Building Wealth with Mortgage and Equity Loans
Loans and mortgages are an important part of your financial present and future. As with any aspect of life, knowledge is the key to success. Learning the proper use of various lending tools can pay you big dividends. Use loans wisely to build wealth and maintain your credit score.
Credit Score
The higher your credit score, the more loan options you have available and the lower the interest rate you will be charged. Transunion, Equifax and Experian are the three main credit-reporting bureaus. These companies will collect a lot of credit information on you during your lifetime. Most of the information will be correct. Unfortunately, some of it may not be correct. Before shopping for a new home or home loan, check your credit reports.
Anything that is incorrect should be addressed. Inactive credit card accounts are not a problem. They can even help your score so leave them alone. Inaccurate active accounts or employment information should be corrected. If you have late payments in your credit history address those late payments. You can make a short accurate explanation for the late payment or challenge its accuracy.
Try to reduce credit card balances and other loan obligations before applying for a home loan. By reducing other monthly payments you will increase your disposable income, a key factor in getting a quality loan.
If you are just starting out, build your credit score. You can get a secured credit card or personal loan to build credit. Use the card or loan wisely and make prompt payments. Automatic payments through your bank are a great way to stay prompt.
Mortgage and Loan Options
Thirty-Year Conventional Mortgage:
The thirty-year fixed interest rate home loan is the most popular home buying tool. The Veteran's Administration (VA) and Federal Housing Administration (FHA) both offer conventional mortgage opportunities to qualified individuals and families. They have been and will continue to be the backbone of the American housing industry.
While the reduced interest rates of shorter term loans is attractive, the thirty year loan allows more homebuyer to access properties without initial over-extension of their financial resources. Higher total interest payments are offset by increased property values (equity) in a long-term market.
A thirty-year mortgage can be reduced in term with additional payments towards principal. Adding just a few percent to your monthly payment can reduce the life of the mortgage by years. This is a highly recommended strategy in most cases. There are real estate market trends and other investments opportunities that are important in determining your mortgage payment tactics.
In a rising real estate market allowing the loan to run full term will result in a greater return on investment if you have other investment options yielding good returns. Paying off a loan early is never a bad investment strategy but be aware of all the options.
If the borrower has few productive investments other than his/her home, early loan payoff is an important consideration. The increased equity produced through additional payments to principal is a very desirable option. The equity generated by both property appreciation and addition principal payments provides a basic yet sound retirement investment strategy.
Forty-Year Mortgages:
With rising real estate prices longer-term mortgage loans can be considered to decrease monthly payments. Forty-year mortgages can be a very attractive option for first time homebuyers and real estate speculators. By extending the normal mortgage term by ten years, the monthly payments are reduced. Total interest payments are of course increased by a significant amount if the loan runs full term.
The "if the loan runs full term" is the key element of the preceding paragraph. Rarely would a savvy investor allow a forty-year loan to run full term. If the loan has a reasonably low interest rate relative to the market is one instance. If the investor is getting a much greater return on other investment that the loan interest rate is another instance were allowing a longer term mortgage to run full term may be advisable.
It all boils down to the interest rate of the loan. If there is a significant drop in interest rates, refinancing should be considered. Making to extra monthly payments towards principal can really help in getting a better refinance interest rate.
The down side of a longer-term loan versus a 30-year conventional is total interest payments. Equity in the property is being added with each payment albeit at a slower pace. In a falling real estate market, there is no impact on the loan payments only on the accrued equity.
Conventional investment wisdom is that 40-year mortgages are most attractive to home buyers that plan on living in the home for less than five to seven years. The forty- year mortgage is not as good a choice if the buyer plans on living in the home for more than ten years. This wisdom neglects to consider one key point. A forty-year mortgage need not run full term.
A longer-term loan can be an attractive option for rental property investors as well. When the property is generating positive cash flow, the owner can make higher than required payments to increase equity. During periods where the property is not generating income, the lower payments prove to be less of a financial burden. The loan can be converted to a shorter term when better financial conditions arise.
Fifteen-Year Conventional Mortgage:
Shorter-term mortgages like a 15-year convention are best for building equity and reducing finance costs. The average interest rate for a fifteen-year mortgage is lower that the mid and longer term mortgage loans. The shorter term greatly improves equity growth with a much higher portion of the monthly payments going towards principal. If your financial situation allows you to comfortably meet the payment schedule without straining your budget, the shorter-term mortgage is a valuable tool in any market situation.
Balloon Loans:
Balloon loans, considered by many as interest only loans, have their place in the loan industry. Typical balloons have a 1 to 5 year payoff date. With a balloon loan the borrower agrees to pay the entire loan amount in that given time period. The loan can be paid either in cash or by obtaining another loan. In a rising market, whether real estate or securities, savvy investors can realize a higher return on other investments or real estate equity than they lose on balloon loan interest rates.
This is not a loan recommended for average homebuyers. It can be useful to bridge a gap between the purchase of one home and the sale of another. Serious consideration should be made before deciding on a balloon loan. Having high equity in the property or a substantial investment portfolio enhances the attractiveness of the balloon loan as an investment tool. Poor equity or limited financial reserves can result in undesirable loan options and even foreclosure in a falling real estate market.
Adjustable Rate Mortgages:
Adjustable Rate Mortgage (ARM) loans are most popular when interest rates are predicted to fall. An adjustable rate mortgage is just that. The rate is adjusted based on a common economic indicator, normally the federal prime interest rate. As that indicator rises or falls so does your loan's interest rate. ARM loans have an amount of risk associated with them. Borrowers selecting ARM loans wisely have sufficient equity in their real estate investment to easily convert to a fixed rate mortgage should interest rates begin to rise. That equity allows the mortgage holder to take advantage of economic changes and stay ahead of the crowd.
ARM loans are often selected by homebuyer's to get into a property they could not otherwise afford. Rapidly appreciating real estate prices and low interest rates inspired many to select ARM loans in conjunction with minimum down payments. A change in the real estate market or rising interest rates can increase the monthly payments. As a rising real estate market cools down or retreats, an ARM loan can result in a negative amortization loan situation.
When selecting an ARM loan pay special note to the maximum or cap interest rate. Since your monthly payments can vary, make sure the payment range stays within your budget. Also pay attention to how much of your monthly payment is towards principal. If your payment has no money paid toward principal you are in negative amortization. This is not a good thing. With rising interest rates and a real estate market retreat, you may be forced to make loan choices that cost you money.
Option ARM loans should be examined with care. An option ARM offers an incredibly low initial interest rate for few months to the first year of the loan. After the option period of the loan has expired the payments increase to meet the normal rate. Rising interest rates or a retreating real estate market, are negatives that can make option ARM loans very unattractive. Always consider the cap rate and the maximum monthly payment before choosing any type of ARM loan.
The keys to taking advantage of an adjustable rate loan are equity, and market conditions. Should market conditions change having sufficient equity or greater disposable income your options are much greater. In a rising real estate market many investors make poor decisions. Avoid the herd mentality and weigh your financial options honestly.
Reverse Mortgages:
Having maximum equity in your home at retirement makes reverse mortgages an excellent option for many. With a reverse mortgage you are allowed to continue to enjoy your home and lifestyle with a monthly income from your primary real estate investment, your home.
Depending on your age (both you and your spouse), the equity in your home and current market trends, the monthly reverse mortgage payments can be significantly large. This provides many retirees with adequate income to not only survive but also enjoy the retirement years.
Home Equity Loans:
The equity in your home can be made available for your use through home equity loans. In retirement, the use of home equity loans should be carefully considered. The more equity you retain in your property increases your financial options. Using that equity unwisely can create adverse financial situations at a time in your life you have few resources available to recover.
Proper use of home equity in retirement would be home improvement loans that make your home more enjoyable and increase the home value. A more efficient heating and cooling system, bath and kitchen remodels or an addition that adds value to the home are good examples.
Using home equity loans for financial investments in other areas can be beneficial. Exercise extreme caution before making such a decision. Remember the old cliché "if it sounds too good to be true it probably is" and avoid the herd mentality.
One good investment would be using a portion of your home equity to purchase a retirement or rental property. Depending on the cost of the property and your home equity, it is possible that you can rent either home and have a net positive cash flow following the transaction. Your total equity between the two properties can be maintained or increased in many cases. Loans are tools for building wealth.
Consolidation Loans:
Home equity loan rates are typically much lower than other loan rates. With sufficient equity in your home, using a consolidation loan can dramatically reduce your total monthly payments. Since the term of consolidation loans is much longer than say an auto loan. The total interest payments may be more with the consolidation loan than with the higher interest short-term loans. As with any loan, consolidation loans need to be thoroughly considered.
All loans have origination fees or points added to the loan that increase the cost of the loan. When considering loans, include these fees and your total interest payments to determine the total loan cost. There are situations where a slightly higher interest rate and lower origination fees can be a better option.
Loans are financial tools you can used to build wealth and a comfortable lifestyle. The more you know about the use of these tools the better prepared you are for the future. Invest a little time in becoming familiar with your various loan options and you will make savvy investment decisions.
