How much house can you afford? Consider the 28/36 rule.

By Sabrina Karl

The best time to decide how much you can safely spend on a new home is before you begin looking, to avoid falling in love with a house that would stretch your finances too thin. Fortunately, there is a tried and true method for determining what’s “too much”.

It’s called the 28/36 rule and it’s been a standard lenders tool for decades. But it’s also a homebuyer’s tool, enabling you to calculate what’s reasonable based on your income and other debts.

Here’s how it works. The number 28 refers to 28% of your monthly gross income (so, pre-tax) and represents the maximum monthly housing payment you should consider taking on. So if you make $5,000 per month, the rule suggests you cap your housing costs at $1,400.

Note that housing includes not just your mortgage payment, but also your monthly share of property taxes and homeowner’s insurance, as well as private mortgage insurance and homeowner association fees, if those apply.

As for the 36, lenders are checking that your total debt obligations each month don’t exceed 36% of your monthly income. This includes not just your housing expenses, but all your debt, such as payments on auto loans, student loans or credit cards.

Using the same $5,000 monthly income example as above, this allows for a total debt obligation of $1,800. So if your existing debt is $400 or less, you’d still be within the boundaries to take on $1,400 in housing costs. But if your monthly debt is already $800, you’d have just $1,000 available for housing.

Since the 28/36 rule is a guideline rather than a federally mandated rule, lenders are sometimes willing to flex the ratios if you have excellent credit. But keep in mind that the rule can still be useful for keeping yourself in check.

How long after bankruptcy can I apply for a mortgage?

By Sabrina Karl

Bankruptcy is a serious financial event that can leave you feeling its impacts for years after filing. But that doesn’t mean you can’t ever apply for a mortgage again. You just have to understand what timing is realistic, and what smart moves to make while you wait.

The first thing to know is that there will be a waiting period, starting at your bankruptcy’s discharge or dismissal date, not the filing date. But the length of that period varies according to whether you filed for Chapter 7, 11, or 13 bankruptcy, and what type of mortgage you’re considering.

Depending on your situation, you’ll need to wait at least one year, and usually two, but perhaps 3-4 years. If you’ve filed more than one bankruptcy, or have also undergone a home foreclosure, the period may be extended up to seven years.

Fortunately for some, if your bankruptcy involved extenuating circumstances, like a one-time income hit from job loss, divorce, or medical bills, you may be able to shorten your wait.

But even after the period concludes, the mortgages you’ll qualify for may not have very favorable rates. That’s why it’s important to play it smart during your waiting period.

First, you’ll want to build up your credit history, establishing an on-time payment track record for at least 12 months and not using your full credit limit (aim for using less than 30 percent).

Second, save as much for a down payment as possible. The more funds you can put down on a new house after bankruptcy, the better the mortgage deal you’ll be able to secure.

Bankruptcy can certainly complicate or delay securing a new mortgage. But focusing on your credit score and down payment savings while you wait for the green light is your best path toward a new home.

Should I consider a balloon mortgage?

By Sabrina Karl

Virtually every mortgage shopper has the same goal: find the best loan for your money. With the most obvious measure being the interest rate, it’s no surprise that the low APRs and reduced monthly payments of a balloon mortgage can be tempting. But, buyer beware.

Like adjustable rate mortgages, or ARMs, balloon mortgages offer fixed payments for a set term, often five to seven years. But whereas an ARM continues after shifting into an adjustable-rate period, balloon mortgages terminate with the borrower on the hook to repay or refinance the remaining balance. The large size of this balance is the “balloon payment” that gives the loan its name.

Balloon mortgages can make sense for anyone certain they’ll sell their home within the 5- or 7-year loan period, since the sale proceeds can pay off the loan balance. But without that certainty, there are significant risks to balloon mortgages.

First, you may not be able to sell your home for the price or timing you need. You could have difficulty finding a buyer, or decreased home values may mean your sale price won’t cover the balloon payment.

Second, you may encounter trouble refinancing. Again, dropping home values could prevent a lender from offering you a sufficient loan. But credit changes also pose a risk. If your credit score drops substantially, it may be hard or even impossible to refinance.

In either case, if you can’t come up with the balloon payment, you could face foreclosure. Some lenders may try to help you move into another loan to avoid this, but there are no guarantees or requirements that they do so.

The initial savings of a balloon mortgage may be worth the risk in a small number of scenarios. But for the majority of homebuyers, the gamble far outweighs the limited upside.

3 Things To Do Before Applying for a Mortgage

By Sabrina Karl

If you’re considering buying a new home, first ask yourself where you stand financially. How strong or shaky you are on three factors lenders care about — your credit score, cash on hand, and debt — will determine how favorable (or not) a mortgage you’ll be offered, or if you’re approved at all. So you may want to bolster these before applying.

Start by looking up your credit score, as well as that of anyone else who will be on the mortgage. Unless you’re already above 760, boosting your score can land you better rate offers from lenders.

Raising your score can generally be done by making all of your payments on time, paying down debt, and not opening any new cards or loans shortly before applying for a mortgage.

Reducing debt is doubly important because it also lowers your debt-to-income ratio. Lenders use this calculation to compare your income to your total debt (including car loans, student loans, credit cards, and any other debt), and the lower your monthly debt obligation, the stronger your application.

Although paying off a loan or card entirely is great, any debt reduction will improve your ratio. Consolidating multiple debts into one lower monthly payment can also help.

The third critical lender consideration is how much cash you have. In addition to wanting to see you’ll have funds in reserve after making your down payment, they’ll also look at how much you had two months ago, not just today. So save as much money as you possibly can, and don’t rely on a large cash gift from a relative right before applying.

When aiming to maximize the size and rate of your new mortgage, fortifying your credit score and savings, while reducing your debt, are surefire ways to put your best application forward.

Is your ARM set to adjust? Here are your options.

By Sabrina Karl

If your home is financed with an adjustable rate mortgage, or ARM, you’ll eventually be faced with a decision. That’s because ARMs have a fixed rate only for an initial period of 3, 5, 7 or 10 years. After that, your lender will start adjusting your rate every year.

If your timing is lucky, you could see a downward rate adjustment. But often, you’ll find yourself looking at higher monthly payments for the next year.

Once in the adjustment period, your lender will recalibrate your rate every 12 months, and you have three main options on how to respond. You can do nothing and accept the new rate. You can refinance into a new ARM, starting over with a new fixed-rate period. Or you can eschew adjustments by refinancing into a fixed-rate mortgage.

Your best choice will depend on a number of factors. Certainly, if your adjustment will lower your payment, you’ll want to do nothing and enjoy your good fortune. But that scenario isn’t especially likely for those with ARMs currently moving into adjustment, as rates have inched upwards over the last 5-6 years.

If your rate will go up significantly, refinancing can be a smart option, with ARMs making good sense if you expect to move in the next handful of years, and fixed-rate mortgages being better if you plan to stay for many years.

Another consideration is the cost to refinance. Though moving out of one ARM into another with a lower rate can be attractive, the gains must be weighed against the refinancing expenses you’ll incur. Keeping your current ARM could turn out to be more economical.

Of course, if you don’t refinance, this decision will come upon you again in a year, when your next rate change is announced. And all of the same considerations will apply.

Buying a home? Here’s what to expect at the closing.

By Sabrina Karl

For most homebuyers, the process of house hunting, arranging financing, finding the right home, and making it through an offer and inspection is a months-long process. So it’s fitting to call the day it all finally concludes “the closing”.

In short, the closing is when ownership and money are legally transferred, providing the seller with funds for the sale and the buyer with a deed in their name and keys in their hand.

Depending on the state and the parties involved, the location and number of people around the table can vary. Sometimes both seller and buyer participate at the same time, while other times the two parties’ closings are handled separately.

In either case, others attending the closing might include the real estate agent(s) and representatives of the title insurance company, the lender, the escrow company, and any representing attorneys.

Generally this happens in person at the offices of the title company, the lender, or an attorney. But some companies have begun allowing electronic signatures, executed either ahead of time or on the day of closing.

The most prevalent activity at closing is reviewing and signing documents, with you penning your John Hancock at least a dozen times, and likely twice that. These signatures execute three categories of transactions: transferring the real estate into your name, finalizing your home loan, and executing title insurance.
As homebuyer you’ll also need to bring a check (usually certified or cashier’s) to cover any down payment, closing costs, or other agreed upon contributions to close the deal, unless arrangements were made to pre-wire these funds.

Ask your agent or lender in advance for a checklist of what to bring and what to expect, as it’s the smartest way to help you navigate this big day with as little stress as possible.

When it makes sense to refinance to a shorter mortgage

By Sabrina Karl

It’s not uncommon for a homeowner’s financial situation to change in the years after taking out their mortgage. And if that change is positive – because income has risen, expenses have dropped, or a windfall has been received – it can make sense to shorten the time that mortgage payments need to be made.

Refinancing can be a good way to do this, but it’s not for everyone and isn’t smart at all times. It depends on rates and on how many years are left in your current mortgage.

Although rates for shorter terms almost always run lower than 30-year fixed rates, whether it’s a good move for you depends on your original rate. You may find that today’s best 15-year rate is higher than your 30-year rate from a decade ago.

But rates are only part of the equation. How much time is left in your current term, and how long you expect to stay in your house, also bear considering. With just 5-10 years left on your mortgage, the only refinance likely to make sense is a 5-year adjustable rate mortgage. But if you have more than 20 years to go, refinancing to 10 or 15 years might pay off.

Knowing you’ll be staying in your home for the full term you’re considering is also useful. If it’s likely you’ll sell in the ensuing years, it’s probably financially smarter to avoid refinancing costs and, if you have funds available, make extra payments on your existing loan.

In all cases, of course, shortening your mortgage duration will increase your payment. While choosing a 15-year mortgage instead of one at 30 years won’t double your payment, your monthly obligation could be quite a bit more than what you’re used to. So consider carefully what level of payment feels comfortable to you.

What is a jumbo mortgage?

By Sabrina Karl

In the world of mortgage jargon, it’s refreshing to see a term that tells it like it is. A jumbo mortgage is, quite simply, a very large mortgage. And if the home you’re buying is expensive or in a high-cost area, you’ll likely need one, so let’s look at how they differ from standard mortgages.

Jumbo loans are also called non-conforming loans because they don’t conform to Fannie Mae and Freddie Mac’s limits for purchasing mortgages. In most of the U.S., the 2018 threshold for conforming loan amounts is $453,100. But in high-cost housing markets — largely in the Northeast, along the West Coast, and in Hawaii — the limit before hitting jumbo territory rises to $679,650, or even higher.

If you’ll need a jumbo mortgage, a few extra things might be required of you beyond qualifying for a conforming loan. For one, you may need a slightly higher credit score, as many jumbo lenders require scores of at least 700.

Your down payment requirement may also increase. Though some conventional mortgages allow down payments as low as 3 percent, a jumbo mortgage will likely require at least 10 percent, and maybe as much as 15 or 20 percent.

Jumbo lenders will generally also require that you show more cash in reserve than a conforming mortgage would require. Needing to demonstrate reserves of 12 months’ mortgage payments is not uncommon for jumbo loans.

As for costs, jumbo mortgages used to charge higher rates than conforming loans. But today, they may be more, less or about the same. They may, however, cost more for processing given their increased paperwork. And some lenders will require a second appraisal be conducted.

Though you won’t have a choice if the house you’re buying requires a jumbo mortgage, you’re wise to know the differences going in.

How can I stop paying private mortgage insurance?

By Sabrina Karl

If you took out your current mortgage with less than a 20 percent down payment, you’re almost certainly paying for private mortgage insurance (PMI) every month. While PMI serves a welcome purpose for those who otherwise wouldn’t be able to buy a home, it’s an added expense that’s best dropped as soon as possible.

In essence, PMI is an extra fee homebuyers pay to make the lender willing to extend a mortgage when the down payment is small. If the homeowner defaults, private mortgage insurance covers most of the bank’s loss.

For any new or refinanced mortgage of more than 80 percent of the home’s appraised value, PMI is calculated during the closing process and generally broken into monthly amounts that are tacked onto the monthly mortgage payment. So when PMI can be eliminated, the monthly payment drops.

For conventional mortgages, the Consumer Financial Protection Bureau allows homeowners to request PMI elimination once their mortgage balance falls to 80 percent of the home’s value. This can occur over the course of normal mortgage payments, or more quickly if the homeowner makes extra payments. It can also occur if the value of the home has risen substantially due to market conditions or significant improvements made by the homeowner.

In order to cancel PMI at the 80 percent threshold, homeowners must make the request in writing, be current on their payments, and have a good payment history. They may also be required to prove there are no additional liens on the property, or to pay for a new appraisal.

There is one additional way to eliminate PMI, and that’s to simply wait until the mortgage falls to 78 percent of the home’s original value. At that threshold, lenders must automatically cancel PMI, though only if the mortgage is current on its payments.

How are ARM rates calculated?

By Sabrina Karl

Adjustable rate mortgages, or ARMs, can be attractive for homebuyers who don’t expect to stay in their house for the long haul or who think interest rates will be lower in the future. But since plans often change, and rates are virtually impossible to predict, it’s important to understand how ARM rates adjust.

Each ARM has an initial period and an adjustment period. The initial period is typically 3, 5, 7 or 10 years during which the rate is fixed. But after that, the rate will change according to its adjustment period. For example, a 5/1 ARM will remain fixed for five years, then adjust every year after that.

Two terms in an ARM’s fine print tell you how the new rate will be calculated: the index and the margin. The index is a market benchmark to which your rate is formally pegged. Many ARMs use the 12-month LIBOR index, but there are several others. Each ARM will name the index with which it is linked, and that index will fluctuate with market conditions.

The margin, on the other hand, is fixed and serves as an add-on to the index. So if an ARM’s margin is 3%, and the 12-month LIBOR index is 2.25% at adjustment time, the new rate would be 5.25% (2.25% index + 3% margin).

Two more ARM terms can also come into play. One is the rate adjustment cap, which limits how much the rate can move with any one adjustment. The other is the maximum rate, which specifies the very highest it can rise over the life of the loan.

Anyone considering an ARM will want to carefully compare different products according to index and margin rates, as well as adjustment caps and maximums, as digging into these details can help differentiate between otherwise similar-seeming ARMs.