MONEY homeownership

How Big Should Your Home Down Payment Be?

Getty Images/Michael Krinke

20% isn't always the magic number.

When buying a home, most people take on a mortgage. There are many things to consider when taking on a mortgage loan, including interest rate, closing costs and the down payment. Once you calculate how much house you can realistically afford, you can start looking at properties and considering how you will afford the house.

There are several ways to fund what will likely be the biggest purchase of your life. Before you start signing with lenders and sellers, it’s a good idea to consider how much down payment you should be making and how that will affect you both immediately and in the long run.

The Basics

In case you are really new to this, a down payment is the chunk of cash you pay upfront when buying a home. This money shows the lender that you are capable of saving and are so serious about this investment that you are willing to put that savings toward making the home yours.

The Magic Number

You may hear that the typical down payment amount is around 20% of the total property value. While some people (like veterans) can qualify for homebuying assistance, most people will have to put 20% down to secure their mortgage without paying private mortgage insurance or taking out a second loan. When you are thinking about what type of house you want and what exactly you can afford, it’s important to keep in mind you will likely want to have 20% of the property’s value in savings dedicated for just this purpose before purchasing a home.

Paying More

If you have more than 20% of the home price socked away in savings, there are some reasons for using it as a down payment. The more you put down, the better position you are in for negotiating a lower interest rate with your lender. You will also have to borrow less if you put more down, meaning you will pay less in interest payments over the life of your mortgage.

Before you jump into this option though, it’s a good idea to be sure you can comfortably afford this house without putting your regular costs at risk, consider what other debts you may have and whether you think the savings could do more for you if used elsewhere. For example, it’s important to maintain an emergency fund so that you have cash set aside if (and when) the unexpected happens.

Paying Less

While the financial crisis left many homeowners defaulting on their little-to-no-money-down mortgages, the tide has turned again, and now the minimum amount needed for a mortgage is only 3.5% (there are some zero-down mortgage programs, but certain restrictions apply). In order to pay less than the normal 20%, you have several options.

You can secure a second loan to make up the difference between what you can afford and the 20% mark. You can also take out private mortgage insurance (PMI) to give your lender peace of mind. In case you get into trouble making payments down the line, this policy would pay the lender. You can check if you qualify for a loan backed by the Federal Housing Administration (FHA). You can also look for state and region-specific down payment assistant opportunities through your local government. If you are buying a house with less than the typical down payment needed, it’s important to know that you are taking on more risk.

Before you apply for a home loan, it’s important to know where your credit score stands. The difference of just a few credit score points can mean better interest rates and a major savings over the life of your loan. You can get two of your credit scores for free on Credit.com, updated every month.

Your down payment amount makes a big difference both now and down the road, but it’s a good idea to leave yourself enough money to afford your next few monthly payments as well as closing costs and other immediate expenses the house may incur. Remember, this is just the beginning.

More From Credit.com

MONEY Debt

Millennials Aren’t Buying Homes, but Not for the Reason You Think

couple looking at house
Troels Graugaard—Getty Images

As student debt has exploded, young consumers are taking out fewer mortgages and auto loans. But are student loans really to blame?

There’s a familiar narrative that the burden of student loans is forcing young borrowers out of the auto and housing markets, crippling their ability to take the same financial steps into adulthood as previous generations.

Think again. A new study from TransUnion says that fears about how much student loan obligations are hindering young borrowers are overblown.

The study looked at consumers aged 18 to 29 who had student loans alongside those who did not, grouped by age and credit score, then tracked their performance on other types of loans in the two years after they started paying off their student debt.

The bottom line: While student loans are way up since the end of the recession, the study found no evidence that such loans are causing young adults to stop opening credit cards, buying new cars, or applying for mortgages. Sure, today’s millennials are doing less of all three than 20- to 29-year-olds did a decade ago—but that’s true whether they’re paying off student loans or not.

According to TransUnion data, the percentage of consumers in their 20s with student debt has jumped from 32% in 2005 to 52% in 2014. The share of student loans in relation to other debt held by young consumers has skyrocketed, too, increasing from 12.9% to 36.8% over the past decade. At the same time, their share of mortgage debt dropped from 63.2% to 42.9%.

But current conventional wisdom about the ripple effect of student debt on other types of borrowing is correlation, not causation, says Charlie Wise, vice president of TransUnion’s Innovative Solutions Group and co-author of the study.

“What we’re trying to do here is cut through the hype and say, ‘what’s the reality?’” Wise says.

The study tracked groups entering repayment at three different times—2005, 2009, and 2012—in an attempt to determine whether performance differed before the recession, immediately following the recession, and more recently as the economy has recovered.

In 2005, a smaller percentage of consumers with student debt had auto loans or mortgages relative to their peers without student loans. But after two years the gap narrowed, and in the case of auto loans, disappeared.

A similar pattern exists for the 2009 and 2012 groups, suggesting that borrowing trends in which individuals with student debt catch up to their peers over a period of a few years have remained steady.

So if student loan debt isn’t causing mortgage and auto loan participation to drop, what is?

Wise points out that about 50% of people aged 18 to 29 have credit scores that qualify them as nonprime borrowers—a percentage that has also held steady since 2005. What has changed, he says, is lending standards, which became stricter in the aftermath of the recession.

The study also shows that young consumers with student debt actually performed slightly better on their new accounts than their peers without student loans.

For example, consumers who started repaying their student loans at the end of 2012 had a 60-day delinquency rate on new auto loans that was 15% lower by the end of 2014 than their peers without a student loan.

The report counters research from a year ago by the Federal Reserve Bank of New York that found home ownership rates dropped more quickly among people aged 27 to 30 who had student debts compared with those who didn’t.

But TransUnion’s findings don’t come entirely out of the blue. A recent Wall Street Journal analysis of data from LoanDepot.com found that loan applicants with student loans aren’t any more likely than those without debt to be turned down for first-time home loans.

And some economists, such as Beth Akers, a fellow at Brookings Institute’s Brown Center of Education Policy, have pointed out that lower participation in the housing market among individuals with student debt is within the historical norm.

Akers says TransUnion’s report that student debt isn’t dooming young borrowers isn’t particularly surprising. “Given the fact that financial returns on investment for higher education are positive and large, the notion that debt is harmful to students is a little puzzling,” she says.

Getting clear answers to the question of how debt affects individuals is challenging, though.

Akers points out that you can’t randomly assign debt to people, and since there are significant differences between the backgrounds and demographics of households with student debt and those without, you can’t expect their behaviors around buying homes or cars to be the same.

Student loan debt may not be overburdening young consumers on a macroeconomic level, she says, but what’s still unknown is the emotional and social cost of carrying such debt.

TransUnion’s Wise describes the study’s findings as encouraging news. For soon-to-be college graduates, there’s evidence that they can stay above water with their loans, and for lenders, there are “credit hungry” millennials who are able to keep up with payments.

Wise’s major takeaway for both groups: don’t despair.

 

More on Managing Student Debt:

The 25 Most Affordable Colleges from MONEY’s Best Colleges
Why You Might Want to Take Student Loans Before Using Up College Savings
8 Ways to Stop Student Loans From Ruining Your Life

MONEY Ask the Expert

Should I Use Home Equity to Invest for Retirement?

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: We recently retired. We have a small mortgage on our home and lots of equity. Should we refinance our mortgage to free up additional money to invest for our retirement? —Bea Granniss, Amityville, N.Y.

A: Even at today’s low mortgage rates, it’s risky to borrow against your home at this stage of your life, says Tim McGrath, a certified financial planner and founding partner of Riverpoint Wealth Management in Chicago.

It’s true that more older Americans are retiring with heavy debt loads. But taking on additional debt when you are no longer bringing in income puts you in a precarious financial position. In retirement, your income is fixed—you probably have Social Security, your retirement savings, and possibly a pension. If an unexpected expense comes up, your chief recourse is to adjust your spending on discretionary costs, such as eating out and taking vacations. If you pile on more debt, you may not have enough leeway to avoid cutting your fixed expenses, says McGrath.

No question, refinancing looks attractive now. At today’s low interest rates, freeing up cash for a potentially higher return is a tempting notion—after all, stocks have done pretty well in recent years.

But it’s a mistake to compare today’s low mortgage rates to an expected return on investment, especially for retirees. Moreover, the basic math of refinancing may not make sense given your financial situation.

Let’s start with the refinancing rules. Unless you have a mortgage rate that’s significantly higher – at least a half percentage point above the current rate—you won’t free up much income with a refi. And now that you’re not working, it will be harder to get the best terms from a bank.

Borrowing against your home will reset the loan, which means you’ll be paying more in interest over time instead of paying down principal. “Instead of building more equity, you’ll be racking up more debt,” says McGrath.

Refinancing also costs thousands of dollars in fees. So you’ll need to stay in your home for a long time in order to recoup those expenses. But when you’re older, you’re more likely to reach a point where you want to downsize or move.

As for those enticing investment returns, there’s no guarantee the money you invest will produce the gains you’re seeking—or any gain at all. Lately, many investment pros have been warning that the returns on stocks and bonds are likely to be lower in the years ahead. Most retirees, in fact, are better off with a more conservative portfolio, since you have less time and financial flexibility to ride out market downturns.

Of course, every retiree’s financial situation is different. Refinancing might be a good solution if you want to pay off other high-rate debt. Or if you’re struggling to afford the mortgage payment, and you want to stay in your home, then refinancing could give you more of a cushion for your regular expenses.

But that doesn’t sound like the case for you. As McGrath says, “Taking money from your home equity and gambling on what could happen by investing it is too much risk in your retirement.”

Read next: How to Squeeze the Most Value from Your Home

MONEY home improvement

How to Squeeze the Most Value From Your Home

woman in kitchen
Getty Images

Buyers and sellers are getting busy, but if you're planning to stay put, low rates on home equity loans and lines of credit make this a good time to remodel.

In part one of our Spring Real Estate Guide, we told you what to do if you’re in the market for a home this year. In part two, we offered tips for sellers. Today we’ve got advice for those who want to say put and add value with smart home improvements.

It’s always nice to remember that the value of your house should climb while you’re enjoying it—and at a great mortgage rate (assuming you take the advice below about refinancing!). If you’re at the love-it rather than list-it stage of your life, remodeling may be a good option. Nationwide, 57% of home-owners surveyed recently by SunTrust said they planned to spend money on home-improvement projects this year. But be warned: The competition for contractors in many markets is fierce. You may have to wait your turn in line.

If you’re staying where you are, here are three ways to get the most out of the home you’re in.

Hit the refi table. According to CoreLogic, roughly 30% of all primary mortgages still carry an interest rate of 5% or higher—even though the average fixed rate today is 1.3 points lower. If you took out a $300,000 loan in mid-2009, say, and refinanced the roughly $270,000 balance at today’s rates, you’d cut your payments by about $370 a month.

You might consider making a few other changes. First, don’t assume that your current lender will offer you the best deal this time around—different lenders are marketing different kinds of loans.

You might also want to switch to a 15-year fixed-rate mortgage, especially if you are a decade or so from retirement and looking ahead to reducing your debt. You’ll pay more each month: about $170 more than the current payment on the $300,000 30-year mortgage at 5% cited previously. But you’d retire the loan nearly a decade sooner and save tens of thousands in interest.

There’s a good reason some homeowners haven’t refinanced at all: They couldn’t. In 2012 about a quarter of homeowners owed more on their homes than the houses were worth. Thanks to rising property values, that’s changing. Today only 11% of owners have negative equity, according to CoreLogic.

If you’re one of them, you may still be able to refinance, perhaps without having to bring cash to the table. Borrowers with FHA and Veterans Administration loans are eligible for “streamlined” refinancing, which looks at payment history rather than equity. For borrowers with conventional mortgages, the Home Affordable Refinance Program (HARP) is still available and has undergone some improvements since it was introduced in 2009. If you were turned down before, it’s worth another shot, says Keith Gumbinger, vice president of HSH.com, a mortgage information provider.

Get the right renovation financing. For a project that requires a one-time loan and at a fairly predictable cost—say, a bathroom—you may want to consider a home-equity loan, says Gumbinger. The 5.9% rate isn’t all that favorable, but you have the security of its being fixed. For a larger project in which you’ll need ongoing access to funds, a home-equity line of credit can be a better option since it operates like a credit card. HELOCs are now ringing in at 4.8%. The downside is that the rate is variable, so if you won’t be able to pay the debt off in two years, it might not be your smartest choice.

Think about the next owner. According to a 2014 survey by Houzz, 53% of homeowners who are remodeling say they are hoping to increase their home’s value. Yet most upgrades won’t help your resale. The most common remodeling projects are kitchens and bathrooms—9.5% and 7.7% of all upgrades, according to Harvard’s Joint Center for Housing Studies. But according to Remodeling magazine’s 2015 Cost vs. Value report, you’ll recoup only 70% of costs on a bathroom remodel, 59% on a bathroom addition, 68% on a major kitchen remodel, and 79% on a minor kitchen. (The only project that recoups more than its cost: installing a steel front door, which runs from $500 to $750.) That doesn’t mean you shouldn’t renovate; just know that you’re not going to get back all of what you put in.

No matter what project you choose, consider adding improvements to appeal to aging baby boomers. According to the Joint Center for Housing Studies, just over half of existing homes have more than one of five key features for aging in place. Notably, only 8% have wide doorways and hallways or levered door and faucet handles. Those could become huge selling points. Just think: Those renovated doors could provide the perfect entrée to your next great home.

Read next: If You Want to Buy a Home Here’s What You Need to Do Now

MONEY Housing Market

6 Smart Real Estate Moves That Will Pay For Themselves

Whether you're new to the housing market or already live in the home of your dreams, these 6 moves can help put money in your pocket.

 

  • Rent Until You Can Stay Put

    rental sign in front of apartment buildings
    Alamy

    When deciding whether to rent or buy a home, don’t forget the fees, commissions, and closing costs that come with buying, says Darrow Kirkpatrick of CanIRetireYet.com. Local prices and appreciation trends matter too. Use the rent/buy calculator at Trulia.com to see the tradeoffs. A good rule of thumb is to rent if you might move in three years or so. (For more help with the decision, see “Should I Rent or Buy a Home?“)

  • Ready to Buy? Remember 28/36

    woman looking at real estate signs
    Dave and Les Jacobs—Getty Images

    Eight years after the real estate crisis, lenders are making mortgages more accessible. But don’t go back to the old days of high borrowing, even if a lender offers some wiggle room. Housing should take up no more than 28% of gross monthly income; housing plus other debt, 36% or less.

  • Fix Up Your Home—the Cheap Way

    home with new driveway
    Greg Nicholas—Getty Images

    Looking to sell fast? Curb appeal literally gets buyers in the front door. An overlooked simple project: a fresh seal coat on the driveway, which “gives a pop” of a first impression, says Kokomo, Ind., agent Paul Wyman.

  • Fix Up Your Home—the Luxe Way

    attic bedroom
    Martin Barraud—Getty Images

    You’ll get the most bang for your buck by adding living space, says Craig Webb of Remodeling magazine. An attic bedroom and basement remodel average $51,700 and $65,400, but, he says, “buyers will appreciate that you made space that wasn’t previously available.” (For a rundown of major projects and what they return in your area, check out Remodeling‘s annual Cost vs. Value survey.)

  • Ditch the 30-Year Mortgage

    Local and Express subway signs
    John Ott—Flickr Creative Commons

    The 30-year mortgage has been called the best friend of the middle class, since it allows families to buy bigger homes. But is that in your best interest? Meet your new buddy: the 15-year loan. The shorter term makes you stay on a tighter budget. The trick is to commit before picking a house, because “that really forces you to save,” says financial planner Ron Rogé. Say you can afford $1,950 payments on a $400,000 home with a 30-year loan at 3.75%. With a 15-year at 3%, you’d have to settle for a $310,000 home. But you’d have a better shot at retiring debt-free. And the total cost savings are immense.

  • Pick the Right ‘Hood

    Ample Hills Creamery ice cream shop, Prospect Heights, Brooklyn, New York
    Richard Levine—Alamy Brooklyn, New York

    “Don’t buy in the part of town that’s already hot—you’ll have missed the opportunity to buy low and sell high,” says Stan Humphries, chief economist at Zillow. Look in an adjacent area “and wait for the cool to come to you.” And don’t listen to that old saw about buying the worst home on the best block. That will bite you when it comes time to sell. One surprising indicator of value? Starbucks. “Homes within a quarter-mile of Starbucks doubled in value, whereas the average home in the U.S. appreciated 65%” from 1997 to 2013, Humphries says.

    Adapted from “101 Ways to Build Wealth,” by Daniel Bortz, Kara Brandeisky, Paul J. Lim, and Taylor Tepper, which originally appeared in the May 2015 issue of MONEY magazine.

MONEY Credit Scores

The One Graph That Explains Why a Good FICO Score Matters for Homebuyers

young couple outside of home
Ann Marie Kurtz—Getty Images

An analysis from an economic policy group estimates that tight credit standards may have prevented 4 million consumers from getting mortgages since 2009.

When it comes to buying a home, there’s a lot more to the process than just finding an affordable home for sale and having enough money for a down payment. Most people need loans to finance such a large purchase, but even as the housing market has rebounded from the foreclosure crisis and low property values of 2010, mortgages remain very difficult to acquire. A report from the Urban Institute, a Washington-based economic-policy research group, concludes that 1.25 million more mortgages could have been made in 2013 on the basis of conservative lending standards practiced in 2001, years before the housing bubble began to inflate.

Whether or not a lender approves a borrower for a mortgage depends on several factors, like income and outstanding debt, but looking at the credit scores of mortgage borrowers during the last several years shows just how tight the market has been post-recession. Here’s how it breaks down.

Urban-Institute-FICO-Score-distribution

The Urban Institute estimates that the stringent credit score standards for mortgage origination resulted in 4 million mortgages that could have been made (but weren’t) between 2009 and 2013. From 2001 to 2013, consumers with a FICO credit score higher than 720 made up an increasingly large portion of borrowers, from 44% of loans in 2001 to 62% in 2013. Consumers with scores lower than 660 made up 11% of borrowers in 2013, but they represented 28% of home loans in 2001.

The study authors note that their calculations do not account for a potential decline in sales because consumers may not see homeownership as attractive as it had been before the crisis.

“Even so, it is inconceivable that a decline in demand could explain a 76% drop in borrowers with FICO scores below 660, but only a 9% drop in borrowers with scores above 720,” the report says.

On top of that, the authors found that tightened credit standards disproportionately affected Hispanic and African-American consumers. In comparison to loan originations made in 2001, new mortgages among white borrowers declined 31% by the 2009-2013 period, 38% for Hispanic borrowers and 50% for African-American borrowers. Loans to Asian families increased by 8%.

Millions of Americans are still feeling the impact of the economic downturn on their credit scores, because negative information like foreclosure, bankruptcy and collection accounts remain on credit reports for several years. Rebuilding the credit and assets necessary to buy a home takes time, particularly in such a tight lending climate, but by regularly checking your credit — which you can do for free on Credit.com — and focusing on things like keeping debt levels low and making loan payments on time, you can start making your way toward a better credit standing.

More from Credit.com

This article originally appeared on Credit.com.

MONEY mortgages

The Surprising Way to Save $190K on a Mortgage

house on chain
Peter Dazeley—Getty Images

A 30-year fixed-rate mortgage is the standard in the industry right now, but with interest rates so low, is the 15-year loan a better option?

One of the best ways to eliminate your mortgage debt is moving into a 15-year fixed-rate loan. With the average spread a full 1% compared to its 30-year mortgage counterpart, a 15-year mortgage can provide an increased rate of acceleration in paying off the biggest obligation of your life.

Can You Pull It Off?

In most cases, you’re going to need strong income for an approval. How much income? The old 2:1 rule applies. Switching from a 30-year mortgage to a 15-year fixed-rate loan means you’ll pay down the loan in half the amount of time, but it effectively doubles up your payment for each month of the 180-month term. Your income must support all the carrying costs associated with your home including the principal and interest payment, taxes, insurance, (private mortgage insurance, only if applicable) and any other associated carrying cost. In addition, your income will also need to support all the other consumer obligations you might have as well including cars, boats, installment loans, personal loans and any other credit obligations that contain a monthly payment.

The attractiveness of a 15-year mortgage in today’s interest rate environment has mass appeal. The 1% spread in interest rate between the 30-year mortgage and a 15-year mortgage is absolutely real and for many, the thought of being mortgage-free can be very tempting. Consider today’s average 30-year mortgage rate of around 4% on a loan of $400,000 — that’s $287,487 in interest paid over 360 months. Comparing that to a 15-year mortgage over 180 months, you’ll pay a mere $97,218 in interest. That’s a shattering savings of $190,268 in interest, but there’s a catch — your monthly mortgage payment is going to be significantly higher.

Here’s how it breaks down. The 30-year mortgage in our case study pencils out to a $1,909 monthly payment covering principal and interest. Weigh that against the 15-year version of that loan, which comes to $2,762 a month in principal and interest, totaling $853 more per month, but going to principal. This is why the income piece makes or breaks the 15-year deal. Independent of your other carrying costs and other credit obligations, you’ll need to be able to show an income of $4,242 a month to offset just a principled interest payment on the 30-year fixed-rate mortgage. Alternatively, to offset the principled interest payment on the 15-year mortgage, you would need and income of $6,137 per month, essentially $1,895 per month more in income just to be able to pay off your debt faster. As you can see, income is a large driver of debt reduction potential.

What to Do If Your Income Isn’t High Enough

When your lender looks at your monthly income to qualify you for a 15-year fixed-rate loan, part of the equation is your debt load.

Lenders are going to consider the minimum payments you have on all other credit obligations in the following way. Take your total proposed new 15-year mortgage payment and add that number to the minimum payments on all of your consumer obligations and then take that number and divide it by 0.45. This is the income that you’ll need at minimum to offset a 15-year mortgage. Paying off debt can very easily reduce the amount of income you might need and/or the size of the loan you might need as there would be fewer consumer obligations handcuffing your income that could otherwise be used toward supporting a stable mortgage plan.

Can You Borrow Less?

Borrowing less money is a guaranteed way to keep a lid on your monthly outflow maintaining a healthy alignment with your income, housing and living expenses. Extra cash in the bank? If you have extra cash in the bank beyond your savings reserves that you don’t need for any immediate purpose, using these funds to reduce your mortgage amount could pencil very nicely in reducing the 15-year mortgage payment and interest expense paid over the life of the loan. The concept of the 15-year mortgage is “I’m going to have to hammer, bite, chew and claw my way through a higher mortgage payment in the short term in order for a brighter future.”

Can You Generate Cash?

If you can’t borrow less, generating cash to do so may open another door. Can you sell an asset such as stocks, or trade out of a money-market fund in order to generate the cash to rid yourself of debt faster? If yes, this is another avenue to explore.

You may also want to explore getting additional funds via selling another property. If you have another property that you’ve been planning to sell such as a previous home, any additional cash proceeds generated by selling that property (depending upon any indebtedness associated with that property) could allow you to borrow less when moving into a 15-year mortgage.

Are You an Ideal Match for a 15-Year Mortgage?

Consumers who are in a financial position to handle a higher loan payment while continuing to save money and grow their savings would be well-suited for a 15-year mortgage. The other school of thought is to refinance into a 30-year mortgage and then simply make a larger payment like you would on a 25-year, 20-year or 15-year mortgage every month. This is another fantastic way to save substantial interest over the term of the loan, since the larger-than-anticipated monthly payment you make to your lender will go to principal and you’ll owe less money in interest over the full life of the loan. As cash flow changes, so could the payments made to the loan servicer, as prepayment penalties are virtually non-existent on bank loans.

There is an important “catch” to taking out a 15-year mortgage — you also decrease your mortgage interest tax deduction benefit. However, if you don’t need the deduction in 15 years anyway, the additional deduction removal may not be beneficial (depending on your tax situation and future income potential).

If your income is poised to rise in the future and/or your debt is planned to decrease and you want to have comfort in knowing by the time your small kids are teenagers that you’ll be mortgage free, then a 15-year loan could be a smart move. And when you’re mortgage is paid off, you’ll have control of all of your income again as well.

Proximity to retirement is another factor borrowers should consider when carrying a mortgage into retirement isn’t ideal. These consumers might opt to move into a faster mortgage payoff plan than someone buying the house for the first time.

Keep in mind that to qualify for the best interest rates on a mortgage (which will have a big impact on your monthly payment), you need a great credit score as well. You can check your credit scores for free on Credit.com every month, and you can get your free annual credit reports at AnnualCreditReport.com too.

More from Credit.com

This article originally appeared on Credit.com.

MONEY credit cards

Can You Pay Your Mortgage With a Credit Card?

best travel rewards credit card
Robert Hadfield

Sometimes, lenders allow you to pay one debt with another, but there are a lot of things to know before you charge a mortgage.

You can use a credit card to pay many kinds of bills, and if you have a rewards credit card you pay in full every month, you can use those payments to increase your rewards. It’s a common strategy.

Still, just because you have the ability to pay a bill with your credit card doesn’t mean it’s a safe tactic. Some consumers are tempted to use their credit cards to make mortgage payments, if they have that option, because large transactions generate more rewards, but doing that might actually cost you, rather than save you money.

It’s not very common to have the option to pay your mortgage with a credit card, but if you have the ability to do so, you’ve probably wondered about the risks and rewards of paying a loan with a credit card.

What to Ask Your Lender

If you can use your credit card to pay your mortgage, find out if there are fees associated with the transaction. Credit card transactions can be very expensive to process — it depends on the card you’re using — so the lender may charge you that fee so they don’t have to foot the bill

If there’s a fee, compare that to the rewards you might earn by charging your mortgage payment. Say you’re using a card that offers 1.5% cash back on all purchases — any processing fee exceeding 1.5% means you’re paying to pay your mortgage.

You should also ask how that transaction will be processed. A Reddit user recently posted about paying a mortgage with a credit card, and the payment went through as a cash advance on the card. Cash advances start accruing interest as soon as the transaction clears, which means they can get extremely expensive. Also, cash advances generally carry a higher interest rate than normal credit transactions, hitting you with a double-whammy of higher interest that starts accruing immediately.

Should your lender not charge fees in excess of your rewards, and if it codes the mortgage payment like a regular credit transaction, the strategy could work in your favor.

At the same time, you may set yourself up for some serious financial damage if you miss a payment on the card and have to pay interest on what might end up being a very large balance. You can see how your mortgage is impacting your credit scores for free on Credit.com.

More from Credit.com

This article originally appeared on Credit.com.

MONEY Taxes

11 Smart Ways to Use Your Tax Refund

Tax refund check with post-it saying "$$$ for Me"
Eleanor Ivins—Getty Images

You could pay down debt, travel, tend to your health, or shrink your mortgage, among many other ideas.

Here we are, in the thick of tax season. That means many mailboxes and bank accounts are receiving tax refunds. A tax refund can feel like a windfall, even though it’s really a portion of your earnings from the past year that the IRS has held for you, in case you owed it in taxes. Still, it’s a small or large wad of money that you suddenly have in your possession. Here are some ideas for how you might best spend it.

First, though, a tip: If you’re eager to spend your refund, but haven’t yet received it, you can click over to the IRS’s “Where’s My Refund?” site to track its progress through the IRS system. Now on to the suggestions for things to do with your tax refund:

Pay down debt: Paying down debt is a top-notch idea for how to spend your tax refund — even more so if you’re carrying high-interest rate debt, such as credit card debt. If you owe $10,000 and are being charged 25% annually, that can cost $2,500 in interest alone each year. Pay down that debt, and it’s like earning 25% on every dollar with which you reduce your balance. Happily, according to a recent survey by the National Retail Federation, 39% of taxpayers plan to spend their refund paying off debt.

Establish or bulk up an emergency fund: If you don’t have an emergency fund, or if it’s not yet able to cover your living expenses for three to nine months, put your tax refund into such a fund. You’ll thank yourself if you unexpectedly experience a job loss or health setback, or even a broken transmission.

Open or fund an IRA: You can make your retirement more comfy by plumping up your tax-advantaged retirement accounts, such as traditional or Roth IRAs. Better yet, you can still make contributions for the 2014 tax year — up until April 15. The maximum for 2014 and 2015 is $5,500 for most folks, and $6,500 for those 50 or older.

Add money to a Health Savings Account: Folks with high-deductible health insurance plans can make tax-deductible contributions to HSAs and pay for qualifying medical expenses with tax-free money. Individuals can sock away up to $3,350 in 2015, while the limit is $6,650 for families, plus an extra $1,000 for those 55 or older. Another option is a Flexible Spending Account (FSA), which has a lower maximum contribution of $2,550. There are a bunch of rules for both, so read up before signing up.

Visit a financial professional: You can give yourself a big gift by spending your tax refund on some professional financial services. For example, you might consult an estate-planning expert to get your will drawn up, along with powers of attorney, a living will, and an advance medical directive. If a trust makes sense for you, setting one up can eat up a chunk of a tax refund, too. A financial planner can be another great investment. Even if one costs you $1,000-$2,000, they might save or make you far more than that as they optimize your investment allocations and ensure you’re on track for a solid retirement.

Make an extra mortgage payment or two: By paying off a little more of your mortgage principle, you’ll end up paying less interest in the long run. Do so regularly, and you can lop years off of your mortgage, too.

Save it: You might simply park that money in the bank or a brokerage account, aiming to accumulate a big sum for a major purchase, such as a house, new car, college tuition, or even starting a business. Sums you’ll need within a few or as many as 10 years should not be in stocks, though — favor CDs or money market accounts for short-term savings.

Invest it: Long-term money in a brokerage account can serve you well, growing and helping secure your retirement. If you simply stick with an inexpensive, broad-market index fund such as the SPDR S&P 500 ETF, Vanguard Total Stock Market ETF, or Vanguard Total World Stock ETF, you might average as much as 10% annually over many years. A $3,000 tax refund that grows at 10% for 20 years will grow to more than $20,000 — a rather useful sum.

Give it away: If you’re lucky enough to be in good shape financially, consider giving some or all of your tax refund away. You can collect a nice tax deduction for doing so, too. Even if you’re not yet in the best financial shape, it’s good to remember that millions of people are in poverty and in desperate need of help.

Invest in yourself: You might also invest in yourself, perhaps by advancing your career potential via some coursework or a new certification. You might even learn enough to change careers entirely, to one you like more, or that might pay you more. You can also invest in yourself health-wise, perhaps by joining a gym, signing up for yoga classes, or hiring a personal trainer. If you’ve been putting off necessary dental work, a tax refund can come in handy for that, too.

Create wonderful memories: Studies have shown that experiences make us happier than possessions, so if your financial life is in order, and you can truly afford to spend your tax refund on pleasure, buy a great experience — such as travel. You don’t have to spend a fortune, either. A visit to Washington, D.C., for example, will get you to a host of enormous, free museums focused on art, history, science, and more. For more money, perhaps finally visit Paris, go on an African safari, or take a cruise through the fjords of Norway. If travel isn’t of interest, maybe take some dance or archery lessons, or enjoy a weekend of wine-tasting at a nearby location.

Don’t end up, months from now, wondering where your tax refund money has gone. Make a plan, and make the most of those funds, as they can do a lot for you. Remember, too, that you may be able to split your refund across several of the options above.

MONEY real estate

The Pre-Recession Housing Problem That’s About to Slam Homeowners

aerial view of subdivision
David Sucsy

Millions of homeowners face major payment increases when their HELOCs reset in 2015-2016. Here are your options if you face massive HELOC payments.

The home equity line of credit (HELOC) had been around for many years before it became a hugely popular financial product in the early 2000s. When the financial crisis happened in 2008, drastically lower home valuations put a stop to the HELOC boom, and today we see far fewer being issued by lending institutions. However, millions of homeowners still have this type of contract and will face major problems when their HELOCs reach a 10-year reset point in 2015-2016.

The Office of the Comptroller of Currency (OCC) defines a HELOC as “a dwelling-secured line of credit that generally provides a draw period followed by a repayment period.” If you don’t know what these terms mean, then it’s time to have a fresh look at your contract. As a debt relief consultant who includes second mortgage and HELOC settlement negotiations in my practice, I routinely encounter clients who are worried about their homes having negative equity, but seem completely unaware of their looming reset problem.

There are numerous types of HELOC agreements, but one common variation is the 25-year contract, with a 10-year borrowing period and a 15-year repayment period. Let’s say you obtained a HELOC in 2005 that was structured this way, and borrowed $50,000 on your house to pay off other bills, do some home improvements, and so on. This whole time you’ve been paying interest-only at 6%, which is high compared to today’s rates, but since you are only paying interest on the principal balance, the payment is still manageable at only $250 per month.

What will happen at the end of your 10-year borrowing period? The line-of-credit feature of the HELOC will expire and the payments must then increase during the repayment period to cover repayment of the principal balance (plus ongoing interest). At a 6% annual percentage rate, the $250 per month payment will suddenly spike to $492 and remain at that level until the $50,000 is paid off (assuming a fixed interest rate).

This of course illustrates a 15-year repayment period, which is already greatly compressed compared to a traditional 30-year mortgage. Worse, some HELOC products were set up for a total contract duration of 15 years, meaning a 10-year borrowing period followed by only a 5-year repayment period. With such a short period of time to repay principal, the monthly payment in our example would jump to $967 after reset, almost four times the interest-only level. Talk about payment shock!

Still other types of HELOC contracts carry no repayment period at all. They were set up for a borrowing period of 5, 7 or 10 years, and at the end of that period the entire principal amount falls due in the form of a single lump-sum balloon payment. Using our same example, at the end of 10 years, instead of paying $250/month, you now owe $50,000 in a single payment.

Such financial products were built on the crucial assumption that real estate values would continue to rise, which would allow qualified borrowers to refinance to more favorable terms within a few years anyway. Essentially, these products were designed with the expectation that borrowers would extinguish the loans before reaching the point of reset, especially if there was a balloon payment rather than a reasonable repayment period.

Fast forward a few years, and the steep plunge in real estate values has left countless homeowners in a position where traditional refinancing is simply not available, thus exposing them to future payment shock when their HELOCs reset in 2015 or beyond. Since so many HELOCs were issued in 2004 through 2008 compared to prior years, the “HELOC reset” problem has the potential to affect America’s housing recovery for years to come.

According to the OCC, in 2012 approximately $11 billion in HELOC loans reached reset point, with “reset” defined as the point where the borrowing period ended and the repayment period began. By 2014, that figure had grown to $29 billion. It will nearly double again to $53 billion in 2015 and could exceed $111 billion by 2018. Between 2014 and 2017, approximately 58% of all HELOC balances are due to start amortizing.

HELOC-OCC

In the next few years millions of homeowners will face the HELOC reset problem and resulting payment shock. Many will have the ability to accept the higher payment after reset, or they will refinance to a new mortgage with more favorable terms. Others may already be planning to sell the home, either via traditional or short sale. But there will still be a large pool of homeowners who find themselves facing a true financial dilemma — a contractual trap based on a product designed years ago in a different banking era, before the “new normal” of underwater property values and strict loan-to-value ratios.

Options If Your HELOC Loan Is Due to Reset in 2015 or 2016

With all that in mind, let’s focus on potential solutions for homeowners facing HELOC reset. First, if you are not sure whether this is happening with your loan, please take a close look at your agreement document. Look for the dates pertaining to the Borrowing Period and the Repayment Period, bearing in mind your contract might use slightly different terminology. If you took a loan in 2005, for example, it’s likely the reset will happen in 2015.

Once you have confirmed the date on which your HELOC will reset, the next step is to determine the new payment schedule including principal. If you have not already received a notice from your lender with this information (many lenders are sending these out well in advance to warn consumers about the pending payment increase), then you should be able to determine the new payment from the contract terms and the help of a loan or mortgage calculator. Or, perhaps much easier, you can simply call your lender and ask them what the new payment will be after reset.

1. Absorb the New Payment

Using our first example above, some household budgets can tolerate a payment spike from $250 to $492 per month. If you can fund the new payment and otherwise don’t have any refinancing options available to you, then why not give the new payment a try for 12 months? See how you do before considering an aggressive solution that may entail serious credit damage.

2. A Traditional Refinance

Some homeowners facing HELOC reset will be able to obtain new mortgage financing that solves the problem. By combining the original first mortgage and the HELOC balance into a new single mortgage, all risk associated with the HELOC reset is extinguished with closing on the new note.

Of course, many homeowners will be blocked from this solution, based on three key factors:

  • Lenders require a loan-to-value ratio of 75-80%, so the property has to be worth enough at market value to offset the two combined notes and still leave 20-25% equity as a cushion. Many homes are still upside-down in value, worth less than the two note balances combined, or perhaps worth less than the first mortgage alone.
  • Your credit score has to be in excellent shape to qualify for the best rates. (You can see two of your credit scores for free on Credit.com.)
  • Your income has to support the new revised mortgage payment, based on strict debt-to-income ratio formulas.

Unless all three conditions are in place, a traditional refinance solution won’t be available to you.

3. Modify Your First Mortgage Under HAMP, or Second/HELOC Under 2MP

Although it was announced with some press attention a few years ago, it’s rare to see the government’s Second Lien Modification Program (2MP) discussed in the context of the HELOC reset problem. Government sponsored programs like the Home Affordable Mortgage Program or Home Affordable Refinance Program (HAMP and HARP) targeted mainly first mortgages, in an effort to stabilize payments so people could stay in their homes or refinance away from toxic mortgages.

While HAMP and HARP have helped millions of homeowners over the past half-decade, the 2MP has been something of a mystery. It’s common to hear someone report having successfully modified a first mortgage via the HAMP solution. Yet reports of successful second lien modifications under 2MP are quite rare. If HAMP modifications have proceeded like a gushing pipeline, 2MP modifications are more like a tiny trickle.

According to the Department of Housing & Urban Development (HUD) website, you may be eligible for 2MP if your first mortgage was modified under HAMP and you have not missed three consecutive monthly payments on your HAMP modification. What this should mean, at least in theory, is that once you have finished making your three trial payments under an approved HAMP modification, then your second lien should be reviewed for a corresponding modification.

Check with your lender directly to see if they are participating in the Second Lien Modification Program. I would also encourage readers looking for more information on the government-sponsored programs like HAMP, HARP and 2MP to call a HUD agency counselor at 1-888-995-HOPE (4673). There is no cost to you, and the HUD counselor can help determine eligibility for one of these programs.

4. Modify Your First Mortgage, Then Apply the Savings to the Payment Spike

A successful loan modification on your first mortgage can result in significant monthly savings. If you modified under HAMP but your second lien did not qualify for 2MP, or you did a non-HAMP modification directly with your mortgage lender (also called an in-house or a private modification), then your first mortgage payment should now be lower than it was previously.

In some cases, the difference may be sufficient to offset some or most of the expected payment spike associated with a pending HELOC reset. Your budget will naturally determine this. If you pursued the modification due to financial hardship, then it may be that even with a lower first mortgage payment you still can’t handle the increased HELOC payment after reset. But others will find that the savings achieved through the first mortgage modification provides enough relief that the payment increase on the HELOC will no longer cause such a severe budget problem.

5. A Loan Modification Directly With the HELOC Lender

There are many situations where none of the above solutions will apply. What if you can’t absorb the new payment after reset or you have a balloon payment coming up? What if traditional refinancing is not available to you because the house doesn’t meet the required loan-to-value ratio? What if none of the government programs apply? What if modifying your first mortgage won’t or can’t work, now what?

Lenders do not want a default to occur. A logical step would be to determine precisely what in-house programs your creditor is willing to offer and see if any of these options look realistic to you. Financial institutions have been issued a strongly worded guidance by the OCC on the subject of HELOC reset, and they want servicers to work with customers to salvage these loans. So it makes sense to find out what the servicer is offering for modified terms and then compare to the original payment spike.

To get anywhere with a loan modification application, be prepared to submit two years of tax returns, bank statements, pay stubs and a personal financial statement. Be patient and polite. Do your own math before you approach the servicer for a modification. Know what you want in terms of a payment and loan duration, including possible principal deferment or even principal reduction, before you enter the negotiation. You may or may not get exactly what you want, but it pays to know your own figures and to be able to argue your case effectively.

6. Strip the Lien via Chapter 13 Bankruptcy

Bankruptcy is an aggressive solution that would only apply in specific circumstances. I mention Chapter 13 bankruptcy specifically because it has a unique feature that allows a second lien to be stripped from a property. This can only happen if the property appraises for less than the balance owed on the first mortgage, and of course with the court’s approval. If the lien strip is approved, the HELOC or second mortgage balance then becomes an unsecured debt co-equal with other unsecured debts like credit cards, medical bills and so on. The debt is then discharged after the case is completed, with five years being the typical Chapter 13 case duration. The advantage of this solution is that it yields a one-mortgage property with no further threat of foreclosure or potential litigation. It’s crucial to get the advice of a good bankruptcy attorney if your intention is a lien strip via Chapter 13.

7. Lump-Sum Settlement

Settlement is also an aggressive strategy that comes with credit damage and only applies in specific circumstances. There are tax consequences of settlement, in the form of a 1099-C for the forgiven balance, taxable income unless an exemption applies.

During the peak years of the real estate crisis many homes plummeted in value to a level below the balance owed on the first mortgage alone. That left second lien holders in a position without collateral, i.e., “underwater.” Under such conditions, many homeowners were able to settle their HELOCs for 10-20% of the balance after having defaulted for an extended period.

While HELOC settlements are still happening in 2015, conditions have changed considerably. We are now in an era of rising property values, and creditors are more reluctant to absorb a loss when the property underwater today may be “in the money” again before too long.

As a debt consultant, I find I’m recommending the settlement strategy for HELOCs much more selectively than I did in prior years. It does still work quite effectively in many situations, but it’s important to have a clear view of the risks before attempting a hardball negotiation strategy like debt settlement on a second mortgage or HELOC.

The bottom line is there is no single best debt relief solution for the problem of HELOC reset. I’ve presented seven potential strategies above, but each of those will only apply under specific financial conditions. Aside from the sister program to HAMP, the 2MP for second liens, there are no “Obama programs” for HELOC relief, and no bank sponsored programs to enroll in. Based on hundreds of consultations with consumers struggling with HELOC issues, my experience has been that creditors are taking a battlefield management approach, with the goal of stemming further losses. So beware of companies or services claiming they can have your lien extinguished, or have your HELOC note declared invalid. The growing HELOC reset problem presents a new opportunity for debt relief scammers to pitch bogus programs that promise to “make your HELOC go away.” Buyer beware!

More from Credit.com

This article originally appeared on Credit.com.

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