What you should know about Mortgages and Home Equity

Sources: Bankrate.com, Experian.com

Mortgages: rent to own residential property. It often involves receiving loans from a bank/organization. You will pay the bank/organization a monthly payment of rent that goes towards the ownership (equity) of the home/house. Like any rental agreement, there are a variety of terms and conditions. The main difference being ownership and term.

Most mortgages give you interest rate options. This interest rate is the extra amount you pay the bank/organization for giving you a loan. It pays only them, not the cost of your home. Therefore, you don’t pay off the house at all through interest rates. To make sure you are paying off the price of the house and less of the interest rate, send payments to pay towards the principle (i.e. the value/cost of the house when you bought it). The more principle you pay, the less interest rate you pay. With houses, interest rates are NOT your friend! They’re your enemy.

There are 2 main types of interest rates: Fixed and variable.

Fixed Interest Rate

Whatever the interest rate is right now is what it will be for the entire term of your mortgage (unless you refinance). It is reliable and stable.

Variable Interest Rate

Your interest rate will change based on current market trends. It’s very unreliable.

I always recommend a fixed mortgage rate of 2 reasons: 1. No surprises and 2. You have more control of your finances.

However, if you like to live life on the wild side and throw caution to the wind, do you! Get a variable rate. A variable rate can be great when the markets decline, making your mortgage payments lower. A variable rate can be terrible when the markets rise; making your mortgage payments higher than usual. Just be mindful that life is unpredictable.

If you’re in a financially rough year and your variable mortgage interest rate increases 5%, you will have to find a way to pay more on your mortgage. You really have to be active with your savings and money management with this option. Even if the interest rate decreases to 5%, you still need to save the excess for that unpredictable market change. If there’s anything we know for certain, it’s that EVERYTHING CHANGES! For better and/or worse. You don’t want to be caught unprepared when the worst comes.

Most mortgages should come with the option of paying off more of the principle to reduce the term of your mortgage agreement. Make sure whoever you are getting a mortgage from (i.e. the Lender), has this written in the contract somewhere. It should say for example: Principle curtailment or Principle only payments. This process is called Amortization (i.e. the loan balance decreases over time). It’s often on a statement you’ll receive called an “Amortization Schedule.” This Amortization schedule tells you how much you owe, when the next payment is due and when the term for payments ends.

Home Equity and Refinancing

Home Equity is the total value of the home minus the amount you still owe on the mortgage. It’s the difference between the 2. You can check home search websites or get a professional appraisal to estimate your home’s value.

Example: You owe $250,000 and it’s worth $325,000. 325,000-250,000 = $75,000 home equity. This can also be written as 23.1% of home equity. Meaning, you officially own 23.1% of your home. Which also means, you now have more bargaining power because you OWN something!

Mortgage Recast

This is when you are making lump-sum payments or a series of payments towards the principle. The lender will update (i.e. Reamortize) your mortgage with the new balance.

When to use Mortgage Recasting:

You can do this after establishing trust with the lender after a specified amount of time (e.g. 1-3 years). Sometimes there is a service fee to do this. People most commonly do a mortgage recast when they’ve received a large amount of money (e.g. a work bonus, an inheritance, a prize, etc.) and want to reduce their mortgage. Having a high credit score and more home equity can offer you better terms.

Mortgage Refinance

This process replaces your current mortgage with a new one for you to get better contract terms.

When to Refinance:

When you want a lower interest rate, different terms, or access to home equity. For example, you can switch from a variable interest rate to a fixed rate. Usually the new lender will pay-off your old mortgage balance and you will begin making payments with the new lender. You’re basically switching lenders/packages when one has more attractive benefits than the current one you have.

Examples of Refinancing:

1.  You can refinance from an FHA (Federal Housing Administration) that is backed by government mortgage entity HUD (Housing and Urban Development) to a conventional loan once you’ve built 20% equity. The FHA is often good for 1^st timers, low to mid income earners, and low credit individuals. You can get a 3.5% down-payment or more depending on your credit score.

2. Cash-out Refinance: Use home equity to withdraw cash to spend on home improvements or investing.

3. Cash-in Refinancing: Make a lump sum payment to reduce Loan-to-value (LTV) which lowers your monthly payment and overall debt.

4. No-Closing Refinance: No closing costs upfront because those costs are now included into the monthly payments (which makes monthly payments higher).

5. Streamline Refinance: Remove financial requirements available for FHA, VA, USDA and Fannie Mae & Freddie Mae Loans.

Have a clear goal/future goal for yourself before refinancing. Make sure you are in a good financial position (e.g. good credit score, good equity).

Foreclosure

When the homeowner (you) can’t pay the mortgage anymore. The lender will then sell the home to recover the remaining mortgage balance; Sometimes at a lower cost than the homeowner bought it due to current market value rates. Foreclosures often come with a variety of fees which reduce your home equity significantly. On average, homeowners receive very little money if any. If the house is sold above the original market value, you could keep your home equity.

Example: Your balance is $200,000. The bank sells it for $150,000 so there is nothing for you. If the bank sells the house for $300,000, you could receive $100,000 (i.e. the surplus).

In summary, you are more likely to lose your equity in a foreclosure. It’s best to plan things through, have an emergency fund and an A-B-C back-up plan if you want to avoid losing ownership of your home.

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