Using your home to pay off your credit cards?
Home equity loans are great. They offer some of the lowest interest rates around, and they are easy for homeowners to get. So, when you look at your monthly credit card statement, that home equity line of credit starts to look pretty attractive. Right? You could borrow against your home, pay off your credit cards and save a fortune. But, this approach can be pretty risky, so put some thought into it before rushing to borrow against your home.
The biggest concern in borrowing against your home is the collateral. When you mis a credit card payment, you have little at risk aside from your credit rating. Credit cards are unsecured debt; you don’t put up any collateral. Home equity loans, on the other hand, are collateralized – with your home. If you default on a home equity loan, you could wind up putting your home at risk. Credit card debt may be more expensive, but in a sense, they also can be safer.
The next problem that many face involves the credit cards. After they pay off their credit card debt with a home equity loan, they start to use the credit cards again. What happens? Well, the borrower has to make payments on the home equity loan. But, he also has all this new credit card debt. In extreme cases, he could wind up with more debt than when he started.
If you plan to use a home equity loan to pay off your credit card debt, cancel the credit cards. This is the only safe way to use this strategy (though it is not completely safe, because you are still using your home as collateral). You need to be able to resist the temptation to use those credit cards again, and sometimes the only way to resist temptation is to remove it completely. Don’t just cut up your credit cards. Call the company, and cancel them. The customer service reps on the phone will do everything they can to keep you as a customer, including offering to increase your credit limit, lower your interest rate (probably only temporarily) and extend cash advances. Be strong. Do not accept these inducements.
If you are using a home equity loan to pay off your credit cards, be careful. Above all else, don’t use your credit cards any more!
Do I need to get out of my ARM?
Analysts expect a record amount of foreclosures in the coming months. In particular, “hot” real estate markets are at risk. Places like Boston, New York and San Francisco – which have seen housing prices grow astronomically for the past few years – could become the scariest markets for existing home owners. As mortgage interest rates go up, homeowners with adjustable rate and interest only mortgages could feel the squeeze. Believe it or not, your mortgage payment could grow every month, and with an interest only or adjustable rate mortgage, there is little you can do about it. Now may be the time to look into a fixed rate mortgage.
If you have a traditional fixed rate mortgage, you probably don’t have to worry. Your mortgage interest rate is locked in, regardless of what happens to housing prices around you. More exotic home loans, though, could be troubling in the current financial climate. If you have an interest only or an adjustable rate mortgage, refinancing should be a top priority.
The reason for the insanity in the mortgage market is the recent credit crunch caused by subprime mortgages. Subprime mortgages are risky. Lenders issue them to prospective home buyers who may not qualify for mortgages with more favorable terms. For a higher interest rate, the lender accepts the risk. Unfortunately, these loans have caused problems for mortgage lenders this year, leading to substantial losses. As a result, lenders are tightening the rules on subprime lending, and they are issuing fewer adjustable rate and interest only mortgages.
Borrowers who currently have interest only or adjustable rate mortgages may want to think about refinancing. As rates go up, your mortgage payment increases. You could see your cost of living increase every month simply as a result of changes in the market for mortgage interest rates. You are at the mercy of the market, and your home could wind up at risk. Instead of hoping for rates to be cut, you can take action today.
Refinance into a fixed rate mortgage, and enjoy the predictability of the same monthly mortgage payment every month. Your fixed rate mortgage may not be as cheap as the ARM with which you stated. But, times have changed, and so have interest rates. Hunt for a deal later. Now is the time to be conservative. Start looking for a fixed rate mortgage today!
A safety fund for your home
Every financial advisor suggests that you put aside a safety fund before you do anything else. You should save three to six months’ expenses in case you lose your job or suffer some sort of financial misfortune. You should have a safety fund before you save for retirement or put money into your kids’ college fund. You can take this thinking a step further and put together a special safety fund specifically for your home.
Think about the money you spend on your home. The monthly mortgage payment probably is the first thing that comes to mind. It is your largest home expense, and it comes every month. But, what else is there? Most people pay their real estate taxes through their mortgages, so it looks like the mortgage is the only expense. Think harder. In addition to your mortgage, you probably pay homeowners insurance. If you live in a condo or a coop, you have a monthly association fee. In some places, like New York City, this monthly fee can be quite high.
Next, there are the unexpected expenses. You may have a problem with your foundation, or you could have a flood in your basement. During a storm, you may find a leak in your roof. These problems have to be addressed, often quickly. They have to be resolved whether you have the money or not. While these expenses can be unexpected, you can prepare for them by putting money aside.
This is why your home safety fund becomes important.
Start with your mortgage payment. Put aside enough money to cover your mortgage for at least three months. Then, turn to your homeowners insurance and (if applicable) association fees. Do the same. Save enough money to pay your homeowners insurance and association fees for at least three months. Finally, think about the unexpected. How much would it cost to fix one major problem, such as a roof, kitchen or termite problem? Find out where your risk is most likely to be, and put that money aside, too.
It is always best to plan ahead. Put together your home safety fund. If you don’t need it, that money will do nothing but accumulate interest, which just puts more money into your pocket. But, if you lose your job or have to fix a leak in your bathroom, you’ll be happy that you have your home safety fund.
Understand the Tax Implications of Investment Property
You are getting ready to buy a second home. You have been pre-approved, run your credit reports and secured a pre-approval letter from a mortgage lender. You are ready to buy your real estate investment property. But, you haven’t thought about taxes. In addition to real estate taxes, you will have to be ready for income taxes as well. After all, you want this investment to make money for you!
Your investment property is a business, and you should treat it as such. You will have to put money into your business, for example, to make repairs. These expenses may be tax deductions! Keep track of them carefully. You should save your receipts and be ready to settle with the IRS (and your state) by the end of the year.
This is especially true if you have income form your investment property – which ultimately is your goal. All that income is taxable, and the rules are not straightforward. It is likely that you will need all those deductions to offset some of your income. Save some of the income you earn to pay the tax bill.
If you are going to buy an investment home, become familiar with the income tax laws surrounding property management, federal tax and state tax. Instead, you could talk to a professional tax preparer who will be informed on these issues and keep up with the changes from one year to the next. Many will be willing to prepare a tax projection for you before you even start to look for an investment property. This will help you understand what your income tax burden would be if you purchased a real estate investment. Make sure that the tax preparer models a few different scenarios for you. Unless you are extremely lucky, your real estate business is unlikely to be completely predictable. Since your tax burden will vary, you should be aware of the possibilities.
Taxes can catch you off guard, sticking you with a sizeable bill when you least expect it. Unless you have extra money sitting around, you will want to plan ahead. Have some tax projections run, so you can be ready for the IRS at the end of the year.
Remember; you can’t afford an investment property if you can’t afford the taxes!
Plan Your Purchase up Front
When you are getting ready to buy a home, everything seems to happen quickly. Surprises arise, and they can catch you off guard. The easiest way to take the sting out of the process is to plan ahead. There is a lot you can do before you cruise the real estate section of the newspaper or contact a mortgage lender for pre-approval.
Start by getting your documents in order; you are going to need them. You should dig out your tax returns for the past two years. If you do not have them, contact your tax preparer. Most will mail or fax you a copy right away, especially if you are not asking during tax season. Do you prepare your own taxes? Many people do. If you did not save a copy of your tax return, you can contact the IRS for copies. Keep in mind that it may take a few weeks for the IRS to get them to you. This is another good reason to plan ahead.
In addition to your tax returns, you will need your W-2 and pay statements for the past few months. Most employers do this electronically now, so you can go to the company intranet at any time and pull copies, print them and keep them for your records. If your company has not moved into the information age, start by talking to your Human Resources department. If they cannot help you out directly, they can still point you in the right direction.
For the self-employed, this step is a bit more complicated. You will need to collect your 1099 forms that have been issued to you by clients (if applicable), and you should prepare a profit and loss report. Make sure you have information, such as bank statements, to support your claims. The mortgage lender will not simply accept a report that you have prepared.
You should run your credit report before getting started as well. You are entitled to a free copy of your credit report every year from each of the three major credit reporting agencies: TransUnion, Equifax and Experian. This will give you an indication of your credit strength, and it will be an important factor in determining the mortgage interest rate you are given.
There can be other documents that you will need, too. Pull together your bank statements and balances from brokerage accounts. If you are divorced, you should have a copy of your divorce decree on hand. It’s better to have all your documents up front, especially if it could take you a few weeks to collect them. If you have everything you need when you start to look for a home, you won’t experience nearly as much stress down the road.
When Should You Refinance
Refinancing is strictly a game of measuring costs. A slight drop in rates may offer little reason to refinance your mortgage, especially if the trend is pointing downward. Instead of jumping for a lower interest rate, pull out the calculator and do a little homework. Measure the costs of a new mortgage against the savings it yields. This quick exercise could save you thousands of dollars, not to mention the headaches that come with the additional cost of buying your home.
A refinancing mortgage, like a first mortgage, has fees. The likelihood that you will have to pay closing costs is quite high. Before applying for a refinancing mortgage, take a look at the outcome. You should recapture more in savings than you pay in closing costs for the mortgage to work in your favor. Realistically, you should look at the savings against how long you plan to stay in your home rather than over the life of your mortgage. When you move, you’ll probably secure a new loan, making your current refinancing moot. Thus, the timeframe for recapturing the fees paid for your refinancing mortgage is shorter than you may think. Keep this in mind as you shop for a refinancing mortgage.
If the closing costs for you refinancing mortgage are $3,000 for example, and you play to stay in your home for another five years, you should save at least $3,000 over five years – at least. Otherwise, you are spending more than you would save. Including inflation, the calculation becomes a bit more complicated, but the outcome is that refinancing savings has to be higher for your new mortgage to work in your favor. Realistically, your mortgage savings should at least double your closing costs for the decision to pay off.
Be honest with yourself when doing the math. Sometimes, it’s too easy to be enchanted with what looks like a great deal. You may tell yourself that you can stay in your current home for a few extra years, even if it seems unimaginable. Don’t put this kind of unreasonable pressure on yourself. Your mortgage is a means to an end: home ownership for as low a cost as possible. When you put the mortgage before the home, you wind up paying more than you have to.
Refinancing is always worth considering, especially as your credit score improves (because you could be eligible for a lower interest rate). But, it pays to work the numbers first. You don’t want to pay the bank for nothing; you already pay them enough! Make sure your refinancing mortgage will save you money before you sign on the dotted line.
When Should I Consider an Adjustable Rate Mortgage?
Adjustable Rate Mortgages (ARMs) are not right for everybody. If you plan to stay in your home for a long time, have a rocky credit history or prefer that your payments be the same every month (i.e. predictable), you would be wise to get a 30-year fixed rate mortgage. But, buyers with strong credit ratings who plan to move after a few years can save a considerable amount of money with a 3-year or 5-year ARM.
Most lenders offer low interest rates on ARMs, making these loans quite attractive to prospective home buyers. For the first few years (three or five, depending on the particular mortgage you secure), the ARM has a low fixed rate. After this initial period, though, the rate becomes variable, changing monthly with the bank’s prime rate. In an economic climate with falling interest rates, an ARM can be advantageous; your monthly mortgage payment actually goes down every month. If rates are going up, on the other hand, your mortgage becomes more expensive. You are at the mercy of the interest rate market when your mortgage rate is adjustable. If there is a maximum monthly payment that you can afford, a fixed-rate mortgage would be safer.
For those who don’t plan to stay in the new home for a long time, though, an ARM can be an effective financing tool. If you plan to live in your new home for only a few years, you can use an ARM to get a low fixed interest rate. The fact that the rate will become variable in three-to-five years does not matter if you plan to sell your home by then. With an ARM, you get a lower interest rate for the short term – which is what you need. If you decide not to move, you can refinance into a fixed-rate mortgage later. Of course, if interest rates are going down, you may want to hold onto that ARM for a while! Keep it for as long as it makes sense, and then refinance when conditions change.
Since the interest rates for ARMs can be unpredictable, mortgage lenders apply stricter underwriting criteria. For the banks, these loans are riskier. If you do not have a high FICO score, you may not be eligible for an ARM. Before basing your house hunting plans on an ARM, talk to a few mortgage lenders first to see if you will qualify. When you have found a favorable mortgage lender, ask to be pre-approved or pre-qualified. Then, you will be more certain that an ARM is the right fit for you.
ARMs can be powerful tools for those who qualify. If you do not plan to spend more than a few years in your new home and you have a high FICO score, talk to a mortgage lender about an ARM. You will notice the savings every month.
