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How Home Equity Works

What is Home Equity?

Your home equity is the appraised value remaining in your home after you subtract the remaining balance you owe on your existing home
mortgage (s). It can be thought of as the part of the home you actually own instead of the bank: the part you’ve paid for so far.

It isn’t difficult to build equity in your home, and chances are if you’ve owned your home for a while and have been making your regular mortgage payments, you probably have built a considerable amount of home equity already. Though the housing market rises and falls in cycles, the overall tendency is consistently upward. In other words, property values tend to rise over the long term.

How Can Home Equity Be Used?

Once you have equity in your home, you can start to use it to fund nearly anything you want  or need. Having equity in your home puts you in a powerful position, as you can use that equity to qualify for credit and borrow money. Buy a new car, take that dream vacation, fund a college education, make renovations and improvements to your home. Whether to pay for an emergency or finance a dream, there are two primary ways to tap into the wellspring that is your home equity: a home equity loan and a home equity line of credit.

What Are Home Equity Interest Rates Like?

A good question to ask before borrowing money from any source is: how much is it going to cost in the long run? Because your home is being used as collateral on the home equity loan or home equity line of credit, the risk for the lender is considerably lower, and therefore interest rates on home equity loans and home equity lines of credit are usually lower than the average interest rate on a credit card.

Home equity loans and home equity lines of credit are, however, usually higher than the interest rate on the average fixed rate mortgage. And in general, home equity loans usually have lower interest rates than home equity lines of credit.

What Are Some of the Other Benefits of Home Equity?

As if borrowing money weren’t advantage enough, home equity offers a bevy of other benefits as well, including:

Consolidating Debt

Debt consolidation was designed to help individuals who are “drowning in debt” to regain control of their financial lives. Consolidating debt gives individuals the chance combine their various monthly payments into a single monthly payment that is usually lower than the sum of the individual monthly payments on the same debt. Payments on consolidated debt are also quite often at a lower interest rate than the rates offered by the individual lenders.

Warning Signs

If one or more of the following applies to you, debt consolidation may be in order:

* you pay for normal living expenses with credit;

* you transfer balances around from one credit card to another;

*  you can only afford the minimum monthly payments on your credit cards, and no more;

* you have maxed out one or more credit cards;

* you find yourself spending more than half your income to pay your monthly credit card payments;

* you’re looking to open yet another line of credit in order to better manage your current debt, expenses, and lifestyle;

The following is a breakdown of some of the best and most common ways to consolidate debt:

Debt Consolidation Loans

The “traditional” way to consolidate debt is to take out a debt consolidation loan. This is a personal loan that is unsecured, and therefore considered riskier other types of loans. Lenders therefore will usually charge higher interest rates for these loans, the advantage to getting such a loan being the single (and hopefully smaller) monthly payment. People with lots of debt may find they have difficulty getting a lender to give them a debt consolidation loan, however, and may need to look further to find a viable debt consolidation solution.

Debt Settlement

Debt settlement agencies help you resolve debt by becoming the intermediary between you and your creditors, You stop paying your various creditors and instead make a single payment to the debt settlement agency.

Home Equity Loan vs. Home Equity Line of Credit

There are advantages and disadvantages to both home equity loans (HELs) and home equity lines of credit (HELOCs), making the choice between the two dependent on your unique needs and circumstances.

Amount You Can Borrow

Both home equity loans and lines of credit allow you to borrow up to 100% of the equity in your home. In some cases, lenders will even allow you to borrow up to 125% of your home equity.

Qualifying Requirements

Both HELs and HELOCs require you show proof of the following:

                * personal income;

                * ownership of the home ownership (ie. Title);

                * current mortgage;

                * current value of the home (via a professional appraisal).

A home equity loan additionally requires proof that at least 20% of the home’s value has already been paid off. So, if you have yet to pay off at least that much of your home’s value, then your choice of which instrument to apply for is made for you.

Purpose for the Money

If you wish to use the money borrowed in a lump sum for a single, one-time expense (ie. a particular renovation, an emergency, a desired purchase, or to consolidate debt), then a home equity loan may be the better choice.

If you don’t have a single, particular use for the money in mind and don‘t think you‘ll need the money all at once but rather feel that you’ll be needing it on a periodic basis (ie. for lengthy and drawn-out remodels, medical bills, or college tuition payments that will be made in intermittent sums), then a home equity line of credit may be the better choice.

How Much Mortgage Can I Afford?

To establish how much mortgage you can realistically afford, you can use one of two main formulas – called “Qualifying Ratios”. Qualifying ratios examine a person’s income and expenses in order to estimate how much money can reasonably be spent on monthly mortgage payments.

Buying the Home: Down Payment and Closing Costs

This is the first and most obvious factor most people consider in buying a home. How much of a down payment can I afford? And how much can I spend on closing costs?

The down payment is usually between 3% and 20% with most conventional loans preferring down payments within the 10-20% range. Low-to-moderate income households, however, can find programs enabling them to purchase homes with as little as 3-5% down.

Closing costs are fees for various items that must be handled through your lawyer in order for the deal to legally go through. These include: origination fees, title insurance, attorney fees, recording and transfer fees, and pre-pays.

Keeping the Home: Monthly Housing Expenses

Taken into account when determining monthly housing expenses are:

                * Mortgage principal;

                * Mortgage interest;

                * Taxes;

                * and Insurance.

This is commonly written as “PITI” for “Principal, Interest, Taxes, Insurance”.

In the case of conventional loans, your monthly housing expenses should fall below 26-28% of your gross monthly income. For FHA mortgages, the qualifying ratio is 29%. If you carry any long term debt (that‘s expenses extending 11 months into the future or more), then the ratios change slightly. Conventional loans allow a maximum monthly housing expenses and long-term debt combined of 33-36% of gross monthly income; FHA loans allow a 41

How to Apply for a Mortgage

Once you select a lender and a mortgage suitable to your needs and abilities, it’s time to officially apply for that mortgage. Submitting an application for a mortgage can seem intimidating at first, but it need not be difficult.

Before sitting down to fill out a mortgage application, be sure you have the following information handy:

* your income, past and present;

* a list of your assets;

* a tally of your regular expenses and existing financial obligations;

* an accounting of your employment history

Mortgage applicants will also need to provide the following records or documents:

* the past two year’s W-2s;

* pay stubs for the month leading up to submitting the application;

* statements from all the applicant’s bank accounts – checking, savings, retirement, investments, etc.

* proof of current outstanding debts that show both the current balance and minimum monthly payment on each (ie. credit cards, car loans, student loans, other home mortgages, child support, alimony, etc.)

If you are self-employed or you own a ¼ share or more in a business, you will also be asked to provide copies of your federal income tax returns.

The preceding is not the only information a lender may require of you, but it is a partial listing of the information that any and all lenders will most assuredly require.

After you’ve submitted your application, the lender will order a property appraisal (paid for by you), and will have your credit checked. Oftentimes, a potential borrower might choose to have the property appraised independently before submitting an application, just to make sure that the property value merits the offer made. Potential borrowers may also check their own credit first before applying for a mortgage so that they may take the initiative to fix or correct any negative items remaining on their credit report before the potential lender takes a look at it. The 3 major credit reporting agencies – Experian, Equifax, and TransUnion – now allow all consumers to receive a free copy of each of their credit reports once per year.

How FHA Works

The Federal Housing Administration (FHA) does not directly make loans to borrowers but rather provides insurance on loans made by approved lenders. FHA-insured mortgages can be obtained for single-family, multi-family, manufactured and mobile homes, and hospitals.

The FHA was created in 1934 by congress to help Americans to obtain a mortgage and purchase a home. Until the FHA came into being around 60% of Americans rented their homes, and most mortgages had high monthly payments, short loan terms, and stringent approval requirements. In 1965, it became part of the U.S. Department of Housing & Urban Development (HUD).

FHA loans differ from conventional loans in a number of ways. The down payment required for a conventional loan is typically much higher than for an FHA-insured loan. FHA loans also have lower credit requirements than conventional loans, making them more available to a wider range of potential homebuyers.

FHA mortgage insurance appeals to lenders because it protects them against loss should the borrower default on the loan. That is the key difference between FHA mortgages and conventional mortgages – that lenders still get paid no matter what. Because FHA mortgages are more preferable to lenders than conventional loans, it‘s far easier for a borrower to get approved for one. It is therefore quite often to a potential homebuyer’s advantage to pursue FHA-insured mortgages.

FHA loans offer borrowers several other valuable benefits, not least of which is those aforementioned smaller down payments. Unlike a conventional loan, which ordinarily requires 10-20% down, FHA-insured loans only require down payments as low as 3-5%. The FHA is also more flexible in calculating factors to determine whether or not to approve the loan, factors such as household income and repayment ratios.

The borrower is the one who pays for the mortgage insurance, usually by having it folded into their monthly mortgage payment. The cost of FHA mortgage insurance typically drops off when the balance remaining on the loan is greater than three-quarters of the property value or after 5 years, which takes longer.

Having insured over 30-million properties since its formation in 1934, the FHA is the world’s single largest mortgage insurer. It is funded completely by way of self-generated income, via the mortgage insurance payments made by its mortgagees (or borrowers). Currently, the FHA has nearly 5-million single-family homes and nearly 15,000 multi-family homes in its insured-mortgage portfolio.

How Reverse Mortgages Work

Reverse mortgages were created in order to help ease the financial burden on aging seniors. A reverse mortgage is a type of financial instrument that permits home owners over the age of 62 to gain access to the money they have accumulated as home equity. 

How a reverse mortgage works is that the lender makes payments to the borrower, rather than the other way around. The amount paid out is based on a percent of the equity remaining in the home (that’s the full property value minus the amount still owed).

Seniors can use money from a reverse mortgage to fund:

                * retirement;

                * medical costs;

                * a new car;

                * home repairs;

                * renovations;

                * estate planning;

                * a grandchild’s education;

                * travel and leisure;

In order to get a reverse mortgage your current mortgage does not need to be completely paid off. The amount you can receive in a reverse mortgage is based on the equity in your home. As a mandatory part of the reverse mortgage process, however, your existing mortgages will be paid off. Some people simply use a reverse mortgage to get out of having to pay monthly mortgage payments, the money they receive just being a bonus.

When you receive a reverse mortgage, your home remains in your name, and your retain total control of the property. It is also still your responsibility to maintain the house and property and pay all taxes and insurance as usual. No reverse mortgage lender can take your home away from you so long as you keep that home as your primary residence.

Why Choose an FHA Mortgage

The Federal Housing Authority (FHA) insures loans against default, protecting both lenders and borrowers. It neither makes loans directly nor sets the interest rates on loans it insures. FHA insured loans can be used to purchase new or refinance existing 1-4 family homes, condominiums, or mobile or manufactured homes on a permanent foundation.

Many excellent reasons exist to select an FHA mortgage, particularly if you fit one of more of the following qualifications:

    * you are a first-time homebuyer;

    * you are unable to offer much of a down payment;

    * you would like to have the lowest possible monthly mortgage payments;

    * you have concerns regarding monthly mortgage payments increasing at some point;

    * you have concerns regarding the consequences of falling behind on your monthly mortgage payments;

    * you have concerns about even being able to qualify for the loan in the first place;

    * your credit is less-than-ideal;

If any of those factors apply to you, then an FHA mortgage might be just thing for you to apply for. This is because FHA mortgages are insured, offering several protections and benefits otherwise unavailable to you through most other loan packages. 

The benefits of an FHA mortgage include the following:

Lower Rates: Since it’s the Federal Government insuring FHA loans for the lenders, FHA mortgages typically offer interest rates considerably lower than the norm. For this reason alone, it is always worth comparing all other loans available at any given point in time against FHA-insured loans.* Less of a Down Payment: FHA mortgages can be obtained with only 3% down