3 Easy Ways to Pay Off Your Mortgage Faster

These tips are your ticket to mortgage-free living.

As long as you’re alive, you have to live somewhere and, generally speaking, you have two options: Rent an apartment (or a home) and line your landlord’s pocket; or buy a home, and over time, hopefully line your own.

This premise is one of David Bach’s most important messages. The author of the New York Times bestseller “The Automatic Millionaire,” is a firm believer in the idea that real estate is critical to building wealth. In fact, he says buying a home is one of the three most important actions people can take in pursuit of financial security.

“I’ve been a lifelong proponent of home ownership,” says Bach, author of 11 best selling books. “How do you build real wealth on an ordinary income? It’s not very sexy, but it’s a simple, timeless approach: Buy a home.”

It’s not merely the act of purchasing a home that Bach advocates. The secrets to financial success that he offers in “The Automatic Millionaire,” include urging readers to pay their homes off early via an approach he calls “automatic debt-free home ownership.”

It may sound radical to some, but according to Bach, who spent nine years as a financial adviser at Morgan Stanley, the common denominator among all of his clients who were able to retire early was that they had paid off their homes early.

Here’s Bach’s approach to debt-free home ownership.

1. Establish a Biweekly Mortgage Payment Plan

A biweekly payment plan is exactly what the name implies. Instead of only making monthly mortgage payments, split the payment down the middle and pay half every two weeks.

When you make a payment every two weeks, (instead of just one per month,) you end up making one extra month’s worth of payments annually. In other words, over the span of a year, you’re making 26 half payments, which is the equivalent of 13 full payments.

“By doing this, something miraculous will happen. Depending on your interest rate, you can end up paying off your mortgage early — somewhere between five and ten years early” he says in the book.

Additional Benefits of Biweekly Payments

The biweekly payment approach also saves the homeowner thousands, if not hundreds of thousands of dollars, in interest. (Having a good credit score can help you save on interest, too. If you don’t know where your credit stands, you can get your two free credit scores, updated every 14 days, on Credit.com.)

In his book Bach provides the example of a 30-year-mortgage on a $250,000 home. If the interest rate on that mortgage is 5%, then the interest paid over the life of the loan will be about $233,139. When paid biweekly, the same mortgage instead costs about $188,722 — a savings of more than $44,000.

Establishing a biweekly payment plan merely requires calling your lender. If the mortgage is held by a large bank, they may refer you to a third-party that handles payment processing.

But one critical point Bach makes in the book is this: Before signing onto biweekly mortgage payments ask the servicing company what the fee is for the program and what they do with your money when they receive it. The second question is particularly important because some companies hang onto the extra money you’re putting toward the mortgage and send it to your mortgage holder all at once at the end of the month.

You want the extra payments applied to your mortgage as soon as possible, so that you’re paying down the mortgage faster.

You also cannot just split your monthly mortgage payment in half yourself (without talking to your mortgage holder, bank or other servicing company) and mail in payments every two weeks. The bank may send the extra payment back to you, unsure of what to do with it.

This trick can also work for paying down your credit card balance faster. (Here are some other tips for paying off credit card debt.)

2. Pay Extra Each Month

The next approach to debt-free home ownership outlined in Bach’s book is a plan he calls “No-Fee Approach No. 1.” It involves merely adding 10% to whatever your monthly mortgage payment happens to be. If your monthly payment is $1,342, pay an extra $134 dollars each month. (Sending the bank $1,467 per month instead of $1,342.)

This approach leads to paying off a home in 25 years, instead of 30, saving about $44,000. However, Bach urges making the extra 10% automatic, so that you don’t come up with excuses not to do it. In other words, have the $1,467 automatically deducted from your checking account each month.

3. Make One Extra Payment Each Year

Pick one month each year and pay the mortgage twice. Translation: Send the bank one extra payment a year.

Try doing this with some of your tax refund, suggests Bach. But no matter when you choose to do it, don’t simply send the bank a check for double the normal mortgage amount.

According to Bach this will confuse the bank. He advises writing two checks. Send one in with your mortgage coupon and the other with a letter explaining that you want the money applied to your principal.

The big takeaway according to Bach is that if you don’t buy a home, you won’t get on the escalator to wealth that home ownership provides. He says this message is particularly important for millennials who have been shying away from home ownership.

“The critical point is that one — you can buy a home. Two — you should buy a home. And three — you will be glad that you did,” says Bach.

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8 Questions to Ask Yourself When Deciding to Rent or Buy a House

Buying a home isn't for everyone. These questions will help you sort out whether it's a good financial move for you.

If you’re at the age when your peers are making major life moves — getting married, having kids and buying homes – you might be feeling it’s time to join them. Or you may simply just be at that stage all on your own.

Either way, plenty of young adults are starting to get the home-buying itch. While there are a lot of appealing benefits to homeownership, taking on that kind of debt is not without risk. The decision to rent vs. buy is one you should make carefully.

If you’re trying to figure out your next move, consider asking yourself these eight questions. The answers should steer you in the right direction.

1. What Is My Top Financial Priority?

Buying a home will slow down your ability to make progress on other financial goals. You’ll need to focus on lowering expenses or increasing your income so you can afford a down payment and monthly mortgage payments. (This guide can help you understand more about how to determine your down payment on a home.)

That extra cash will be funneled toward your mortgage rather than paying off credit cards or student loans if you have them. Other financial goals, such as saving for retirement and building an emergency fund, may also have to take a back seat.

Assess your competing financial goals and decide which ones take priority. Buying a house might come first in your book, or perhaps you’ll decide to work toward other money goals before committing to a mortgage.

2. Do I Have Savings For a Down Payment & Closing Costs?

Renting requires some savings – you’ll need enough cash to cover the first month’s rent and the deposit.

To buy a home, however, the minimum you’ll need to have saved is usually 6% or more of the home’s value. Even FHA loans require a minimum down payment of 3.5%, and closing costs add another 2-3% to the costs.

But that’s the minimum; a 20% down payment is better to give you a decent amount of equity and avoid private mortgage insurance.

If you don’t have sufficient savings, you’ll need to focus on saving for a down payment before you’re in a position to buy. And even if you do have savings, it’s worth it to think through the best use of those savings and whether you’d rather allocate that cash to other goals.

3. How Do Home & Rent Prices Compare?

Housing markets also affect whether it’s a better idea to rent versus buy. If you’re facing sky-high rent prices that climb each year, a mortgage starts making a lot of sense. On the other hand, if you want to live in an expensive area, you could be priced out of buying a home (especially without extensive savings).

4. How Long Do I Plan to Live Here?

The longer you live in a home, the more likely it is that the financial investment of buying a property will pay off.

If you like your city, have a steady job, and are ready to live in the same space for a few years, buying is often more cost effective, but not always. You may want to crunch the numbers to see how long you’d need to live in a home to break even on your initial costs.

5. Will I Qualify for a Good Deal on a Mortgage?

You’ll need a decent income and good credit to qualify for the lowest rates and best terms on mortgage loans. It’s sometimes possible to get a mortgage if you have bad credit, but you’ll pay a lot more over time. (Haven’t checked where your credit stands? Now’s the time. You can get your two free credit scores, updated every 14 days, on Credit.com.)

Think of it this way: most mortgages last 30 years. With that in mind, you may see that it’s financially worth it to spend a few months to a year rebuilding your credit if it means qualifying for a lower interest rate for those 30 years. For example, if you boost your credit score by 50 points – from the mid-600s to over 700 – you could qualify for a mortgage rate that’s 80+ basis points lower, according to MyFICO.com.

6. What Other Costs Will I Be Responsible for as a Homeowner?

When comparing costs of renting versus buying, make sure you’re including home-owning costs beyond mortgage principal and interest.

There are escrow costs, homeowner’s insurance, and property taxes. You can expect home maintenance costs to equal 1-3% of your home’s sale price each year. Then there are homeowners’ association fees and new utility costs such as trash collection and water. Meanwhile, renters are usually not responsible for any of these costs.

7. Am I Comfortable with the Risks of Owning a Home?

It’s a popular argument that owning is smarter than renting because you’re investing in a home. But as with any investment, owning a home has its own inherent risks.

There are no guarantees you’ll get a good return on your investment. Just ask the many homeowners who defaulted on their homes after the 2008 mortgage crisis. And even in a strong housing market, there are the everyday risks of unemployment or other financial hardships.

8. How Would Renting vs. Owning Affect my Lifestyle?

Guiding forces in your decision to rent or own are your lifestyle and values. For many, the freedom of choice, privacy, and control that come with owning a home are big selling points. Other people might prefer the convenience, flexibility, and short-term commitment that comes with renting.

Know what you want and choose a housing setup that will help you achieve it. Owning a home can be an admirable accomplishment for some people. Maybe it will be for you, too. Only you know the answer.

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This Common Mistake Can Kill Your Mortgage

If you're thinking about buying a home, you'll want to avoid this common mortgage mistake.

In order to qualify for a mortgage, you need to show your lender that you have a down payment and access to funds for closing. This money needs to come from documentable sources prior to moving it from your bank account to your escrow account. Unfortunately, a lot of people don’t do this, which can end up creating unnecessary challenges during the underwriting process.

Lenders are going to require at least 60 days of asset documentation from each source that your money comes from. This is required because your mortgage lender will need to verify that the money promised does exist and is eligible for use.

Let’s say you’ve put your money into escrow and, as requested, are doing your best to document the movement of money from the account going to escrow. This entails providing a bank statement specifically showing the money leaving your account and the money being accepted by escrow through an EMD (earnest money deposit).

If you can’t get a bank statement, though — say it’s the middle of the month and new statements are not out yet — the next best thing is to get a bank printout confirming the transaction and confirming the amount of money remaining in the account. (There are literally dozens of other things you also should be thinking about during the home buying process. Here are 50 ways you can get ready for buying your home.)

How a Bank Printout Can Help You Close

The bank printout must show the date of the transaction and the current timestamp of the printout, confirming that the money has been moved prior to the printout date. If the bank printout does not have this information, it will automatically halt the closing process of your loan and delay your loan contingency removal or extend your close of escrow date.

This method can be used for both your down payment and funds for cash to close. This is to provide authenticity for your account and to show clearly on paper that the account is yours and the money is yours to use. Banks and lenders require this information to be clear cut and “in your face.” Never assume that “common sense” will be enough.

Documents & Other Items You’ll Want to Avoid

Providing any of the following items in lieu of the bank printout will not work:

  • A bank statement with someone else’s name on it
  • Bank statement in trust
  • Pictures of bank statements taken from a smartphone or snapshot application
  • Bank printout with no timestamp and date

In addition, the bank printout and timestamp must show the remaining balance that is left in your account. For example, if you had $130,000 in assets and your down payment from this account was $50,000, your account statement should now show $80,000 remaining.

If you are looking to purchase a home, talk to a seasoned loan professional who can walk you through properly documenting the money required to buy your home. Also, take a few minutes to check your credit scores so you’ll know going in what kinds of terms you’re eligible for. You can get your two free credit scores, updated every 14 days, at Credit.com.

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Here’s How You Can Control the Cost of Your Mortgage

Mortgages aren't cheap, but there are some ways you can keep your lending costs down when buying a home.

Mortgages are not cheap. Closing costs and interest paid over time to your lending bank will make the cost of having a mortgage very pricey over the 15-30 years that you have it. But, when it comes time to get your mortgage, you actually have more control over your loan costs than you think (even in the 2017 mortgage market).

Here are a few ideas on how you can keep costs down without cutting corners.

Remember the Rate-Lock

When you apply for mortgage loan financing and agree to move forward with the loan, there is something called a “rate lock”. Rate Locks are usually set for 15, 30, 45, or 60 days. The rate lock is a commitment; you are committing to your lender that you are going to take the mortgage interest rate and terms they have offered.

In turn, the lender is committing to giving you those terms with zero changes. The big “if” in this statement is whether this rate lock is set for a specific timeframe – 15, 30, 45 or 60 days. The average rate lock is 30 days for most mortgages. If your loan is locked for 30 days and it does not close by day 30, it will have to be extended in order to maintain that rate. If the lock is extended, the cost of your mortgage can change and your loan terms can get unnecessarily expensive. It is not uncommon for a mortgage that started with zero points to end up with pricey discount points due to a lock extension.

You can avoid this, though. The speed and momentum with which your mortgage loan is processed is directly related to how quickly you provide your lender with documentation and requested items throughout the process. The longer it takes you to gather and supply these items, the more it can cost you. You can reference the old adage, time is money.

Get Organized Before You Apply

When you first approach your loan officer and/or lender about mortgage loan financing, try to provide all of the documentation they ask for up front and before you begin. It’s also important to make sure your credit is in good standing and there are no errors on your credit reports before you begin the loan approval process. Doing so can help ensure you get the best rates and terms from your lender.

Once your loan has been underwritten and you are asked to provide additional documentation, get it back to them as soon as you can. The longer it takes for your lender to receive these items, the higher the chance that an extension will be needed. The ideal response period is 24-48 hours after the request is given. If it is going to take you more than 48 hours, or if you know you cannot get it quickly, let them know as soon as you get the request. Do not wait the 48 hours and hope that the condition will disappear. It will not.

Be Proactive & Prompt

The loan process is not always smooth. When items are requested by the lender, things can get frustrating for some consumers. These are some common comments made by consumers that come up during the process:

“I have already provided that piece of documentation multiple times.”

“Why do you need this?”

“I am waiting on my accountant and he won’t get it back for a week.”

Homebuyers can often feel frustrated because the reality of today’s lending environment was not made clear by the mortgage professional at the beginning of the process. If you are the type of consumer that understands that 5+5 will always equal 10 in any situation, prepare to be disenchanted by the mortgage loan process. In the current mortgage market, 5+5 will equal 10, 11, or 0. The environment you are entering is bureaucratic and heavily reliant on compliance to rules and regulation. These can often seem redundant and unnecessary but, remember, they were put in place to protect you.

If you can step back from the frustration and provide the items quickly, not only will you be ahead of the game but you will be saving yourself time and money. If you are prone to providing pushback to your lenders on requests, know that you are costing yourself in time, effort, and money.

Ask for clarification, call your lender, get on their calendar, bite the bullet and you will maintain control of your costs. The way to make sure you are set on the cost of your mortgage is to lock in the interest rate and terms, provide documentation within 24-48 hours, and be on call for any updates that your lender has.

There will always be circumstances beyond your control, but being proactive and on top of what your lender needs is the number one way to stay in control of your financial mortgage success.

Trying to buy your first home? Check out our roundup of first-time homebuyer mistakes you’ll want to avoid and visit our mortgage learning center for more answers to questions that come up during the process.

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Trump’s Mortgage Fee Cut Reversal: What it Really Means for House Hunters

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Almost lost amid all the celebrating and marching this weekend were a set of official actions the Trump administration took soon after the Inauguration. One directly impacts some consumers who are house-hunting right now.

You might have seen headlines suggesting President Donald Trump raised taxes on middle-class homeowners, but that’s not an accurate way to portray what happened. Instead, Trump signed an administrative order to halt a fee rate cut, announced just days earlier by the Obama administration, that would have saved homebuyers who don’t have big down payments and use Federal Housing Administration-backed home loans an average of about $450 annually in their monthly house payments.

The order will make home loans more costly for a large group of buyers — about 40% of millennial buyers use the program targeted by the Trump order. That, in turn, can make life harder on older owners looking to sell their homes and trade up.

What Really Happened

In the hours after he was sworn in, Trump signed an order that stopped a lame-duck step by the Obama administration that would have lowered monthly fees for consumers who buy homes with less than 20% down payments and use a government program operated by the Housing and Urban Development department known as “FHA loans” to insure their mortgages. The decrease would have saved average homeowners about $37 monthly, according to Attom Data Solutions. It would have saved homeowners much more in places where home prices are higher — averaging more than $1,000 annually in 13 counties across the United States.

FHA loan fees were raised during the recession to cover program losses, and Obama’s move would have returned them to about the level they were before the housing bubble burst. For now, they remain above their 2008 levels.

Keeping the fees higher effectively lowers the buying power of home shoppers, as money that could be spent toward mortgage payments is instead shifted to insurance payments.

Help For Less-Liquid Homebuyers

Many homeowners are familiar with the additional fees that come with low-down-payment mortgages. Buyers with less than 20% generally must pay for mortgage insurance in case they cannot make their mortgage payments. That’s because the owners will have so little equity in their homes that banks can’t be sure they’d make their money back if they foreclosed on the home and sold it.

There are several forms of this kind of insurance; the most popular is provided by the Federal Housing Administration through FHA-backed loans. For an upfront fee and an ongoing monthly cost, the FHA will guarantee a loan between a buyer and a bank — that gives banks the ability to lend money to buyers with as little as 3% down.

The program dates back to the 1930s, and helps create first-time homebuyer activity. The FHA has insured 34 million properties since its inception, and the agency says it is the largest insurer or mortgages in the world.

Low-down-payment buyers can opt for private mortgage insurance, or PMI, instead. PMI tends to be less expensive, but buyers with lower credit scores or smaller down payments might not qualify for it.

Without these kinds of insurance programs, a buyer shopping for a median-priced $185,000 home would need at least $37,000 in a cash down-payment to buy a home, or would be required to finance the down payment some other way.

Younger Buyers Could Be Hit Hardest

FHA loans are particularly popular with millennials; 38% of new loans closed by younger buyers are FHA loans, according to mortgage data firm Ellie Mae.

FHA insurance isn’t cheap. At closing, buyers pay 1.75% of the loan in an upfront fee. For a $185,000 mortgage, that’s an extra $3,238 in cost; it’s usually financed as part of the loan. The ongoing monthly fee on that mortgage is about $126 per month — a rate of .085% of the loan annually, paid in monthly installments. The fee is known as the MIP, or mortgage insurance premium. The MIP was targeted by Trump’s order.

In the waning days of the Obama administration, the FHA announced it would drop the fee from 0.85% to 0.60% — a 0.25% drop. That would have provided $37 in monthly savings for a buyer with a median-priced home, or about $446 annually, Attom says. An FHA buyer in Santa Clara County, California, would have saved much more— $1,448 annually.

The fees collected from consumers go into the fund used to support the FHA loan program.

Before the recession, ongoing FHA fees were 0.55%. Not surprisingly, the FHA fund collapsed in the face of massive defaults during the collapse of the housing bubble. To restore the fund, FHA fees were raised steadily, beginning in January 2008, reaching a high of 1.35% in January 2013.

When the fund reached Congressionally-mandated reserve levels, the premiums were reduced, down to 0.85% in January 2015

A drop that would have returned FHA monthly fee levels to their 2008 levels, announced Jan. 9, was set to take effect on Jan. 27.

On the eve of HUD nominee Ben Carson’s confirmation hearings, Financial Services Committee Chairman Jeb Hensarling, R-Texas, was critical of the fee cut.

Greater Risk of Another Bailout?

“It seems the Obama administration’s parting gift to hardworking taxpayers is to put them at greater risk of footing the bill for yet another bailout,” Hensarling said. Carson then said he would “really examine” the premium cut at his hearing.

Daren Blomquist, senior vice president at ATTOM Data Solutions, says the rate cut two years ago triggered a short-term jump in home sales to FHA buyers. On the other hand, the impact of the rate cut wasn’t as dramatic as hoped, in part because fast-rising prices gobbled up much of the anticipated increased buying power.

“This decision not too surprisingly reflects the Trump administration’s fiscally conservative philosophical bent, favoring not putting taxpayers at risk — or at least what they perceive as risk — for the sake of a government program that helps people buy homes,” Blomquist said to me. “This is not to say that the Trump administration won’t take policy steps to help the homeownership rate rebound, but the levers pulled will more likely involve trying to allow the market to address the situation with deregulation rather than addressing the situation through government programs that potentially put taxpayers at risk.”

HUD did not immediately respond to Credit.com’s request for comment as to why the fee cut was suspended.

Buyers might be tempted to wait and see what the Trump administration does with FHA fees — some observers think they could ultimately be lowered — but that might be a mistake. If home prices continue to rise, those increases would quickly eat up any savings from lower FHA fees.

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How to Get a Loan for a Manufactured Home

If you're looking to purchase a manufactured home, or if you already own one and want to refinance, here are some things to keep in mind.

If you’re looking to purchase a manufactured home, or if you already own one and want to refinance, here are some things to keep in mind.

Manufactured homes are not the same thing as modular homes. Manufactured homes are constructed, purchased at a dealer, and then moved to their final destination where they are permanently attached to the earth. If you’re looking to purchase a manufactured home, many mortgage lenders will deny you because it is a risky financing vehicle. This is due to the fact that, technically, you could detach the dwelling and move it to another property.

If you are able to secure financing, manufactured home loans often contain higher rates and fees due to the associated risk that comes with this type of property. Some lenders will allow you to secure financing for a manufactured home without the need for mortgage insurance, meaning you can avoid a Federal Housing Administration mortgage, which contains a monthly mortgage insurance payment and can end up costing you more. An FHA mortgage can be an option for you, however, if you have no alternatives.

Conventional Mortgages

To get a conventional mortgage without mortgage insurance, you need to have at least 20% as a down payment (or in equity if you’re refinancing) and have a credit score of 640 or more. It can be used for purchasing or refinancing without pulling cash out under certain circumstances, but you should consult your mortgage lender about the requirements specific to manufactured homes before assuming the home will qualify for a conventional mortgage.

If you are looking to purchase a manufactured home for the first time, conventional mortgages will allow you to do that type of financing so long as you find a property with the real estate included. In other words, the house is already affixed to the earth and is being sold as real estate. Financing to secure the land and attach the unit is an entirely different animal that typically comes with higher rates and fees. These loans are more difficult to come by. If you are looking to get a manufactured home, get pre-approved to purchase a house with the expectation that the manufactured home is already attached to the real estate and is going to be sold as one property. This will give you the best outcome for success in this particular type of property arena.

FHA Mortgages

Another outlet for this type of financing is FHA. FHA contains two forms of mortgage insurance; an upfront mortgage insurance fee and a monthly mortgage insurance payment that is otherwise avoided when you go with a conventional mortgage. No matter what your financial situation is, look at getting qualified for both types of financing. It is helpful to know that if you can use conventional financing and avoid PMI, you will have an easier time handling the payment. The payment will be lower which can increase your buying power while you remain under the 20% equity margins.

Remember, before you begin the mortgage lending process — or even start your search for a new home — it’s a good idea to check your credit scores to see where you stand. Doing so will let you know exactly how much loan you’ll qualify for and what terms will be associated with that loan. Also, it’s a good time to pull your credit reports to ensure there aren’t any mistakes, which could hurt your ability to get the best loan terms. You can get your two free credit scores, updated every 14 days, at Credit.com.

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Yes, There’s a Special Mortgage Loan Just For Doctors

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One of the more unique ways borrowers in the health care industry can get a mortgage is the doctor’s loan. Yes, there’s special mortgage financing options available just for doctors.

One of the benefits of being a physician is being able to get a mortgage even with a lot of debt. That’s because doctors can get a little bit more flexibility than traditional underwriting otherwise allows. This can help bridge the gap between renting and owning a home. This financing vehicle allows physicians to borrow money more easily.

Here’s how this program works.

Most mortgage loan programs take the minimum payment on a student loan and apply that into the qualifying ratios when computing the debt to income ratio for the homebuyer. This can limit borrowing power, especially if the payments are several hundred dollars per month. If you have a student loan that is in deferment for year or longer, the doctor loan allows you to have that student loan payment not count in your debt-to-income ratio, allowing you to borrow more on a mortgage. To have monthly debts not hurt your borrowing chances, you’ll need $2 of income per every $1 of monthly debt. For example, if your student loan payment is $500 per month, you need $1000 per month of income to offset $500 per month on a student loan payment or any other monthly payment other than mortgage loans.

The program also allows you use just 5% down and allows gift funds to be used for closing costs. This program is good all the way up to the maximum county conforming high balance loan limit in the county in which you’re looking to buy a home. So, in Sonoma County, California, for example, $554,300 is the maximum high balance loan limit which is eligible for this program.

The basis of the doctor’s loan is to allow doctors, specialty doctors, and dentists to have an easier time with securing financing to purchase or refinance a home.

Doctors Can Also Use Future Income

The program also allows doctors to use future income to qualify. For example let’s say you’re in your residency. Within 30 days you have an employment contract to earn substantially more. Lenders that offer the program will allow you to use the future income to qualify to buy the house. This is something FHA, Conventional, VA and Jumbo financing do not allow.

The doctor’s loan requires a minimum credit score of 680 and supporting income and asset documentation certainly will be required. If you don’t know what your credit scores are, you can get two free credit scores, updated every 14 days, on Credit.com. It’s completely free and you’ll never be asked for your credit card information.

If you’re a physician and are looking for some mortgage options, the doctor’s loan is flexible choice. Ask your lender if they have this program. If they do not offer it, find a mortgage company that does. Remember, it’s incumbent on you as the homebuyer to make sure you’ve done your research as to what’s available in the marketplace to tip the scales in your favor for securing the best type of mortgage financing available.

Image: Justin Horrocks

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How to Tell If You’re Really Ready to Buy a Home

ready-to-buy-a-home

Buying a home is no easy feat. There’s a lot of paperwork you need to be on top of to secure the big-ticket purchase. Here’s how do determine if you should pull the trigger or wait until your finances are in better shape.

Banks will let you take on a mortgage payment at no greater than 45% of your monthly income. This means if you’re earning $8,000 per month, your lender will allow you to take on approximately half of this on a monthly basis for a mortgage payment, with other monthly liabilities. The reality is 45% of your monthly income is a huge percentage of your income going toward a housing payment and other monthly obligations, excluding childcare, college savings, savings in general, other household bills and retirement planning. So if you find you’re unable to make those ends meet, chances are you may not be ready to buy a home.

What follows are some ways to keep your mortgage payment as manageable as possible.

Pay Off Debts to Qualify

If you have a workable down payment, but you have debt payments such as a car loan that are pushing you above that 45% mark, you may want to pick the debts that have the greatest balance with the highest monthly payments, and pay those off in full. Doing so will allow you to not only buy more house but, more importantly, to afford a new mortgage payment.

Keep Your Debts in Check

Car payments, credit card payments — whatever payments you are currently making will limit your buying power. These debts should be as absolutely low as possible.

Don’t Focus on High-Interest Debts First

It’s not what you owe, it’s what you pay that counts. The minimum payment that you’re obligated to make on credit obligations independent of whatever interest rate you have is what lenders will look at to qualify you. Yes, that 0% auto loan could adversely affect your ability to borrow, especially if that payment is a few hundred dollars per month.

Just because you qualify for a mortgage does not automatically mean you should pull the trigger. The ideal approach is to purchase a house in the following way: Make the mortgage payment low enough so you can pay off other obligations, have the ability to save and contribute to retirement.

If buying a home prevents you from being able to save or from getting out of higher-interest rate debt such as credit cards, student loans, personal loans, etc., put the housing project on hold or pause and ask yourself whether buying a house is really the best financial move for you right now. In some cases, buying a house — despite the obligations — might still make financial sense. In other cases, it might make sense to just say no.

Remember, only you will be making your mortgage payment. So buy a home when it financially makes sense for you. Low rates are an attractive reason to buy a home, but exercising financial prudence should be your number one objective when buying a home.

Also keep in mind that your credit score will impact your ability to qualify for a mortgage with reasonable terms. If you’re not sure where you stand — or want to see what you need to improve — a good place to start your research is by getting ahold of your credit reports. You can view a free snapshot of your credit report, updated regularly, by signing up for an account on Credit.com.

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Should I Use the Value of My House as My Emergency Fund?

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Q. I don’t have an emergency fund, but I have always felt very secure knowing I have a zero balance, low-interest home equity line of credit that would allow me to get, on an emergency basis, close to three times my annual salary. Is this a legitimate substitute for a separate emergency fund? — Curious

A. A home equity line of credit is one kind of backup plan, but it’s not a foolproof kind of backup plan.

traditional emergency fund covers anywhere from 3 months to a year’s worth of expenses, depending on your personal needs. The money is usually kept in a safe and liquid account.

Chip Wieczorek, a certified financial planner with Tradition Capital Management in Summit, N.J., said it’s not advisable or realistic to keep two or three years of living expenses in a savings account with a near 0% yield.

However, he said, home equity lines have pitfalls.

“I advise clients to maintain three to six months of living expenses in a savings account in addition to establishing a home equity line of credit (HELOC) for large unexpected expenses,” he said.

Wieczorek said when using a line of credit as an emergency fund, you must be aware that lines have a draw period and a principal pay down period.

A typical HELOC has a seven- to 10-year draw period during which the client can access funds and make interest only payments based on a 20- to 30-year amortization schedule. After the draw period expires, funds can no longer be drawn from the line of credit and both principal and interest payments are required.

“You may think you have two to three years of salary accessible from your line of credit but if the draw period expires, your emergency fund has dried up, Wieczorek said. “Most people do not realize this and should review their HELOC terms on an annual basis.”

Also keep in mind that home equity lines are variable and can be frozen by a bank. The interest rate for the line is generally based on an index, such as the prime rate, Wieczorek said.

“This means that the interest rate can increase over time, which would increase your monthly payment as well,” he said.

Also, in 2008, major home equity lenders began informing borrowers that their home equity lines of credit had been frozen or restricted.

“Falling housing prices led to reduced equity for borrowers, which was perceived as an increased risk of foreclosure in the eyes of lenders,” he said. “Courts have held that a bank may freeze a HELOC in instances where a home’s value decreases substantially.”

Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Boonton, also referenced 2008 as a problem for many home equity line borrowers.

“It is very possible that the condition that requires you to tap into that credit line — you lost your job or got hurt — may make the bank close the credit line,” he said.

Lynch said a mortgage and a home equity line is not a loan on a home, but instead is a loan on your income.

“If that can be shut down, and that was your plan, you need a better plan,” he said. “Plan A never works. What’s your plan B and C?”

Consider going a more traditional route over time and build the kind of emergency fund you can always count on.

[Editor’s Note: If you plan on opening a home equity line of credit, make sure your credit score is in good shape, as it will be a major factor in determining the interest rate you’ll pay. You can check your credit scores for free on Credit.com.]

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How to Buy a House When You Have Too Much Debt

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When you fill out a mortgage application, lenders look for income to offset debt. If your monthly debt payments consume too much of your income, you may have a tough time qualifying for a home loan.

Underwriting, which is the decision-making of whether or not to grant credit, determines what your income is with supporting documentation like pay stubs, W-2s and tax returns. (It also looks at your credit scores to decide whether you qualify. You can get your two free credit scores, updated each month, on Credit.com.)

Fortunately, a lender may be willing to look at more than just your regular salary when it comes time to calculate your debt-to-income ratio. Here are various forms of income most mortgage banks will sign off on.

1. Annuities

If you’re eligible, you can purchase an annuity, a contract sold by a life insurance company that provides regular monthly income in return for an initial lump-sum deposit.

The income derived from this annuity will be used to determine how much mortgage and/or house you can qualify for. An annuity can be brand new — you need not have a long history of this income as long as it’s set to continue for the next 36 months or longer.

2. Social Security Income

If you’re eligible for Social Security, you might want to consider taking it early as this income can easily be used to help you qualify for a mortgage. You may be also able to “gross up” this income by up to 1.25%, depending on whether or not you pay taxes on it.

3. Notes Receivable 

Generally, you’ll need to earn income from a note receivable (a credit extended to a business) for at least 6 months for it to count on a mortgage application. Notes receivable income has to be based on the market rate and it’s the interest on the note that is used to determine your eligibility for your desired borrowed amount. For example, if you have a note receivable at 5.5% based on a principal balance at $50,000 that income would be $229.16 per month used for a mortgage.

4. Purchasing a Rental Property

If you are looking to purchase a rental property, you’re in luck. You can use projected fair market rents to qualify for its mortgage. Lenders will use up to 75% of gross market rents to offset the mortgage payment. In other words, because the renters are making the mortgage payment, you don’t need to earn as much to get a green light on your loan application.

5. Renting Your Current Home

If you are trying to buy a new primary residence, but don’t have enough income to support two mortgage payments, you can rent out the property. A rental agreement and tenant security deposit allows you to offset the mortgage payment on your current home to qualify for a mortgage on a new home. The concept is almost identical to purchasing a rental property, with the exception of needing to have a rental agreement in place for your current home.

6. Self-Employment Income

A history of self-employment income is required for it to count on your mortgage application. Generally, Schedule C Sole Proprietor income needs to be in place for at least 12 months in order for that income to count. Note: If you have been self-employed for the past two years and you had one bad year, followed by a good year, your income will be averaged by your lender.

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