The post How to Buy an Investment Property appeared first on RealtyHop Mortgage Center.
]]>The potential upside of owning an investment property is clear. However, that doesn’t mean that every property owner will necessarily be able to achieve their earnings goals. If you do want to maximize your earnings, you’ll need to be sure to choose a property whose value is well-supported by data, and you’ll also need to develop an effective property management strategy. Investment owners have to consider the size of the property they wish to purchase if they want to rent it as a vacation or long-term rental, and how to find tenants.
An investor does not need a strong real estate background to purchase an income-generating property. Continue reading to learn more about important considerations and the process for acquiring an investment property.
An investment property is a term used to describe any property purchased with the explicit intent of generating income. While you may have purchased your primary residence with the hopes it would increase in value, very few people would classify that as an investment property. An investor will not live in the secondary property and instead rent it to tenants. The rental income they generate from their tenants offsets the cost of homeownership, like mortgage payments, maintenance costs, and property taxes, and can then generate additional revenue.
Investors can select from several types of investment properties. Residential properties, especially multi-family residential properties, are among the most common for people entering the market for the first time. Commercial, industrial, and other investment properties can also generate substantial revenues, especially when the market conditions are strong.
When buying an investment property, you’ll need to put down a substantial down payment of at least 15% of the purchase price. As the size of the investment property increases, lenders may require a higher down payment of up to 25%. While many homebuyers strive to put down 20% for a down payment on their primary residence, many mortgage lenders will work with lower down payments, accepting as low as 5%. Therefore, investment purchasers may need to spend more time saving up to afford the initial cost of ownership. Investors also cannot rely on first-time homebuyer programs to help offset the cost of the down payment and closing costs.
Compared to buying a primary residence, purchasing an investment property is similar. Buyers who need to finance their purchase with a mortgage will work with a mortgage lender but will encounter stricter requirements. Investors typically need credit scores of at least 700 and will have to prove that they can afford the cost of two mortgages, not including the income they’ll generate from the investment property.
Most property investment loans are agency loans, meaning a private lender issues them but receives backing from federal agencies Freddie Mac or Fannie Mae. The only time you will be to secure a loan from the FHA, VA, or another government lender is if you plan to buy a multi-family property and actively live in one of the units. Property buyers can use this strategy if they do not have as much money for a down payment, as FHA investment loans can accept as low as 3.5% down.
As is the case when you are applying for any mortgage, buyers should receive pre-approval before they begin looking for properties. The pre-approval will prove you’re serious to sellers and highlight what you can afford. The higher your credit score, the less money you will have to provide in your down payment. You’ll pay 20% if your credit score is 620 and 15% if your credit score is above 720.
Your prospective mortgage lender will ask for financial information like multiple years of tax returns, several months of bank statements, and the ability to prove your income. If you’ve managed property in the past, your lender may ask to see relevant documentation which could help you secure a lower down payment.
Investment properties have become an increasingly popular component of a diversified portfolio due to their following benefits:
Property owners can find consistent renters who can generate steady and predictable income. For example, when you sign a tenant for a year-long lease, you can count on that rental income monthly. When your building has full occupancy, you’ll see the greatest return on your investment and be able to generate enough income to offset your operating expenses and make a profit.
Looking to find renters? Advertise your property on RentHop
On average, the value of real estate grows at a rate between 5-10% per year, frequently outpacing the stock market. Property owners will make money off an appreciating home from income while knowing that their investment continues to appreciate. When owners are ready to sell, they can use the profit to finance the purchase of a larger investment. Some owners may purchase an investment property with the sole goal of affording retirement.
One of the main appeals of primary homeownership is the ability to take out a home equity line of credit (HELOC). That benefit also applies to investment properties, where homeowners can borrow against the property’s value to finance significant purchases. For example, an investor who plans to flip the investment home and sell it at a significantly higher value can afford the renovation by taking out a HELOC.
Owners should note that HELOCs on investments have more strict requirements than those for primary homes, as this comes at a higher risk to the lender. Borrowers will need a higher credit score, typically above 720, at least 20% equity in their property, multiple appraisals to confirm the property’s value and a debt-to-income ratio (DTI) between 40 to 50%.
Investors may choose to split their assets across several industries, including real estate. A real estate asset provides security and helps diversify your wealth portfolio. Compared to most other speculative assets (like stocks), real estate is fairly recession-resistant and can hedge against inflation.
The government wants to encourage property ownership and is willing to offer a wide range of tax deductions and credits. While owners must pay taxes on their rental income, they can offset that cost by claiming deductions on operating expenses, real estate taxes, repairs, mortgage interest payments, and depreciation. Those who wish to purchase investment properties should consult with tax professionals during the tax season to ensure they properly file and claim all possible deductions.
Learn more: A Guide to Rental Income and Expenses
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While the benefits of owning an investment property are clear, there are certainly quite a few drawbacks, as well. Consider the following risks when deciding if purchasing an investment property is right for you:
Even when you are well leveraged, owning an investment property will require a major financial commitment, and that means there will likely be other investment opportunities you’ll have to pass on. As miscellaneous expenses pop up, you may have to scale back your investments in other areas and revisit your budget. In more extreme cases, your investment could end up losing money and putting you at a financial disadvantage.
Real estate is notoriously illiquid, meaning it will be much harder to turn your investment back into cash. This limits your financial flexibility and decreases the freedom you have with your money. If you wish to turn your investment into cash, you will have to go through the extended process of getting your property ready to sell, putting it on the market, and completing the closing process. If you need to access cash quickly, you will not be able to through your property.
The only way to make money on your property is to rent it out to tenants. If you’re unable to find tenants and cannot generate consistent income, you’ll risk losing money. There are some years where you can charge more for rent and some years where you may need to scale back and minimize your potential profit.
The current real estate market can influence when you conduct real estate activity. If you decide to sell your property, you may want to wait for a seller’s market to take full advantage of the financial reward.
Your property will require upkeep and consistent management to ensure renters renew their lease and continue to stay in the property. While you can complete this task on your own, you may decide to hire a management company to attend to daily tasks. Generally speaking, the larger the size of your property, the more help you will need to manage it.
Property management costs money, and you will also have to pay for repairs and general maintenance, taxes, insurance costs, and other ownership expenses. If you have a high vacancy level, these costs quickly eat into any potential revenue and decrease the opportunity to generate profit.
After deciding to embark on investment property ownership, you will then have to make the difficult decision of which kind of property to purchase. You can use the following metrics to compare properties and consider which one to buy:
This number represents how much you can earn from your investment. To calculate NOI, simply subtract all operating expenses (excluding your mortgage) from your revenue (projected rent). When browning available listings on RealtyHop, you can refer to the Property Analysis feature that will display the anticipated monthly income and operating expenses.
Pro tip: When determining your project revenue, it will prove beneficial to research current rental market conditions. You can refer to online sources, like the RentHop Average Rent Costs to see how much you can expect to generate from a rental unit of varying sizes.
The capitalization rate, also called the cap rate, is the most common way for real estate investors to evaluate the return on their investment. To calculate the cap rate, divide the total income produced by the property by the total amount you paid for the property. The cap rate evaluates the level of risk associated with purchasing that property as an investment. A lower cap rate in a city indicates lower risk, which can appeal to investors seeking a steady income-generating stream.
Learn more: Cap Rate – What Is It and Why Is It Important?
Mortgage lenders use the DSCR to determine the borrower’s ability to repay their property investment loan. Specifically, it analyzes if the potential property can generate enough income to finance mortgage payments. While lenders specifically use this factor, buyers should also pay attention to the DSCR as it directly reflects a property’s potential income-generating power.
The IRR, sometimes known as the “great equalizer” among investors, helps show how much money you receive per dollar invested.
When exploring different properties, you’ll want to contextualize your research and compare like properties against one another. Comparable properties, also called comps, should be in a similar location, have a similar price per square foot, and serve a similar function (for example, don’t compare a commercial property to a multi-family residence).
You can consult your real estate agent to conduct a comparative market analysis (CMA) that directly analyzes the differences between prospective properties. The CMA can consider each property’s NOI, cap rate, DSC, and IRR. You can also refer to your real estate agent to help provide resources and more information about the investment property search.
Various life factors will influence your decision to purchase an investment property. If you’re financially stable and looking to diversify your wealth portfolio, an investment property can prove itself a strong source of revenue. Owning an investment property can become a risky move, as you must properly manage your property and continue to find renters to fill vacancies.
As with any significant financial decision, you should consult with an advisor to explore your options and consider the benefits and risks of property ownership. When you’re ready to take the next move, reach out to real estate professionals and mortgage lenders to begin searching.
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]]>The post What is a Home Equity Line of Credit (HELOC)? appeared first on RealtyHop Mortgage Center.
]]>A HELOC is an appealing aspect of homeownership, and those considering acquiring this loan should assess their situation to ensure they can afford the risk.
A HELOC is a revolving line of credit that homeowners can access as they need. For those with a primary mortgage on their home, the HELOC becomes a second mortgage that borrowers pay back in time. Homeowners without a mortgage will take out the HELOC as their primary mortgage.
HELOC’s come with their own interst rate, and borrowers will pay back the interest just like they would on a mortgage or credit card payment. Interest rates for HELOCs are adjustable, meaning they can change with the market. HELOC interest rates typically remain close to mortgage rates.
Homeowners should use HELOCs to finance purchases that contribute to their wealth, like a home improvement project that adds value to their home. Those who need access to smaller amounts of funding should consider other financing options like a credit card.
A HELOC consists of a draw and a repayment period. During the draw period, homeowners will continuously borrow against their home using a credit card for the account, transferring funds, or depositing a check. They will have to make a minimum interest-only payment each month but should also entertain the idea of paying back part of the principal to avoid a higher balloon payment down the line. Additionally, paying down the principal frees up more potential funds that homeowners can access again should they need them in the future. The draw period typically lasts for ten years.
During the repayment period, homeowners can no longer draw against their home and will only pay back the loan, paying back both interest and principal. If the homeowner sells their home or reaches the end of the repayment term, they will likely pay a lump sum to cover any outstanding balance. The repayment period typically lasts for twenty years.
HELOCs use your home for leverage, allowing you to secure significantly larger amounts of money than you’d otherwise have access to. However, it is important to note that this means the lender could place a lien on your property in the event you fail to make payments.
HELOCs consider the amount of equity that a homeowner has in their home and allows them to tap into the equity they’re building. When someone purchases a home, they immediately begin to build equity by contributing a down payment and then slowly paying off the principal balance on their mortgage payments. Homeowners can determine if they have enough equity by multiplying their home’s value by the percentage of value that a potential lender will let them borrow. They will then find the difference between that potential amount of equity and the remaining balance on their mortgage to determine the total borrowable amount.
A homeowner with a home valued at $500,000 may have paid $200,000 of their principal. If their HELOC lender allows them to borrow up to 85% of the home’s value, they will multiply $500,000 by 0.85 to determine they can borrow a maximum amount of $425,000. That maximum, minus the $300,000 they still have to pay off on their mortgage, means they can acquire a HELOC for up to $125,000.
Homeowners should note that the amount they paid for their home may not always correspond to the home’s value when they apply for their HELOC. The lender may order an appraisal to establish a true market value.
Those who wish to acquire a HELOC can consult with various lenders to find one that offers the most percentage of value along with a competitive interest rate. Potential buyers can work with banks, credit unions, and possibly their primary mortgage lender to acquire a HELOC. The lender will consider the borrower’s current standing and provide them with an application.
To secure a HELOC, borrowers must start by filling out an application. Typically, HELOCs banks, credit unions, and other financial institutions work with homeowners. Applying for and receiving approval for a HELOC can take several weeks, so potential borrowers should prepare to wait before they can begin accessing their funds.
HELOC lenders will consider several qualifications when evaluating a borrower. However, the approval process can be less strict than a credit card application as the homeowner already has property they can use as collateral. Homeowners will need to meet the following criteria to qualify for a HELOC:
Similar to a credit card, HELOCs have a revolving credit line that allows borrowers to continuously draw from funds up until they reach their established limit. Borrowers can then make monthly minimum payments or pay down the outstanding balance in full to free up potential borrowing power in the future.
Borrowers should note that if they sell their home with an outstanding HELOC balance, they must pay the remaining balance in full. Additionally, failure to make payments on monthly payments can result in a lien or risk foreclosure.
A HELOC is the easiest way to access a home’s equity and can provide borrowers with several benefits.
Homeowners who plan to complete home improvements and renovations can take advantage of this opportunity as the money they put into their homes will pay off when it comes time to sell. Therefore, if they still have an outstanding balance on their HELOC, the additional profit their home improvements earn them can help satisfy the remaining balance. HELOCs typically allow borrowers the chance to access more funds than they would be able to afford with a credit card or personal loan.
HELOC interest rates vary from credit card interest rates, making this option more appealing to borrowers. While a credit card can have an interest rate near 12%, a HELOC interest rate remains similar to mortgage rates, placing them currently near 6%. Since homeowners typically use HELOCs to access large amounts of financing at once, lower interest rates help keep monthly repayment costs down.
Some homeowners may use their HELOC to improve their homes, making the interest on their second mortgage tax-deductible. Therefore, borrowers can continue to save money by claiming the interest during tax season.
Of course, as with any sort of borrowing, HELOCs also have a few drawbacks.
The largest drawback of a HELOC is the potential risk of foreclosure. If a borrower stops making payments, they could lose their home. Therefore, borrowers should ensure that they have a stable income and can reliably make payments before acquiring this type of loan.
HELOCs can also have application and closing fees that make acquiring a loan unaffordable. Each lender could also have their own terms and conditions that set a minimum withdrawal amount and strictly define a draw period, limiting a borrower’s flexibility and financing options.
The market’s potential changes could drastically affect the amount that a borrower has to pay on their monthly payment. In 2022, interest rates more than doubled, which increased the interest rate for HELOC borrowers. Potential borrowers should cautiously consider the implications of an unstable housing market and understand that they will need to continue making payments to avoid foreclosure.
A HELOC is a revolving line of credit that homeowners can access when needed. Home equity loans, on the other hand, simply offer borrowers a lump sum of money that they must repay on a predetermined payment schedule.
Many homeowners might consider applying for a HELOC as they undeniably present clear benefits when compared to other financing options. HELOCs can present an ideal option for homeowners who have substantial equity in their homes and who wish to make upgrades or improvements to their property.
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]]>The post What are Contingencies in Real Estate? appeared first on RealtyHop Mortgage Center.
]]>While most homes move through the pending status and close, some transactions do not finalize due to failure to comply with contingencies. This article will discuss the role contingencies play in the closing process, along with the most common types of contingencies that buyers and sellers should prepare for before they enter a real estate transaction.
In real estate, a contingency is a condition that must be fulfilled for a sale to finalize. In other words, the sale is contingent on the completion of clearly defined events, otherwise, a party can void the contract, and the transaction does not progress.
There are several types of contingencies that both buyers and sellers can request of the other party. While some contingencies are more common than others, such as a home inspection or financing contingency, some do not often come into play except in particular circumstances. A contingency for buyers will look different than one for sellers, as each side must meet its end of the bargain.
A buyer will disclose their contingencies when they submit their formal offer for the property. If the seller decides to accept the offer, they may still negotiate with the buyer and disclose their contingencies as well. When both parties agree to the offer that includes each side’s contingencies, the sale progresses into the closing stage. The buyers will submit their earnest money deposit before moving forward.
Both buyers and sellers will naturally consult with their real estate agent during the offer and negotiation process to ensure the transaction meets their needs. Buyers should consider what they must do to fully close on the home, and sellers should consider how they can guarantee that the buyer will follow through on their offer.
Both the buyer and the seller can potentially add contingencies to an underlying real estate contract. However, the seller initiates most contingencies to ensure the buyer moves forward with the agreed-upon terms.
Some of the most common contingencies include:
A financing contingency, also referred to as a mortgage contingency, gives the buyer time to secure their mortgage so they can finance their purchase. The contingency typically has a timeline and a buyer can request an extension if it takes longer to secure the financing. If the buyer cannot secure a mortgage before the deadline, the contract becomes void and buyers can recoup their earnest money deposit.
Buyers should receive a pre-approval prior to the home searching process, so they know how much they qualify for on a mortgage. It’s important to note that pre-approval does not guarantee that they will be able to secure a mortgage.
A buyer should take every precaution to guarantee they receive a home that is in proper condition. Buyers can include a home inspection contingency that states that the sale will only move forward once the property passes the inspection. If the home inspection presents significant problems, the buyers can request that the seller bring the home up to par before moving forward with closing.
Buyers and sellers can negotiate who pays for the home inspection, which wraps into the closing costs. In a busy seller’s market, buyers may waive their home inspection contingency to receive an approval on their offer. This gamble can become risky, especially with older properties. Buyers should therefore exercise caution if they decide to waive the home inspection contingency.
While most mortgage lenders and states require that homebuyers acquire a homeowner’s insurance policy, residential real estate contracts may include an insurance contingency as well. The contingency states that the buyer must purchase a policy to move forward with the transaction.
There are several different types of insurance policies, but buyers may want to consider adding additional policies, like flood insurance, if they live in at-risk areas.
If a buyer currently owns one home and needs to sell that home to finance the purchase of the new property, they may include a house sale contingency that gives them a fixed period of time to complete their sale. Buyers typically include this contingency so they can use the profit from the sale of their home to offset part of the cost of their new home.
First-time homebuyers will not need this type of contingency as they will not have another property to sell. To help finance their purchase, they can apply for first-time homebuyer programs.
A title contingency protects the buyer if the owners cannot prove their current ownership. Liens on the property can also fall under a failure to comply with the title contingency. In the case the that the seller cannot fulfill the title contingency, the buyers can walk away and recoup their earnest money.
A kick-out contingency adds an extra layer of protection for a home seller by stating that if the seller receives a second offer without contingencies, they can kick-out the first buyer and void their contingent contract. A buyer may want to include this contingency in an offer if they need to sell their property during a slow buyer’s market, or if they need time to acquire financing. This contingency shows the seller that they acknowledge the current market conditions and do not want to waste the seller’s time if the sale falls through.
Sellers who accept an offer with a kick-out contingency can continue showing their home while the potential buyer attempts to sell their home or acquire financing. This type of contingency is less common in a seller’s market.
This contingency protects the buyer and states that the sale only moves forward after an appraiser submits a fair market value for the property that matches the sales price. If the appraisal comes back with a lower value than the asking price, the buyers can ask the seller to lower their asking price. Should the seller not agree to lower their price, the buyer can then walk away from the sale and recoup their earnest money.
When creating a contingency, whether as a buyer or as a seller, it will be important to be as specific as possible. A vague condition gives leeway for a lawsuit down the line. Buyers and seller should consult with their real estate professional during this process to ensure they disclose a thorough contingency. Contingencies should also define clear deadlines and timeframes.
The contingency should also include a specific event and condition. A vague contingency might say the seller needs to “leave the property in good shape,” but a specific contingency would say, “the property needs to have no mold, pests, or other problems revealed during the inspection.”
Lastly, the contingency should be unambiguously binding. The contingency itself is not just a simple “to-do” list for the buyer and seller. Rather, it is a legal declaration that if one party fails to fulfill its responsibilities, the other will have the right to walk away from the deal.
Each contingency should clearly outline what happens if the other party does not fulfill the contingency. In some cases, failure to fulfill the contingency will automatically void the contract, meaning that if parties still wish to complete the sale, they will need to start over.
In other situations, the failure to fulfill the contingency could give one party the right to void the contract but not necessarily the obligation. For example, if the buyer has not been able to secure financing, the seller might be willing to extend the deadline without voiding the contract.
Contingencies play an important role in residential real estate as they protect both buyers and sellers. It is essential that each party carefully craft their contingencies and ensure they understand the other parties’ terms before progressing with a real estate transaction.
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]]>The post What is a Mortgage Recast? Everything You Need to Know appeared first on RealtyHop Mortgage Center.
]]>Mortgage recasting provides homeowners with the opportunity to lower their monthly payment via a lump sum payment, without requiring the hassles that come with refinancing. In the right situations, mortgage recasting can benefit borrowers with a bit of extra cash. This article highlights the important things to know about mortgage recasting, including what it is and whether it makes sense for your financial situation.
Mortgage recasting involves making a lump sum payment to your mortgage lender in order to decrease your future monthly payments. To initiate a mortgage recast, you will need to have surplus cash that you are willing to contribute to the principal of the mortgage. Once you have made this lumpsum payment, your lender will then amortize your loan (basically, reallocate outstanding costs) over its remaining life. Depending on how large your lumpsum payment was, you can significantly reduce your future monthly payments.
By paying down the principal quickly, you can also decrease some of your future interest expenses and potentially set yourself up to pay off your loan early. However, once you have initiated the mortgage recast, you will not be able to take it back and regain access to the lumpsum payment. Homeowners should therefore carefully consider whether this option is appealing enough for them to commit to for the remainder of their mortgage term.
A borrower can always call for a mortgage recast, the lender will never require one. If the borrower has surplus cash that they want to allocate towards their home, they will then need to contact their lender and let them know they are interested in mortgage recasting.
A mortgage recast will typically come with a minimum required payment, which is usually around $5,000. All of this payment goes toward the principal of the outstanding mortgage, meaning it will directly decrease the principal balance that is due to the lender.
After the borrower completes their first payment, themselves and the lender will establish a future mortgage schedule, meaning that all future payment requirements will change. In most cases, lenders will offer their borrowers a clear amortization chart that illustrates how much they will be expected to pay towards principal and interest each month, as well as how much they can potentially save over time.
Due to the compounding effects of interest, initiating a mortgage recast closer to the beginning of the mortgage will have a larger financial effect. It is also important to note that initiating a mortgage recast will usually carry a fee from the lender, though this fee is relatively small and certainly much lower than the total cost of refinancing.
Keep in mind, the only thing that mortgage recasting changes is the monthly payment. Both the interest rate and the mortgage term remain the same. However, because your monthly payments, and total payments, will decrease, you might eventually find yourself in a position where you can pay off your mortgage early.
Not every homeowner may qualify for a mortgage recast. To qualify, borrowers cannot have a government-backed loan, such as those supported by the FHA, VA, USDA, and other agencies.
Furthermore, you will also need to meet your lender’s basic requirements. Usually, this includes making a minimum number of consecutive payments on time, making a minimum payment, and having a minimum equity share of your home. If you are unsure whether you can qualify, you should speak directly to your lender.
Mortgage recasting and refinancing offer borrowers the opportunity to decrease their monthly payment. However, it is important to note the differences between these two processes. When you refinance, you essentially apply for a new mortgage, meaning that any terms, including monthly payments, interest rates, and the length of the mortgage, can potentially change.
With mortgage recasting, on the other hand, you will still keep your current mortgage and your current lender. The only thing that changes is the amount you pay monthly. This process is significantly less expensive than refinancing, which is why, when available, it can be an appealing option.
The most obvious reason to recast a mortgage is that it lowers your exposure to interest. Mortgage recasting also offers the additional following benefits:
As you’d probably expect, mortgage recasting also has its fair share of drawbacks, including the following:
Whether a mortgage recast is right for you will depend on your personal financial situation. If you’re entertaining the idea of a mortgage recast, make note of the money you have to put toward your initial payment and consult with your lender to set up a schedule that works with your finances. While mortgage recasting can decrease the amount you pay monthly, borrowers must carefully weigh their options and take decisions about their mortgage seriously.
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]]>The post Choosing Between a 30-Year and 15-Year Mortgage: What You Need to Know appeared first on RealtyHop Mortgage Center.
]]>A mortgage’s term length represents the amount of time it will take to pay off a mortgage in full, assuming you keep making all of your monthly payments in full and on time. The most common term for a mortgage in the United States is 30 years. The second most common term length is 15 years, and while you can find mortgages with various other term lengths, they are not very common.
Ultimately, the term length you choose for your mortgage will affect various factors, such as your future monthly payments and the amount of money you end up paying in interest. While it will be possible to refinance your mortgage in the future if you change your mind, doing so can be somewhat expensive, so this is a decision you will want to take seriously.
This article will discuss the most important things to consider when choosing between a 15-year vs. 30-year mortgage, including how these contracts work and their pros and cons.
A mortgage is a specific class of loan issued by a mortgage lender that helps homebuyers finance the cost of a real estate purchase. Today, the two most common types of mortgages are 15-year mortgages and 30-year mortgages.
A mortgage will use the property itself as leverage, meaning that the mortgage lender can claim ownership of the property if the borrower stops making payments. Using leverage is why most borrowers can secure mortgages for a significantly lower interest rate than their other lines of credit (such as a credit card).
As mortgage owners continue making their monthly mortgage payments, their home equity share will continue to grow. To qualify for a mortgage, you will usually need to be able to validate a minimum income level and have the equity available to make a down payment.
As long as you can meet your lender’s corresponding income requirements, whether you choose to get a 15-year mortgage or a 30-year mortgage will be entirely up to you. Regardless of the type of mortgage you are considering, it is a good idea to consider multiple different lenders before making your final decision.
The main difference between a 15-year and a 30-year mortgage is the amount of time it takes to pay off the loan in full. Once you have made all of your mortgage payments (and paid off any outstanding fines), the title will transfer from your lender, and you will become the outright owner of your home.
With a 15-year mortgage, you will make 180 mortgage payments before owning your home, and with a 30-year mortgage, you will make 360 mortgage payments. Since it takes less time to pay off a 15-year mortgage, the size of each monthly payment will be considerably larger than that of a 30-year mortgage.
Contrary to what some people assume, the size of a 15-year mortgage payment is not double that of a 30-year alternative. It is usually only about 1.5 times the size of a 30-year payment, meaning that, in the end, the total cost of paying off a 15-year mortgage will be notably less. The borrower will only be subject to 15 years of interest rate charges rather than 30 years.
Both types of mortgages can be appealing, depending on your personal financial circumstances.
The most obvious benefit of a 30-year mortgage is that your monthly payment will be significantly lower. Due to the extended period of time you have to pay off your mortgage in full, you will not have to make nearly as large of a payment every month.
Suppose you are applying for a $300,000 mortgage and secure a six percent interest rate. Using the RealtyHop Mortgage Calculator, you can see that with a 30-year term and no down payment, your monthly payment will amount to $1,799. However, with a 15-year fixed-rate mortgage, your monthly payment jumps up to $2,532.
That difference is $733 per month, or about $9,000 per year. For many homeowners, that might be the cutoff between whether a given home is affordable or whether that home is too expensive.
Using a 30-year mortgage allows you to afford a considerably larger home without needing to modify your budget. For example, suppose you know that the most you can spend on your monthly mortgage payment is $2,000. With a 30-year mortgage with a six percent interest rate, you could afford a home worth up to $334,000. However, if you had a 15-year mortgage with the same interest rate, you’d only be able to afford a home worth $237,000.
These are not minor differences. For both experienced and first-time homebuyers alike, the 30-year mortgage is considerably more manageable, which is why it is currently the most popular mortgage in the United States (and many other countries, as well).
One reason people will choose a 15-year mortgage is that, in many situations, 15-year mortgages offer slightly lower interest rates. Typically, the rate gap between these loans will be around 1 percent (or slightly less).
Additionally, because it takes less time to pay off the loan, 15-year mortgages can help you save a substantial amount of money in interest payments. Using our previous example of a $300,000 mortgage with no down payment and a six percent interest rate, it is easy to highlight the benefit of this lower amount of interest.
If you take 30 years to pay down this loan (with a monthly payment of $1,799), you will pay $648,000 over time. That means that by the time you own your home, you will have paid more in interest payments than you did in principal payments.
On the other hand, while the monthly payment for this property with a 15-year term will be $2,532, the total amount you’ll end up paying between the principal and interest is just $456,000. That’s a total savings of $192,000.
Many homebuyers select a 30-year mortgage due to the lower monthly payments, which provide financial flexibility. If you sign on for this longer term and increase your cash flow down the line, you can always refinance to secure a new monthly payment amount and pay off your mortgage in a faster timeline.
Homebuyers with a more considerable income who wish to purchase a property below their budget may find a 15-year term appropriate. Buyers can save money in the long run by paying larger amounts monthly due to fewer payments and a lower interest amount. Shorter loan terms also offer lower interest rates, allowing buyers to save even further.
No matter the type of mortgage term you decide to pursue, it is important to shop around with various lenders to ensure you find the best interest rate. Consider your interest rate, loan term, and the amount you can put toward a down payment to find the best financing solution for your home buying needs.
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]]>According to Freddie Mac, the current average interest rate on a 30-year fixed-rate mortgage is 6.57%, after topping at 7.08% on November 10th. Despite dropping a bit since the end of 2022, mortgage interest rates continue to impact prospective buyers looking to purchase a home. This article will discuss five main ways homebuyers can lower their borrowing costs, as even a slight reduction in interest payments can save copious amounts of money in the long run.
Interest rates peaked at the end of 2022 and slightly decreased throughout 2023. While some buyers returned to the market to purchase property, others may still wonder if interest rates will continue to decrease, creating a more appealing market. However, there is no strong evidence to suggest that rates will return to the low levels of 2021 and early 2022.
Jerome Powell, Chair of the Board of Governors of the Federal Reserve, and the Fed, raised the benchmark interest rate at the start of May 2023. While the Committee hopes to bring inflation down to a steady 2%, raising interest rates continues to impact mortgage interest rates. Until the Fed delays its rate hikes, mortgage interest rates cannot significantly decrease.
The Fed may not continue to raise interest rates throughout 2023. Mortgage interest rates may not quickly decrease, but prospective homebuyers can expect rates to remain steady for the remainder of the year. Rates should not increase at the rates they did throughout the summer of 2022.
Depending on where you’re looking to purchase a home this year, you may consider adapting the type of mortgage you select. Some housing markets, like “Zoomtowns,” witnessed drastic growth in light of COVID-19 but have since dropped their asking prices. Buyers may therefore use a fixed-rate mortgage to secure a current interest rate and ensure they can purchase with a lower asking price.
Additionally, those looking to purchase in competitive and more expensive markets, like Miami or New York City, may consider an adjustable-rate mortgage (ARM) to acquire an initial lower interest rate, then refinance in the future before their rates increase.
Making a more significant down payment isn’t always realistic, but putting down more than the traditional 20% is one of the best ways homebuyers can reduce borrowing costs. Buyers should only consider this option if they have the financial resources to do so safely, as tapping into their financial reserves can cause more harm down the line. However, a larger down payment leaves the lender with less risk, meaning they usually feel more comfortable offering a lower interest rate.
Additionally, initially paying off a higher portion of the purchase price means homebuyers receive a lower monthly mortgage payment. They can therefore spend more of their funds on other homeownership costs or put a larger amount toward their mortgage payments and pay off the loan in a faster timeline.
Homebuyers who can’t meet the 20% down threshold may have to buy private mortgage insurance (PMI). Mortgage insurance protects the lender, who takes on additional risk by providing a loan with a lower down payment. While you might be able to secure a slightly lower interest rate by purchasing mortgage insurance, the insurance cost will likely negate the lower interest payment, leading to higher borrowing costs.
Learn more: What Is Loan to Value Ratio
Choosing a shorter loan term is arguably the best way to reduce mortgage interest rates. Shorter-term mortgages typically have lower interest rates because of reduced risk to lenders, as they are likely to receive their money faster than with a 30-year mortgage. Freddie Mac’s most recent numbers show that the average interest on a 30-year fixed-rate mortgage is 6.57%, but the average interest on a 15-year fixed-rate loan is 5.97%. Someone who acquires a loan with a 5-year term can expect an even lower interest rate.
Since homeowners pay off a loan with a shorter interest rate sooner than they would on a 30-year term, monthly payments will be higher. Therefore, only borrowers with enough income or money in their savings can get approved for a shorter-term loan. Homebuyers can acquire a mortgage with a 20, 15, or even 5-year term. Their loan term length depends on how much they can afford to pay each month.
Borrowers should plan to spend a higher amount of their monthly income toward their mortgage and understand that they may not be able to allocate as many funds to other costs of homeownership. Therefore, they should only decide to move forward with a shorter loan term if they are confident they can afford the monthly payments and still have savings for repairs and maintenance.
A poor credit score will increase a borrower’s interest rate. Consumers can typically raise their credit score within months and request a rescore from their lender to update their credit score quickly and then present that new score to the lender.
Generally, a homebuyer will know several months ahead if they want to purchase a property. Therefore, they can use that time to work on their credit score by repaying outstanding debt, disputing any errors, apply for any additional credit cards which help build credit. A higher credit score will help secure a lower interest rate on a loan and prove to lenders that you have a history of paying back your debt promptly.
Prospective homebuyers who don’t have enough credit to qualify for a mortgage or a satisfactory interest rate can consider the growing rent-to-own market. They may also consider an ARM with a fluctuating interest rate. While generally more risky, ARMs have lower qualifications and can appeal to borrowers who do not qualify for a fixed-rate mortgage.
Those with a high credit score can also ask lenders for a lower interest rate. Since banks want to work with homebuyers who have higher credit scores, homebuyers can use this to their advantage and showcase that their score makes them strong customers. Sometimes, lenders might lower their rate if borrowers can prove they’re a competitive applicant.
A borrower can purchase mortgage points from a lender for a lower interest rate. Points typically cost 1 percent of the mortgage amount — one point on a $500,000 loan would be $5,000, for example. Each point lowers the mortgage interest rate by 0.25 percent for the loan’s lifetime. A real estate agent or a financial professional could help you decide if this option is right for you, as it does require investing more money upfront, and borrowers need to decide if that initial investment pays off financially.
Homebuyers can purchase multiple mortgage points and half points and must provide the funds at closing. Buying mortgage points is an effective way to prepay part of the mortgage and lower the money you will spend over the loan term.
Before closing on a mortgage, homebuyers should compare rates from various banks and lenders. Multiple offers allow borrowers to choose the best terms and lowest interest rates. Consider reaching out to banks or credit unions you have worked with in the past, as they may reward your loyalty with a lower rate. Homebuyers can consult a mortgage broker to find rates from multiple lenders. If a potential borrower wants to work with a specific lender, they can acquire lower price quotes from various lenders and try to present that number to their preferred lender. There is a chance that lenders could price-match to ensure they get the customer.
The easiest way to get an initial estimated interest rate on your mortgage is by checking current mortgage and refinance rates.
Learn more: How to Find the Best Mortgage Rate
Homebuyers have several options to help secure a lower interest rate on their mortgage. With mortgage rates averaging around 6.57%, homebuyers with lower interest rates obtain more purchasing power and can afford to purchase a higher-value piece of property. Despite a homebuyer’s financial situation, we recommend shopping for the most attractive interest rates.
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