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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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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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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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Qualification Requirements for Stated Asset Loans

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If you need an alternative document loan, you will have to meet certain requirements. First, you will need to find a lender that is even willing to write this type of loan. After the housing crisis, most lenders pulled out of the stated income/stated asset arena. They didn’t want to take the chance of dealing with defaulted loans.

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Today, though, more and more lenders are willing to write stated assets loans. Just how do you increase your chances of approval on one? Keep reading to find out more.

Have a High Credit Score

First, you need a high credit score. If you want a lender to take your word on your income or assets, you have to give them reason to do so. Think of the difference between a borrower with a high credit score and one with a low credit score.

The borrower with the high credit score probably manages his money correctly. He doesn’t overextend his credit or pay his bills late. Lenders look at him as a good risk. The borrower with a low credit score may not manage his money correctly. He may overextend his credit or pay his bills late. His credit history is typically filled with negative information that makes a lender wary of giving him a loan.

If you think about the risk of a lender offering a stated income or stated asset loan, they are taking your word for what you make or have. They take a much larger risk doing this for a borrower that doesn’t have a decent credit history. Making sure you have a high credit score before you apply for this type of loan can increase your chances of approval.

Have a Low Debt Ratio

A low debt ratio goes hand-in-hand with a high credit score. The more debt you have outstanding, the higher the risk of default you pose to a lender. You may find that it’s harder to find a willing lender when you have a high debt ratio.

This doesn’t mean that you can’t have any debt outstanding, but you should try to minimize the amount you have outstanding before you apply for the loan. If you have credit card debt, try to pay the balances off in full. If you aren’t able to pay them off in full, at the very least, try to get your balances paid down enough so that they are less than 30% of your total credit limit. Once you owe more than 30% of your credit limit, it’s a red flag to lenders, making them less likely to give you a loan.

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Have Stable Employment

Even if you are applying for a stated income loan, you still need to prove your employment. Lenders want to know that you have stability and reliability when it comes to your income. The longer you are at your job, the more stability you show a lender.

Ideally, you should have at least 2 years at the same job. This shows lenders that you are consistent with your efforts to stay at your job. It also gives you room for raises, putting you in a better financial situation moving forward. If you don’t have a 2-year history at the same job, you’ll need to explain why you made changes. Did you better yourself by taking a higher position? Did you go back to school to start in a different industry?

Your lender will need to know the exact reason you changed jobs so that they can gauge your ability to be successful at the new job. Since your job is the source of your income, your lender will need to make sure beyond a reasonable doubt that you are able to succeed in your chosen profession.

You can increase your chances of getting a stated asset loan by making sure all qualifying factors go above and beyond what the lender wants to see. Just meeting the basic guidelines isn’t enough. Lenders need to know that you are a good risk and that you don’t pose a high risk of default.

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How to Handle Cash Deposits When Applying for a Mortgage

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When you apply for a mortgage, your lender will look at your bank statements very carefully. They aren’t looking at where you spend your money, though, instead, they look at your deposits. They need a paper trail of every deposit so that they know its origination. If you have cash deposits, it could pose a problem with your mortgage application.

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Keep reading to learn how to get around this issue.

You Need Proof of the Funds’ Origination

If you have cash to deposit in your checking or savings account, you can do it, but you need proof of its origination. Let’s say for example that you have $1,000 in cash that you received from selling some antiques your grandmother gave you.

You could just go and deposit the money and think nothing of it. But if it is within two months of a mortgage application, the lender will question it. If you don’t have proof of where you got the funds, the lender will not be able to include the $1,000 in your available funds and they may even deny your loan.

On the other hand, if you had a Bill of Sale or receipt to show the lender that you sold the items, it could serve as your proof. The lender will compare the receipt to the deposit amount – make sure the amounts match perfectly in order for the lender to accept this form of proof.

The same method works for any type of cash accumulation, whether you sell stocks, sell a car, get a bonus from work, or get a gift from a family member. You need proof of the receipt of cash.

Gift Funds are a Little Different

If you do receive gift funds from a family member, you have a few more steps to take. The lender needs to know where the funds originated, but also that the donor does not expect you to repay the funds. In other words, the lender needs to know that you don’t have a loan somewhere down the line.

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You can prove gift funds with a few documents:

  • Gift letter – You need a gift letter from the donor stating that the funds are a gift, the amount of the gift, and the reason for it (purchasing a home). The letter should also state that the funds are a gift and there is no expectation of repayment.
  • Proof of the funds – The donor must provide his or her own bank statement showing ownership of the funds. Just like with you, the borrower, the bank statement shouldn’t show any recent large cash deposits. The lender needs to know that the funds the donor provides are his own funds.
  • Proof of transfer of the funds – The donor must write you a check, which you must keep a copy of to show the lender. You then deposit the check in your account, taking a deposit receipt as proof of the deposit, again, giving it to your lender.

Make Deposits Earlier Than 2 Months Before You Apply

One last method you can use if you need to make cash deposits in your account is to do so before you apply for the loan. Lenders typically only ask for bank statements from the last two months. If you do not have any large deposits within that time, you should be able to use the funds in there for your down payment and closing costs.

Lenders only look for recent large deposits. If you took out a loan more than two months ago, it would show up on your credit report and the lender would know about it already. It’s the loans that are new that don’t show up right away and could put the lender in a bind if they don’t catch it.

It’s wise to avoid any cash deposits when you want to apply for a mortgage in the near future, but sometimes it is just necessary. As long as you are upfront with your lender and tell them what the funds are from and you can document it, you should be in good shape. It is always wise to be honest with your lender as they can walk you through the program and take the steps necessary to get you approved.

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The Best Mortgage for Self-Employed Borrowers

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Today’s economy requires many people to turn to self-employment to make a living. The unfortunate part of this, however, is that it becomes harder to obtain a mortgage when your income fluctuates so much. Self-employed borrowers typically have fluctuating income that makes it hard to pinpoint just how much they make. In addition, many self-employed borrowers write off a large number of expenses on their income taxes, making it look like they do not make nearly as much money as they really make. Because mortgage lenders are required to use the amount of money you make as reported on your tax returns, it becomes very difficult to qualify for a mortgage.

Applying for a Conventional Loan

If you have good credit and think your debt ratio is close enough to qualify for a conventional loan, you can apply for this type of loan. In order to qualify, however, you will have to provide full documentation which includes:

  • Last two years’ tax returns with all schedules
  • Business license
  • Bank statements
  • Current Profit & Loss statement

If the tax returns do not report income high enough to get your debt ratio down, you can do one of two things: apply for a different type of loan or wait a year or two and file your taxes with fewer write-offs in the future. Typically, potential borrowers choose to apply for a different type of loan.

A Great Alternative

Since most self-employed borrowers will not qualify for a conventional loan, there is a great alternative that makes it easy to qualify for a loan. This alternative is the Bank Statement Loan. This loan is as close to a subprime loan as a borrower can get today. As the name suggests, the lender uses your bank statements to verify your income rather than any paystubs or tax returns. The benefit to this method is that the lender can see the gross amount of money you put into your bank account every week or month, depending on how you get paid. In this case, your expenses are not taken into consideration as of yet – your total gross income is able to be used.

How the Income Gets Verified

Because bank statements have the potential of being forged, there are certain precautions lenders need to take with this type of loan. When you use tax returns to qualify for a loan, the lender can verify the amounts you provide them with the IRS through an activated IRS Form 4506 which allows the lender access to your tax transcripts directly from the IRS. Because bank statements do not have that type of verification, the lender must verify other things, such as:

  • Your self-employment and income from your CPA – The CPA can provide a letter of verification on his letterhead to verify your employment and income status
  • The presence of a business license to show that your business is legitimate
  • A bank’s stamp and date to verify that the account statements are real

Using the Right Account

You have to choose the right account to use to verify your income when you use a bank statement loan. You are unable to use both a business and personal account – you have to choose one or the other. If you do need to use both in order to qualify for the loan, it will be necessary to determine the difference between the two as the lender needs to make sure you are not “double dipping” or using business income in your business account and then again in your personal account.

How to Pay Your Mortgage Off Faster

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You took out a mortgage with a specific term, but now you want to pay it off faster. Fortunately, you don’t have to refinance to pay your loan off sooner. There are ways that you can make larger payments, getting your principal paid down faster, which pays your loan off early.

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Pay a Little Extra Every Month

Most lenders allow you to pay extra money toward your principal balance. How much you pay depends on what you can afford. Whether you send an addition $50, $100, or $500 – it’s up to you. Just make sure you mark your mortgage coupon accordingly. There should be a spot to mark the extra principal. This ensures that the extra funds get allocated correctly.

While $50 or $100 a month doesn’t sound like a big deal, it adds up. Even this little amount can knock some interest off the life of the loan and a few months off your loan’s term. The key is to keep the extra payments consistent for the greatest results.

Make an Extra Payment Every Year

It’s easy to make an extra payment every year. You have two options:

  • Make one lump sum payment – If you get a bonus, tax refund, or have some other way that you get a windfall, you may want to make the extra payment all at once. You can do this at any time of year. Again, make sure you mark the coupon accordingly so it directly pays down your principal.
  • Pay 1/12th of the mortgage payment each month – If you can’t afford a lump sum payment, divide the payment by 12, and pay that amount in addition to your regular mortgage payment each month. After 12 months, you’ll have made an extra payment that year.

Making 13 payments a year can knock a few years and several thousand dollars of interest off the life of your loan.

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Make an Extra Payment Every Quarter

If you have the funds, make an extra payment more frequently than once a year. If you make an extra payment every three months, you’ll have made four extra payments each year. This could easily knock off several years and a lot of interest off your loan.

Apply a Windfall to Your Mortgage

If you receive a work bonus, work on commission and have a large sale, or get a tax refund, consider applying the funds to your mortgage. You can send any amount that you want to knock your principal down. If you do this regularly, you can knock plenty of time and interest off the life of your loan.

Pay Your Mortgage Every Other Week

This may sound strange, but if you make half of your mortgage payment every other week, you’ll naturally make 13 payments every year. Since there are 52 weeks in the year, you make 26 payments without having to budget extra money. At the end of the year, you’ll have made one full extra payment. If you do this continually, you’ll save yourself money on interest in the long run.

Calculate 15-Year Payments

If you can afford 15-year payments, but don’t want to spend the money on refinancing, here’s a simple tip. Use a mortgage calculator to figure out how much a 15-year payment would be given your interest rate and loan amount. Then make those payments. Make sure you let the lender know that the extra money is for your principal balance. You can then pay your loan in half the time, saving yourself thousands of dollars in interest and being mortgage-free in half the time.

Paying your mortgage off faster is possible. Whether you pay a little or a lot, your efforts pay off in the end. Always check with your lender to make sure they don’t charge a penalty for paying your loan off early, but most don’t today. Also, make sure you don’t pay the lender to set up bi-weekly payments for you. Many will do that as a service, but then charge you a fee for each payment. This takes away from the amount you pay toward your principal balance. You can do it on your own just as easily.

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Can you Deduct the Closing Costs to Refinance?

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It costs money to refinance, just like it did when you bought a home. The lender and appropriate third parties provide their services, for which they need to be paid. The costs add up, so many people want to know if they can deduct the closing costs on their tax returns.

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We help you explore the answer below.

Deducting Closing Costs

In general, you can’t deduct your closing costs when you refinance a loan. The same is true when you purchase a home. But, the good news is that there are a few expenses you can write off during the year that you refinance as well as the years you own the home.

Whether or not you can deduct closing costs depends on if your deductions exceed the standard deduction. The Tax Cuts and Jobs Act increased the standard deduction to $12,400 and $24,800 for singles and couples respectively. The higher standard deduction makes it the most common way to take tax deductions today since many people don’t have itemized deductions that exceed that amount.

If you do have deductions exceeding this amount, though, you can include the following deductions.

Mortgage Interest

Everyone pays interest on their mortgage. No matter your rate or type of mortgage, you can deduct these expenses on your tax returns. You must meet the following requirements to qualify:

  • The home must be your primary or secondary home
  • The refinance must be to improve your home
  • The loan must be for $750,000 or less

If you have a loan amount higher than $750,000, you may only deduct the interest on the first $750,000. For example, if you have an $850,000 loan, you can’t deduct the interest on the last $100,000.

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Mortgage Points

If you pay points to buy down your interest rate or as a part of your closing fees, you may deduct the points. Remember, points are prepaid interest. The lender collects the points at the closing, rather than over the life of your loan.

Unlike when you buy a home, you can’t deduct the full amount of the points during the year you paid them. With a refinance, you must deduct a portion of the points over the loan’s term. If you took a 30-year term, you can deduct 1/30th of the points each year. If you took a 15-year term, you can deduct 1/15th of the points paid each year.

Real Estate Taxes

Just as when you bought your home, you can write off at least a portion of your real estate taxes. The Tax Cuts and Jobs Act states that you can write off up to $10,000 in real estate taxes paid per year. This continues to be possible even after you refinance your mortgage.

Other Closing Fees

Any other closing fees you pay to refinance your loan cannot be deducted. This includes any fees paid to lenders or third parties, such as appraisers, attorneys, or title companies. Keep this in mind as you shop for a lender. Try to find a loan with the least amount of fees to help keep your costs down and to make refinancing make sense.

Always talk to your tax advisor when deciding whether you can write off certain expenses on your tax returns. Typically, just the interest and points get deducted, and as usual, you can still write off your property taxes.

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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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Can a Friend Provide Gift Funds for a Down Payment?

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The down payment is the largest obstacle when buying a home. First-time homebuyers struggle the most, because they don’t have equity in a home to sell. All money they put down comes from their own liquid assets.

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What if you don’t have the liquid assets? Can you get a gift from a friend? Technically the rules state that only family, your employer, or a charitable organization may provide gift funds. There are exceptions to the rule, though.

Proving the Friendship

Accepting money from a friend is different from accepting money from a family member or employer. What if the friend demands repayment? You may end up in a financially difficult situation. Will you default on your mortgage as a result? These are the issues lenders have with friends supplying gift funds.

However, that doesn’t mean you can’t accept gift funds from a friend. You will need to prove the friendship though. Family is easy to prove, whether a blood or marriage relationship. Friendship is a bit harder.

Lenders want to know how long you have known the friend and the depth of your friendship. Lenders want to know the friend is ‘close.’ Just how you prove this will vary by lender.

Proving the Gift Funds

No matter how you prove the friendship, you must prove the gift funds and their origination. You need a gift letter from the donor. Also, the donor must prove the origination of the funds. Just like you would have to do to use your own funds, lenders need to know there isn’t a loan lurking somewhere deep in the trenches here.

Let’s start with the gift letter. The donor must write a simple letter that states the amount of the gift, the reason/address of the property, and the date. The donor must also state that the funds are a gift and not a loan. They must state that no repayment is expected. This one sentence makes or breaks a gift letter.

Next, donors must provide proof of the funds. Are the funds in his/her bank account? The lender may source the funds with their income. If there are large deposits on the donor’s bank statements recently, the lender may ask about them. Basically, the lender needs to know if they are a loan from anywhere else.

If the donor sold a car, stocks, or any other asset, he or she must provide the bill of sale or any other proof of the sale. The lender needs solid proof that the funds aren’t a loan. Any funds the donor can’t prove may not be able to be gifted.

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What is the Maximum Amount you Can Gift?

Lenders typically allow 100% of the down payment to be a gift. Certain loan programs, like the FHA loan for borrowers with credit scores lower than 580 have different rules. The FHA requires the borrower to come up with at least 3.5% of the purchase price for the down payment. The remaining 6.5% may come from gift funds, though.

Aside from lender/loan restrictions, the IRS limits how much one person can gift you too. As of 2019, the IRS allows gifts of up to $15,000 without tax implications. If you receive any more than $15,000 from one person, you and the donor may have to report it at tax time.

Should a Friend Provide Gift Funds?

Before you accept gift funds, think about what it means. You shouldn’t be repaying the money, but how does the friend feel? Will the friend expect equity in the home? Will the friend expect to be on the title of the home? Working out these questions, no matter how difficult they may be to ask, is important.

You may even want to consult with your attorney before accepting gift funds. Make sure everything is on the up and up before you accept anything. Your lender isn’t the only person you have to face – you’ll face your friend for a much longer time in the future. Know his or her expectations before accepting the funds.

Gift funds are a great way to become a homeowner when you don’t have the money for a down payment. Many loan programs allow them, but exercise caution when accepting them. If they are from a friend, work out the fine details to avoid any issues in the future.

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