly debts, you may qualify. You don’t have to make a certain amount of money for the program. The size and price of the house are what determines how much you must make to afford it. As long as your total debt ratio doesn’t exceed 43% and you have enough disposable income to meet the VA guidelines, you are in good shape.

The FHA Loan

The FHA program is also great for borrowers with low income. This is another government-backed loan program with flexible guidelines. The FHA requires borrowers to have a maximum 31% housing ration and 43% total debt ratio.

You do need a down payment for FHA loans, but only 3.5% of the purchase price. If you bought a $150,000 loan, you’d need $5,250 down. But, the FHA does allow you to accept gift funds from relatives, friends, or even your employer. The seller can also help you with the closing costs. It’s possible to come to an FHA closing with no money and still walk away with keys to your new home.

Don’t make the mistake of thinking you can’t buy a home if you have low income. Several programs cater to buyers just like you. The key is to shop around and find the best deal. Talk to lenders about the different programs that apply to you. This way you can receive quotes for each program, allowing you to choose the loan that works best for your financial situation.

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What is Mortgage Acceleration and Does it Work?

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Many companies advertise the mortgage acceleration program, promising to save you thousands of dollars in interest and cut years off your mortgage. Does it work? Is it worth it? These are the questions most people ask themselves and the professionals.

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While everyone wants to pay off their mortgage as fast as possible, it’s not always worth paying a service to make it happen. You have to pay money to save money, which is a little bit of backward thinking when in reality, the money you pay to the acceleration company could actually go toward your mortgage and further your ability to pay it off faster.

Understanding Mortgage Acceleration Programs

There are two basic ways to accelerate your mortgage according to mortgage acceleration programs:

  • Bi-weekly payments – You pay half of your mortgage payment every two weeks rather than making one full monthly mortgage payment. This turns into 26 half payments or 13 full payments (one extra payment per year).
  • Home equity line of credit accelerator – You take out a HELOC and use the funds to pay your mortgage down. Let’s say you take out a $20,000 HELOC. You pay $20,000 directly to your 1st You then deposit every paycheck to your HELOC, basically living off the HELOC. Any money left over pays your mortgage balance down.

Mortgage acceleration companies charge for both services. The fees vary by company, but they add thousands of dollars to your costs, thus eating away at the benefits of accelerating the mortgage.

However, you may be able to accelerate your mortgage yourself and without any extra cost. Check out how below.

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DIY Mortgage Acceleration

While mortgage acceleration companies claim to have the ‘secret’ to get you out of mortgage debt fast, it’s really not a secret. They are providing a service, which if you can’t trust yourself to handle on your own, may be worth it to you, but most people can manage it.

You can accelerate your mortgage in a variety of ways:

  • Bi-weekly payments – Using the same method mortgage acceleration companies use, you can pay half of your mortgage payment every two weeks (aligning it with your paydays). Just read the fine print on your mortgage to make sure you don’t have a prepayment penalty. Most mortgages today don’t, but if you do, this may not be an option.
  • Make one extra payment per year – If making payments every two weeks is just too much, consider making one full extra payment every year. You can do it at any point. This can knock off a few thousand dollars in interest and a few years off your loan.
  • Pay an extra amount each month – Send in any extra money that you can afford on your mortgage payment each month. Choose an amount that you can afford consistently for the greatest results. For example, an extra $50 or $100 can knock thousands of dollars off your loan and help you pay it off faster.
  • Apply windfalls to your mortgage – If you receive windfalls throughout the year, consider applying them to your mortgage. A few examples include tax refunds, commission checks, bonus checks, or inheritance money.

The key is to set up your own plan and stick to it. If you aren’t sure that you’ll stick to your plan, consider enlisting support – someone to hold you accountable. Whether it’s a family member, friend, or your financial advisor, let someone know of your plan. Set reminders on your phone or calendar and always check up on yourself. Look at your progress as you go to keep yourself motivated. Seeing your mortgage balance decrease will help keep you on track.

So should you pay for a mortgage acceleration program? The truth is that it’s probably not worth it. These companies are doing what you can absolutely do on your own. If you wonder about the financial effects of your extra payments or want help figuring out the best way to pay your loan off the fastest, talk with your financial advisor. He/she can help you figure out the plan that is most affordable and most effective without forcing you to pay a monthly and annual fee for a mortgage acceleration program that you could set up on your own.

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What are the Disadvantages of a Home Equity Line of Credit?

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If you have equity in your home, you might consider tapping into it with a home equity line of credit. This second mortgage gives you access to your equity with low interest rates and costs, in many cases. While they are often easier to qualify for, they do have their downsides, though.

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Before you apply for a home equity line of credit, it’s a good idea to familiarize yourself with the downsides and how they pertain to you.

You Put Your Home at Risk

When you take out a home equity line of credit, you put your home on the line. Just like with your first mortgage, if you default on the loan, you can lose your home in foreclosure. In other words, the bank can come take your home from you in order to make good on your debt.

The reason that you take out the home equity line of credit will determine if this is a serious risk for you or not. Many people take out a HELOC to consolidate their consumer debt. A common example is people that are over their head in credit card debt. If you take the equity in your home to pay off the credit card debt, it can be freeing. But now your home just became at risk whereas with just the credit card debt, there wasn’t anything secured to the debt. If you didn’t pay your credit cards, the credit card company couldn’t take your home.

Before you take out a HELOC, it’s important to consider the reason to determine if you should put your home on the line or if there is another way to help your situation.

You Could Get in Over Your Head

A home equity line of credit isn’t like any other mortgage product out there. With the HELOC, you get a credit line. The bank gives you access to this credit line either with a checkbook or a debit card. You are then free to use the funds as you see fit.

You only pay interest on the funds that you withdraw. So if your credit line is $15,000, but you only use $5,000 of it, you only pay interest on the $5,000 that you used. You have the option to also pay back the principal if you want. If you don’t, you’ll start paying it back after the first 10 years that you have the credit line.

Here’s the downside. If you pay back the debt, you can reuse the funds until the first 10 years are over. In other words, you could have a large credit line at your disposal, encouraging you to use it when you otherwise might not have spent the money. This is the most common with borrowers that consolidate their debt into their HELOC. These borrowers often end up racking up their credit cards again because they are free. It also happens with borrowers that don’t pay off credit cards, but use the HELOC funds in another way, but pay the loan back early. They are often tempted to use the funds because the credit line is there and available for use.

You May Pay an Annual Fee

Many banks charge a fee, much like credit cards do in order to keep your credit line open. You need to read the fine print of the loan the lender gives you. Some lenders don’t charge a fee at all. Others charge one but only if you don’t withdraw a certain amount from your line of credit each year.

Knowing what the loan will cost you, aside from the interest is important. If it’s going to cost you a few hundred dollars per year and you are just going to let the money sit there, it’s not worth it. You are paying a fee for something that you don’t need.

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The Interest Rate is Variable

Most home equity line of credit loans don’t have a fixed interest rate. In other words, the rate can vary on a monthly basis. This means that when you do have money outstanding, you will never know what your exact monthly payment will be until you receive the bill.

It can be disconcerting to not know what your payment will be each month. While the interest rate won’t vary excessively, it will still vary. If you have a large HELOC balance, even a small increase in the interest rate can be difficult for you financially.

You May be Upside Down on Your Loans

As we all saw during the housing crisis, home values can fall and fall fast. There’s no way to predict if that will happen to us again. If it does and you have not only a first mortgage, but also a HELOC, you could find yourself upside down. This means that you owe more in mortgages than your home is worth. This could leave you stuck in your home for longer than you anticipated.

While lenders may offer a way out of an upside down loan, such as a short sale, it still affects you financially. It can also damage your credit. It’s wise to make sure that you keep your total outstanding loan-to-value at less than 80% of your home’s current value if possible to help prevent this situation from occurring to you.

You May not be Able to Deduct the Interest

If you enjoy deducting your mortgage interest on your taxes, you may be disappointed with your HELOC and inability to deduct the interest. The new tax law only allows you to deduct mortgage interest on a HELOC if you used the funds to improve the home.

If you used the funds for anything but home improvement, you cannot deduct the interest that you pay on the loan. While the rate may be lower than you would pay on a credit card, that’s about the only benefit you’ll see when you use a HELOC vs a credit card.

Before you take out a home equity line of credit, it’s important to look closely at the downsides of doing so. This isn’t to say that you can’t benefit from a HELOC, because many people can. You just need to give the loan amount, interest rate, and reason for taking the loan careful thought before making a decision.

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The Top Reasons Underwriters Need a Letter of Explanation

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The mortgage process can feel like a serious of questions that never ends, but it’s for good reason. Lenders need to make sure you can afford the loan beyond a reasonable doubt. The last thing you or the bank wants is a foreclosure.

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After you provide documentation for your income, assets, and liabilities, expect to answer questions about certain areas of your life, most notably your bank account, credit and job history. Sometimes lenders ask questions about these factors that require a Letter of Explanation. All an LOX does is put into writing the reasons for your current situation that may need a little more explanation.

So why do lenders ask for a Letter of Explanation? Check out the top reasons below.

You Change Jobs Often

Lenders want a consistent job history. While a 2-year history is recommended, if you changed jobs within the last two years it doesn’t automatically mean you won’t get approved. When lenders get the most concerned is when you changed jobs frequently within the last two years or if you completely changed careers within that time.

Let’s look at an example. You used to be a teacher but decided to get trained as a real estate agent last year. Those are two completely different career paths and since your real estate career is rather new, a lender may worry that you won’t succeed. You may need to write a Letter of Explanation stating your reasons for changing careers as well as what training you underwent so that you succeed in your new career.

If you didn’t change careers, but change jobs often to the point that a lender considers it ‘job-hopping, they may want an explanation for your actions. In other words, they want to know why you keep leaving your job (is it forced or voluntary) and what you benefit from leaving and starting a new job.

Lenders use these answers to decide if you are a good risk for a loan or if you are a high risk of default.

You Have Large Deposits

If you make large deposits in your bank account within two months of applying for a loan, you’ll have to explain it. If a lender can’t tie the deposit in with your employment income, they’ll need concrete proof of its origination.

Along with the paperwork proving the funds’ origination, lenders will want a Letter of Explanation. The LOX should state where you obtained the funds and why. If you don’t have proof of your explanation, a lender may not be able to accept the deposit as a part of your funds. For example, if you claim you sold your car and received cash for it, but you don’t have a Bill of Sale and/or a canceled check from the buyer, the lender may not be able to use the funds for qualifying purposes.

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Late Payments

Lenders look closely at your credit score and credit history. Your credit history actually tells them a lot more about your financial responsibilities. If upon looking at your history they see many late payments or collections, they may want an explanation.

For example, some people fall onto hard times and make several payments late within a short period. This may be easily explained with a Letter of Explanation. For example, if you fell ill and were in the hospital, it would make sense why you were unable to pay your bills on time for that short period. An LOX could explain the situation and if you could provide proof of your downfall as well as how you picked up the pieces, it would help your situation.

Lenders need to know that late payments aren’t a typical habit and that this was a one-time occurrence, which you can prove with your LOX.

Change in Income

If you’ve had a change in income recently, and it wasn’t a raise, you’ll need to explain the situation in a letter. All lenders see is a drop in income, which makes them want to decline your loan. But, if you have a valid reason, such as you started a new career or started at a new company that has more opportunities for advancement, an underwriter may see the value in it and approve your loan. Without the letter, the lender would see you as a high risk of default and decline the loan.

A good Letter of Explanation can be the difference between loan approval and loan denial. Stay in close contact with your loan officer to find out what questions the underwriter may have on your loan so that you can clear up any miscommunication right away and keep your mortgage approval.

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How to Use Home Equity as Retirement Income

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One of the largest investments you’ll make in your lifetime is your home. But did you realize that you can live off the equity when you retire? This can come in especially handy if you didn’t quite save enough for retirement. While you can’t count on your home solely for your retirement income since home values are so volatile, it can be a supplement to your retirement income.

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So how do you make your home equity work for you? Check it out below.

Sell Your Investment

First, you should know that the IRS allows quite an exception for capital gains on your home. As long as you lived in the home for at least two of the last five years, you can exclude up to $250,000 in capital gains if you are a single taxpayer and $500,000 if you are married filing jointly. This means you can earn $250,000 or $500,000 in tax-free retirement income.

Of course, you’ll need a place to live even after you have the money in hand, so now what? How do you make the most of your situation?

Sell and Downsize

The most obvious way to live on your home equity is to sell your home and downsize to a smaller home. This offers a few benefits:

  • Lower price range leaving you with money to live on
  • Lower property taxes
  • Lower homeowner’s insurance
  • Fewer maintenance costs

Sell and Rent

There’s no rule that says you have to buy a home after you sell your original home. If you’d rather not deal with homeownership, renting is always an option. You’ll likely save money on your monthly payments, as well as reap the following benefits:

  • Pay no property taxes
  • Only pay for renter’s insurance which is cheaper than homeowner’s insurance
  • Not have to worry about maintenance and repairs
  • You can live off a larger amount of the capital gains

What to do With Your Home Equity

Now the bigger question is what do you do with your capital gains? Whether you downsize or rent, what you do with the proceeds really determines what happens next. You have a few options:

  • Invest the funds and let your proceeds grow to help you have more money in retirement
  • Put the money in a high-yield savings account to use during retirement

What you choose depends on where you are in life. If you are still a few years from retirement, why not invest the money in low-risk investments and reap the rewards? If you are closer to retirement, however, you may want to play it safe and avoid losing any of your retirement income.

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Other Options to Use Home Equity in Retirement

If selling your home isn’t on your top list of things to do, there are a couple of other ways you can live on your home equity:

  • Take out a home equity loan – Find a lender that allows you to withdraw up to 80% – 85% of your home’s equity. If you’re nearing retirement, you should have little to no first mortgage, so there should be plenty of home equity to use. Keep in mind that you’ll have to make payments each month depending on the type of home equity loan you take. A home equity line of credit requires interest only payments for the first 10 years and then full principal and interest payments for the next 20 years. If you take out a home equity loan, you’ll pay principal and interest for 20 years.
  • Take out a reverse mortgage – If you and your spouse are over the age of 62, you may be able to borrow the home’s equity in a reverse mortgage. The reverse mortgage doesn’t require you to make any payments while you are alive (and living in the home). You use the equity as income, receiving it either as a lump sum or in monthly installments. The mortgage does accrue interest, but you don’t have to pay the balance back until you or your heirs sell the home.

If you look at your home as an investment, it can be a retirement income vehicle for you as you age. Whether you stay in the home (aging in place) and take out a reverse mortgage or you sell the home, downsize, and live off the proceeds, your home can help supplement any money you’ve saved for retirement thus far.

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How Does an Asset-Based Mortgage Work?

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Did you know that you don’t have to have an income to qualify for a mortgage? As shocking as that sounds, it’s true. There’s a trick though. You have to be able to prove that you have enough assets to cover the mortgage payment for the next 30 years.

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The asset-based mortgage can help retirees or those just living off their assets to get a mortgage. Maybe you don’t want to exhaust all of your assets at once. If you don’t mind paying interest on the loan, you may be able to secure a mortgage even without verifying that you work.

What Type of Assets Can you Use?

You can use almost any type of liquid asset that you have available. In other words, you can’t use other pieces of real estate or a vehicle as an asset. But you can use things like your checking, savings, CDs, money markets, stocks, bonds, mutual funds, and even retirement accounts.

You should know, though, that you can only use 100% off any cash you have on hand. This includes any checking or savings accounts. Any assets tied up in an investment will be taken at 70% of the current value. This allows the lender to account for any taxes and/or fees you may pay for using the funds.

Does Age Matter?

Your age may matter when applying for an asset-based mortgage. There are two reasons for this – retirement age and the length you will hold the loan.

As far as retirement goes, lenders care about your age so that you don’t deplete your retirement savings before you are even of retirement age. If you apply for an asset-based mortgage using your 401K or IRA and you are over the age of 65, a lender may be willing to count those funds. Again, they will only use 70% of the value to qualify it as income, though.

If you are far from retirement age, a lender may not be willing to count your retirement funds as income. If you are too far from retirement, it can be risky to let you use those funds to pay your mortgage. What does that leave you with when you retire?

Finally, your age matters to help determine the length of the loan. Generally, lenders use 360 months to determine your income. In other words, they divide your total assets by 360 to come up with your monthly income. If you are over the age of say 75, the lender may divide your income over 120 months rather than 360 months. Anyone younger than 75 years old, though, will likely have their assets divvied up over 30 years, though.

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What Will Lenders Use to Qualify?

Once you have the total amount of your assets based on the 70% formula with the exception of cash, checking, or savings accounts, you divide that number by 360. See the example:

You have $1,500,000 in assets. $300,000 of it is in cash, the remainder is in stocks, bonds, and IRAs. You are 45-years old. Lenders will do the following:

$1,500,000 – $300,000 = $1,200,000

$1,200,000 x .70 = $840,000

$840,000 + $300,000 = $1,140,000

$1,140,000/360 = $3,167 monthly income

The lender will use this figure to determine how much you can afford each month, just as they would if you made money from employment.

Qualifying for the Loan

Once you know your monthly income, the rest of the qualification process works much the same as any other loan. You must meet the credit score and debt ratio requirements of each loan program. The lender needs to make sure that you can afford the loan beyond a reasonable doubt. They will do so by verifying all aspects of your loan including taking a long, hard look at your credit history.

The question you need to ask yourself is if the asset-based mortgage makes sense. Many people know this mortgage as an asset depletion mortgage. As the name suggests, you deplete your assets. You need to make sure this is a smart choice for you not only now, but well into the future. What will the future hold? How will you pay for your expenses moving forward? Are you retired for life or will you seek employment again sometime in the future?

These are things you must consider when determining if the asset-based mortgage makes sense. Talk with lenders to see what options are available to you and make sure you can comfortably afford the loan before making any decisions.

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What is Seasoning and Does it Affect Your Eligibility for a HELOC?

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You have equity in your home so you think you can access it right away. That may not be the case, though. Some lenders and/or programs require a specific amount of seasoning. In other words, you must be in the home for a certain amount of time before you can access the equity. Some lenders also require a specific amount of equity before you can touch it, which is in line with the time requirement as it takes time to build equity.

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Just how long do you have to wait? Keep reading to find out.

The Amount of Equity

What lenders really care about is the amount of equity you have in the home. Typically, the magic number is 20%. Most loan programs require you to have 20% of the equity untouched. This gives lenders a cushion should you default on your loan.

This means that you can borrow as much as 80% of the home’s value, leaving 20% of the equity untouched. For example, if your home is worth $250,000, you can borrow up to $200,000. If you have a first mortgage with a balance of $150,000, you could still borrow up to $50,000 in a HELOC.

The Time

Most HELOC lenders don’t have a specific amount of time you must wait to take out a HELOC. Some may have the stipulation of six months to a year, but it typically takes at least that long to have enough equity in the home.

If you didn’t make at least a 20% down payment, it will take quite a bit of time to get to the point that you have more equity than the 20% cushion lenders require. At this point, time isn’t an issue, because it takes long enough to build up the equity. Lenders care more about the 20% equity requirement than how long you’ve been in the home.

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Other Eligibility Requirements for a HELOC

Seasoning isn’t the only requirement you must meet to get a HELOC. Yes, it’s a big part of it, but having 20% equity in the home isn’t the only requirement. You could have 20% equity and still not qualify for the loan.

Here’s what you need:

  • Good credit – Second loans are risky for lenders. If you default on your payments, the first lender gets paid first. Second lienholders only get the money that is left, which oftentimes isn’t enough to pay them off in full. Having a good credit score helps balance out the risk, showing lenders that you’ll make good on your debts.
  • Low debts – Lenders also look at your debt-to-income ratio. This compares your gross monthly income to your monthly debts. If your debts take up too much of your income, you pose a high risk of mortgage default. Keeping your debts low helps keep your DTI down, which increases your chances of approval.
  • Stable employment – Lenders love to see borrowers with many years at the same job. Even if you changed jobs recently, if it’s within the same industry, it may help. Lenders need stability, knowing that you won’t change jobs often or be out of a job and unable to afford your mortgage payment.
  • Assets – While it’s not a requirement, having assets on hand helps your chances of HELOC approval. If lenders know that you have money set aside for an emergency, they’ll feel better about your ability to pay your HELOC even if you lose your job or experience any other type of financial emergency.

HELOCs typically have flexible requirements, but the seasoning isn’t one they let go of very easily. Lenders need to know that there’s room in the home’s value should you experience a foreclosure. Having more than 20% equity in your home and having at least a year between when you bought the home and applied for the HELOC will give you the best chances at securing an approval.

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