Home Equity Line of Credit or HELOC is a line of credit based on the borrower’s home equity. Since it is a line of credit,one can use it as desired within a certain duration called the draw period. Draw period may range between 5 to 10 years.During this time the borrower is only charged with the interest amount.
Since the amount withdrawn from the line of credit can vary on a daily basis, the interest is calculated on your daily balance and eventually chargedat the end of the month. Repayment of the principal amount starts once the draw period is over. The borrower can pay it in equal monthly installments over a period of 10 to 20 years. The principal balance that needs to be repaid includes total drawn amount plus any interest accumulated during the draw period.
Difference between HELOC and Mortgage
Although borrowers use both types of loan facilities against homeowner’s property, there are some significant differences between the two.
Purpose – Since lenders offer HELOC based on a home owner’s equity, it is not necessary that a homeowner would borrow it for the sole purpose of buying a new property. On the other hand, borrowersapply for Mortgage for the sole purpose of buying a new property, which banks keep as collateral until the borrower pays the loan in full.
Interest Rates – Home Equity Line of Credit acts like a second mortgage. In the event of foreclosure due to non-payment, borrowers are obligated to clear their first mortgage before paying off their Home Equity Line of Credit. This makes the interest rate on HELOC higher than a normal mortgage due to the higher risk associated.
Payment Schedule – In a Mortgage loan, the interest payment is pre-determined through equal monthly installments paid over the lifetime of a loan. However, in the case of HELOC, the borrower incurs a variable interest amount during the draw period, which can last for up to 10 years.
Installment versus revolving – HELOC is a revolving facility which means borrowers can pay-off certain amount and get an extra cushion to borrow more at a later date. A regular mortgage is an equal monthly installment facility where the total loan amount is disbursed at the beginning and payments are equally divided over the loan term.
How People Use HELOC
Refinancing Existing Mortgage –Borrowers can sometimes get some extra cash from this re-financing facility if the property values have gone up since the disbursement of their original mortgage loan. However, this technique can backfiresince interest rates on HELOC fluctuate a lot and can eventually cost borrowers more than their first Mortgage.
Home Renovation –Since HELOC is disbursed based on the home owner’s equity, the borrower can utilize it for renovation purposes as well. This helps in increasing the property’svalue for future use.
Debt Consolidation– Home Equity Loan can act as a great tool for debt consolidation. Since the loan amount is higher than other small debts such as credit cards and personal loans, borrowers can use HELOC to pay off their existing debt. Another benefit of debt consolidation through HELOC is that borrowers eventually start paying lower interest on their consolidated debt.
- Home Equity Line of Credit is fairly easy to get based on your home equity. The process is less complicated than a regular mortgage where banks spend more time evaluatingthe borrower’s capacity to pay on time.
- HELOC provides borrowers with excess running capital which can be used as and when required.
- Since HELOC is a secured loan facility, it provides borrowers a higher revolving loan amount at a much lower rate than similar types of revolving facilities such as credit cards.
- Although lender forwards Home Equity Line of Credit against the borrower’s home, it gives borrowers the liberty to spend their capital in any way they want. This is a major HELOC benefit.
- HELOC is disbursed to borrowers based on how much their property is worth. If the property market plunges after the borrower has secured a Home Equity Line of Credit, they will have to pay more than what their property is actually worth.
- Although HELOC facility may seem enticing due to its lower rate and versatility of use, it can increase your overall debt burden. This may have an adverse effect in case you lose your job and cannot pay your monthly interest on time for any other reason.
- Some lenders may charge an annual fee regardless of whether you use your line of credit or not. This results in a higher APR on the loan.
Eligibility Criteria for HELOC
Percentage of Equity –Banks require that HELOC borrowers should have at least 20% equity in the home they are putting as collateral for Home Equity Line of Credit.
Debt to Income Ratio – Banks require borrowers to show a debt to income or debt burden ratio of 50% or less to gain access to HELOC facility. This debt burden requirement helps banks to secure their monthly payments even in tough economic times when HELOC interest rates go high or borrower’s monthly income goes down.
Credit Score –Most banks would require a credit score of 620 or above. This will tell the bank if you are making timely payments on your existing debts or not. In case you are using HELOC for debt consolidation, your credit score will assure the bank that you will pay your monthly interest on time.
HELOC is a great option for borrowers looking to refinance their existing mortgage or gain access to a second mortgage. However, when availing such a facility it is beneficial for you to pay-off your debt as soon as possible as interest rates may fluctuate rapidly putting more burden on your existing debt.
PITI – What Is It and How to Estimate It Yourself
PITI, or “Pity”, is a sum of mortgage payments that include the principal amount, Interest on the loan, property tax, and insurance premiums. PITI helps lenders calculate a loan applicant’s ability to pay their mortgage payments based on the income level. Using PITI, lending institutions, such as banks, decide on how much loan amount they can offer to an applicant. Lenders also use PITI to create a reserve requirement as well. This is a multiple of PITI, which the lender keeps as a deposit. They use it to cover any shortages, if the borrower faces financial hardship and defaults on their monthly payment.
Breaking It Down
Breaking PITI down into its individual components helps us understand the term better and realize why each element is important in a mortgage payment calculation.
This is the base amount that you borrow from your bank to finance the new property you require. Your monthly payment doesn’t depend only on the principal amount. Principal will only make part of it while other portions will include interest, taxes, and insurance premiums.
When a lender such as a bank or any other financial institution offers you a loan, they are losing out on an opportunity to invest that amount somewhere else. To cater to this opportunity cost, the bank will charge you an interest on your loan amount. Most banks want to recover maximum interest during the beginning of the loan tenure. Hence, interest amount forms a major chunk of initial mortgage payments.
The amount of PITI can vary based on the tax rate and assessed value of the property being financed. Some of the elements that determine your property tax include:
- The state in which your property is located
- Local tax assessor who comes to assess the value of property being financed
- Market value of the property and its surrounding areas
The property tax is calculated by applying your local county tax rate on the assessed value of the property. After the principal and interest amount, property tax is the major contributor to the PITI amount.
Just like property tax, home insurance is another variable that plays an important role in raising or lowering your PITI. The type and amount of home insurance you have to pay for depends on two factors:
- The area you would like to live in
- How much down payment you are willing to make
The most common types of insurances include:
- Homeowners Insurance – This type of insurance protects you against vandalism, theft or other hazards such as a fire.
- Flood Insurance – Depending on the area you are willing to move to, your lender may require flood insurance as well. This will be in the interest of both the parties in case of a natural disaster such as flood or hurricane, which can completely destroy the financed property.
- PMI or Private Mortgage Insurance – According to 20% down payment rule, if a borrower makes a down payment of less than 20%, they are liable to purchase PMI as well.
Various elements can increase or decrease the amount of insurance premium on a property. Hence, borrowers need to be mindful while choosing a locality and making down payment to minimize their monthly mortgage payments.
Estimating Your PITI
It is always good to do a little homework and get a rough estimate about your monthly mortgage expense before you finance a property. This will help you maintain your monthly budget once you start making your loan payments. Your interest rates and principal amount are determined by your bank, but having a good grip on variable expenses such as taxes and insurance premiums can help reduce your mortgage payments. Some useful steps to determine your PITI value include:
1. Looking For a PITI Calculator Online
An online PITI calculator will help you identify your monthly payments by amortizing your interest rate over the loan period. It will also take into consideration your property tax and home insurance by dividing the yearly payment in to 12 equal installments. It then adds all these elements together to form your monthly payment schedule.
2. How Much You Need
PITI is calculated based on the amount you are financing from the lending institution rather than the property value itself. Before entering the loan amount in PITI calculator, you need to subtract your down payment from it as well. It is important to note that there are some closing costs associated with the mortgage loan. It would be wise if you allocate some of your savings to these charges to avoid any surprises after you have paid your mortgage in full.
3. Tax and Insurance Variables
Almost any PITI calculator you choose will ask you for the tax and insurance amount. Banks usually include these variables in their monthly payment to protect themselves from property damage or tax liens.
- Estimating Insurance Premium – A general rule of thumb is to set aside $35 for every $100,000 of your loan amount. If your bank requires you to acquire flood insurance, then your insurance premium may rise accordingly.
- Tax Estimate – Check your local state regulations to figure out the tax rate and multiply it by market value of your property to get a rough tax estimate on your property.
Putting all these variables along with the loan tenure in the calculator will give you a rough idea of how much your PITI would come around to. You can then use this figure to manage your monthly budget accordingly.
Having an understanding of PITI is an essential part of taking out a mortgage. Lenders use the ratio of PITI to your gross income to determine your repayment capacity on a mortgage loan. For most lenders to offer you a mortgage loan, this ratio should be above 25%. Hence, doing your own PITI calculation beforehand will help you choose property that will provide you with best value for money.
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How Does a Reverse Mortgage Work?
With rising healthcare costs and increase in property taxes, many retirees face difficulty in meeting their monthly expenses. Reverse Mortgage is an effective way for old age homeowners to convert their home equity into cash. Homeowners can use this cash in multiple ways such as renovating their property or paying off their monthly dues.
You can use a Reverse Mortgage to pay off a regular mortgage. This way, you can avoid monthly payments to your lender. If you can manage your property dues, such as taxes and other maintenance costs, you can apply for a Reverse Mortgage. You can pay the loan off any time before the last surviving property owner passes away or moves out.
Step By Step Guide To Securing a Reverse Mortgage
The first step towards securing a Reverse Mortgage facility is obtaining objective information about the Reverse Mortgage loan from counselors approved by Housing and Urban Development organization. Once the counseling session is complete, you will receive a certificate of completion at your home address. This certificate is part of the Reverse Mortgage loan application.
2. Submit Loan Application
To initiate the Reverse Mortgage loan, borrowers need to submit an application packet to their lender, which usually includes:
- A Valid Identification document
- Proof that the property put up as collateral is your primary residence
- Proof of income showing that you have enough money to pay for homeowner insurance and property taxes on your property
- Reverse Mortgage counseling certificate
Once you submit the loan application, the lender will appraise your property value. This is a major step in the Reverse Mortgage process as it determines the amount you are eligible to receive as a loan.
- Request for Appraisal – According to latest housing regulations, lenders cannot order appraisers of their own choice and need to contact an independent Appraisal Management Company to appraise the property’s value.
- Property Visit By An Appraiser – Once the lender makes a request for appraisal, FHA-approved property appraisers will visit your home for inspection and take necessary pictures to determine the property’s worth.
- Submission of Appraisal Report – The appraisal report is shared with the lender within 3-5 business days after the property visit. Latest regulations require that lenders share a copy of the latest appraisal report with the applicant as well.
4. Underwriting the Loan
During this stage of the loan process, underwriters review the application along with submitted documents and stipulate the terms and conditions associated with the loan. Once the application meets all the conditions, the lender will set a closing date for loan disbursal.
Cash Payment Options
- One-time Disbursal – You can receive a lump sum payment from your lender through Reverse Mortgage. However, this is only available for fixed-rate
- Term Option –Using this option borrower can receive a fixed amount of cash on a monthly basis for a pre-determined period.
- Line of Credit –This is useful for applicants who need to utilize their Reverse Mortgage facility as and when required. The interest accrues depending on how cash the borrower draws over a period of time.
- Since these loans were designed for senior citizens, Reverse Mortgage facility is available for people above 62 years of age.
- You should either own the home or have low enough mortgage to pay it off using a Reverse Mortgage loan.
- You must be living at the property and must not stay at any other place for more than 12 months.
- For multi-family homes, you should be using one of the units as your primary residence. In the case of manufactured homes, they are approved for Reverse Mortgage as long as they follow FHA requirements. An HUD-approved condominium can also be used for availing Reverse Mortgage facility.
- You must be able to pay your monthly dues during the life of the loan. These may include home insurance, property taxes, and maintenance fee such as homeowners
- Many lenders require that you must not be delinquent on any federal loan.
Fees Associated With Reverse Mortgage
1. Origination Premium
The federal government insures Reverse Mortgage loans, but the loan applicant has to bear the insurance costs. Insurance premium can range between 0.5% and 2.5% depending on the appraisal value and the amount you borrow from your initial limit in the first 12 months.
2. Processing and Closing Fee
The lender can charge you up to $6,000 for processing the loan depending on your property value. Closing costs include fees for background and credit check, property appraisal, taxes and any other fees.
Risks Associated With Reverse Mortgage
- Reducing Family Inheritance – Reverse Mortgage is a high-interest loan, which is compounded over a period of time. The upfront costs and accrued interest can considerably reduce your home equity. This means you may not be leaving behind much for your family or surviving spouse as an inheritance.
- Risk of Foreclosure Proceedings – This could be a major problem for a surviving spouse who did not co-sign the Reverse Mortgage facility with the primary applicant. In case the applicant passes away, their spouse will be forced to sell the property to pay-off the loan. Hence, it is important that borrowers talk to other house occupants about a backup plan in case they do not survive.
- Stringent Terms – Reverse Mortgage borrowers’ risk of losing equity in their home very quickly as the high-interest rates compound over a period of time. The terms for Reverse Mortgage are quite stringent as well, with lenders refusing to amend loan terms such as lowering interest rates or adding a co-borrower after loan disbursal.
Reverse Mortgage allows borrowers to use their home equity to manage their monthly expenses. However, before availing this type of loan, borrowers should spend some time in understanding the loan terms and devising a strategy to maximize the loan proceeds. Otherwise, they may end up leaving little or no inheritance to their spouse or other family members.
Mortgage Points – An Overview
When looking for a mortgage for your house, there are many options that you have. With each option having different advantages, there is none that can be deemed as being ‘universally right.’ Each mortgage plan will have its conditions and will hence be suitable for a particular category of borrowers.
Applying for a mortgage is thus not an easy task. Before you start the process, carrying out a need analysis is extremely important. At this point, you will be looking for any discount or reduction in the interest rate that you can be eligible for. Mortgage points are considered to be one beneficial way of getting an interest reduction. Here’s how this works:
What are Mortgage Points?
Mortgage points primarily come in two types, origination points, and discount points. Origination points can be seen as a fee that is paid to the lenders for their part in the processing process and approval of the loan. On the other hand, discount points can be used in order to get a reduction in interest rate from the lender. It can be thus seen as a prepaid interest. Generally, in both cases, one point results in a one percent reduction in the interest rate.
For ease of understanding, we will be discussing the discount points in this article. If you are thinking of applying for a fixed-rate mortgage and plan to keep the house for an extended period, it would be beneficial to consider using mortgage points. However, it should be noted that the upfront costs when applying, will be higher in case you choose to go for the mortgage points. The benefit of using them, however, can be seen in the long run in the following ways:
Benefits of Using Mortgage Points
Reduced Interest Rate
When buyers opt for prepaid interest, the interest payments that they are required to pay every month witnesses a reduction. Getting a reduction in interest rate takes off the burden from the borrower’s shoulders significantly and can thus be seen as an advantage to using discount points.
Reduction of Monthly Payments
Similarly, because of the decision to use discount points, you would reduce the amount of the monthly payment that you owe to the lender. This amount will be lower than what you had originally owed to the lender and is therefore considered a relief for the borrower.
Reduction of Total Cost
If you become successful in getting the return on your investment of mortgage points, in the long run, you enjoy the benefit of having the total cost of your loan reduced significantly. This advantage is, however, experienced in the long run.
Depending on the life of your refinance, the amount you paid for discount points is deducted from your income taxes amortized over the course of the refinance. This gives the borrower a tax relief, something that is highly welcomed at such a time.
Understanding How Points Work
Mortgage points can be seen as a fee that you pay to get relief in future interest payments. When doing the cost-benefit analysis of mortgage points, it is important to consider the break-even period. Break-even period is the time it will take for you to recover the cost that you incurred at the beginning of the process as a result of purchasing mortgage points. The following method is used to determine the break-even period:
Cost of mortgage points/Monthly savings of payment = Break Even Period
Mortgage points are not considered to be the viable option for every borrower looking for a home mortgage loan. This is because as mentioned above, there is a break-even period that is associated with the use of mortgage points. If you plan to leave home before the break-even period, it is advised against using mortgage points as they will not carry any benefits for you.
Moreover, depending on your financial situation at the time of application, it may or may not be an option worth considering. This is because the pre-paid interest will increase your initial costs. The interest rate reduction as a result of points can also vary depending on the lender. This is another point that needs consideration before you make the decision.
With a variety of brokers, internet lenders, and banks all around, it might feel that taking up a loan is a straightforward process. However, in reality, there are many factors that you need to consider before you make the right decision. Having prior knowledge about the whole process and doing the necessary homework will allow you to make the best decision possible.
When looking for ways to finance your home loan, it is extremely important that you give attention to your needs rather than going with a process that is followed by others. What works for one individual might not prove to be beneficial for you.
Hence, it is advised to do a thorough analysis of your needs and wants and then move on to shop around for the right lender. Your financial condition might place obstacles in the course of your mortgage process. Therefore, it is helpful to take into account every expense at the beginning of the process. Also, it is advised to meet a tax consultant and discuss how using mortgage points will affect your tax situation to ensure the optimal situation.
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