Buying a home? You’ll likely need to get it appraised before you receive the clear to close. If you’re wondering what is the home appraisal process, or why you should care, this article is for you. We’ll cover everything you need to know on both the buy and sell side of the appraisal.
Simply put, the home appraisal process is when a licensed home appraiser carefully reviews and inspects the home you’re looking to buy. The appraisers job is to provide a fair valuation on the property. This valuation is not the price the house is currently listed for, but what the house is worth in the eyes of a bank/lender. Getting a home appraised can help prevent overpaying for a property.
First and foremost, as the home buyer, you may be required to get the property you wish to buy appraised. Unless you’re paying for the house fully in cash, many lenders will demand the home gets appraised before they issue a loan.
Appraisals typically happen once an offer has been accepted. The mortgage lender will order the appraisal, and the results will be shared with all parties involved. Lenders will only issue a loan up to the appraised value of the home.
The home appraisal process doesn’t take long. Generally speaking, the professional appraisal will finish the job in just a few hours. Keep in mind, the appraisal is not the same as a home inspection. The appraiser will still carefully review the home, but their scope of view differs from what an actual home inspector will look for.
On average, a home appraisal costs between $200 and $700. There are a few variables that can influence the cost of the appraisal. Such variables include the size of the home. A home that is only 1000 square feet may cost $200 to appraise, whereas a home that is 3,500 square feet may be closer to $600 or $700. Additionally, the type of home may also influence the price. A one story condo may be less expensive to appraise than a 3 story colonial.
First and foremost, a home appraiser will inspect the quality of the home. Is the home in good condition, or does a lot of work need to be done to it? For example; are the hardwood floors in good condition, are there stains on the carpet, is the roof, gutters, shutters, and doors in good condition? Once the basics are inspected, the home appraiser will begin to look for value adding items.
Items that add value to your home are not necessarily essential, but are certainly appreciated by the buyer and can be rather expensive. These items include; decks, energy-efficient appliances or systems, fireplaces, a fence that surrounds your property line, interior trim work, and various updates/upgrades to the home.
If you’re looking to sell your home, there are various steps you can do to help your house appraise out, or increase the appraised value of your home.
If you’ve lived in the home for a while, there is a good chance you’ve done some work to the home. Perhaps you’ve replaced the windows, upgraded the electrical system, replaced the HVAC system, or added a deck. Getting all of your paperwork in order, and leaving that paperwork on the counter for the home appraisal, will help the appraiser get an understanding of what work has been completed.
Additionally, they’ll want to see the closed permits for the jobs completed, so be sure to have the permit information neatly organized as well.
It can be difficult to look past a cluttered home. A neatly organized home is always easier on the eyes, and makes the home look better. Not only does a neatly organized room look better, it’s also more practical. If your attic or crawl spaces are cluttered, and the appraiser can’t move around the mess, they may not be able to fully complete the valuation.
Before the home is appraised, you may want to complete some basic work yourself. If doors are damaged, you should replace them. If there is a huge stain in the carpet, consider renting a carpet cleaner to remove the stain. You don’t need to go crazy and replace the entire kitchen, but there may be a list of items you can complete yourself, without breaking the bank, that can help improve the appraised value of your home.
Your entire property will be appraised, not just the inside of your home. Make sure your grass is mowed and edged, add some mulch to the mulch beds, and plant some flowers. Dedicating a Saturday or Sunday to sprucing up the yard will likely pay dividends.
If the foundation is leaking water, if the roof needs to be replaced, or if the sliding door doesn’t open to the deck, get that fixed before it’s identified. Understandably, these are not cheap fixes, but it may make the difference between selling your home and not selling your home. Remember, a bank will not issue a mortgage for the listing price unless the house appraises for at least the listing price. If there are major damages with the home, it may not appraise for the price you were hoping for!
The house should have the right placement of smoke alarms. If there is a security system, make sure it works properly. These small details are often overlooked by the seller, but a professional quickly picks up on them and begins to deduct against the home's value.
Craftsmanship, build quality, and the condition of the home will all help increase the value of a home. Having a new roof, updated electrical, a well maintained and functioning HVAC system, and updated rooms will all help improve the home's value.
You don’t have to go nuts and redo your entire house before putting it in the market. There are plenty of small jobs one could do themselves that can help increase the value of the home. Adding updated lighting fixtures, faucets, replacing doors, and doing a thorough deep clean will certainly pay dividends.
If you were looking to make investments in the home before listing it, be sure to spend that money wisely. Don’t replace the appliances if the roof is leaking. If the siding is chipped or falling off the house, be sure to address that before you add ceiling fans to the bedrooms. Updated kitchens and bathrooms are certainly a huge selling point in any market, and will help increase your home's value.
If the home is in bad condition, that will certainly negatively impact the appraised value of your home.
For instance, if your hardwood floors are cracked, discolored, or if there are boards missing, that will be a red flag. If the yard is overgrown and not maintained, that will also negatively impact the home's value.
Buyers and appraisers understand not every home is brand new construction. However, it’s hard to look past a leaky roof or a cracked window.
In the event you do not agree with the results of the home appraisal, you do have the opportunity to dispute the appraisal.
The first thing you’d have to do is receive a copy of the appraisal. Figure out what negatively impacted the home's value, and verify the information is correct. For example, if the report suggests the HVAC is dated, but you just replaced the system in recent years, you have every right to bring that up and dispute the claim.
If the appraiser failed to identify the upgrades or improvements in the home, you can also call attention to all the changes you’ve made and the money you spent.
Home appraisers aren’t perfect. There certainly can be a margin of error on the report. In the event you believe the report is off base, you can request a second appraisal.
What happens if the home appraisal is less than the sale price? That happens all the time. If the home buyer is fixed on this home and would happily over pay for it, they’ll still have an opportunity to do so. The bank will only provide a mortgage for what the appraised value is. If the appraised value is less than the asking price, and the buyer still wants the home, they’ll have to make up that difference with cash.
This is rare as people generally don’t want to overpay for something. More commonly, the seller will need to lower their listing price to be aligned with the appraised value of the home.
Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.
Getting a home appraised is looked at as an unavoidable step in the home buying process. Although many people are intimidated with the appraisal process, as a home buyer, you ultimately want to get this done.
A home appraisal is designed to provide a fair, unbiased, valuation on the home. The listing price is not always the appraised price. In many cases, the appraised price may be lower. Without knowing the true value, you may overpay for a home.
As a home seller, there are various steps you can take to help increase the value of your home. Many steps can be completed on a tight budget, and most of them won’t take a great deal of time.
Whenever you are borrowing money, whether it’s for a new mortgage, a refinance, credit card, or car loan, you’ll hear the terms interest rate and APR discussed quite a bit. Both of these terms are expenses, and it’s important to understand what each expense means and what they are made up of. What is the difference between interest rate and APR? We’re glad you asked
The interest rate is simply the annual cost associated with borrowing the principal balance from a lender. Interest rates are present on various different types of loans, including; mortgages, credit card balances, car loans, student loans, and even personal loans.
Lenders are in the business of making money, and charging an interest rate on the money lent allows them to do so. Borrowers will be required to pay back the principal balance plus the associated interest rate with the loan
Understanding how the interest rate works is also important. Some loans have a fixed interest rate, which means for the duration of the loan the interest rate percentage does not change. Other loans have a variable rate, or adjustable interest rate, which means the rate is subject to change over time.
The lower the interest rate is, the less money the borrower has to pay back. The higher the interest rate, the more expensive it is to actually borrow money from the lender. Credit card debt has a notoriously higher interest rate, whereas mortgages tend to have lower interest rates.
There are various ways interest rates get calculated. We’ll address three of the most common.
First and foremost, interest rates can be derived from an associated risk equation. If one has a lower credit score, a high debt to income ratio, or an unstable financial history, the lender may view them as a higher risk of defaulting on the loan. To adjust for that risk, the borrower will charge a higher interest rate on the borrowed money if in fact the loan was approved.
Conversely, if the borrower is in a solid financial position, and has a history of paying debt back in full and on time, the lender may not view that borrower as a risk of defaulting on the loan. For that reason, the lender may charge a lower interest rate on the borrowed money.
Secondly, the time of the loan can also affect the interest rate. The longer the loan is, the more risky it can be considered - which results in a higher interest rate. The shorter the loan is, the easier it is for a lender to predict what will happen to the economy or one's financial situation, and will tend to charge a lower interest rate.
Last but not least, market conditions will impact interest rates. The government can pull various levers that will cause the interest rate to change. At a time where consumers are scared to spend money, the government may put policies in place to lower interest rates, resulting in consumers gaining confidence to spend. If consumer spending is high and the economy is thriving, banks and the government may raise interest rates. Various macro and micro economic factors will all influence interest rates, not only in the mortgage industry but in the overarching lending market.
Now that we’ve covered interest rates, let’s dive into what APR is and why you should care.
APR in an acronym for annual percentage rate. Said differently, APR is the total cost associated with borrowing money yearly. This is a more encompassing way to measure the true cost of borrowing money from a lender.
The annual percentage rate (APR) is made up of; the interest rate, any fees associated with borrowing money, any discount points the lender associates with the loan and various other charges you’ll be required to pay on the loan.
APR gets calculated by adding up the total principal balance of the loan, the interest rate on the loan, and the various fees associated with the loan into one final total. Once that number is finalized, you divide that number by the duration of the loan, and convert that total into a percentage of the total loan value.
A $300,000 loan that has $10,000 in fees and a 4.5% interest rate actually has an APR of 4.71%. The 4.71% is the true cost of borrowing money, and as shown, the APR is always greater than the interest rate.
Calculating the numbers by hand or excel is a thing of the past. There are various online calculators that can help you understand your true APR rate by just inputting a few numbers.
The interest rate is needed to calculate the annual percentage rate because the interest rate is added to the total fees paid, and the principal balance, to get one final aggregated number. From there, that total is divided by the number of days in the loan, multiplied by 365 and again divided by 100 to convert that number into a percentage. That percentage is your APR.
Generally speaking, the APR is a more accurate representation of the true borrowing cost of the loan. The lower your APR is, the less expensive it was to borrow the money.
A lower interest rate may be easier on the eyes, as the monthly payment will likely be lower, but don’t be fooled. There may be high fees or costs associated with borrowing, which allows the lender to offer a lower APR
Read all about the hidden fees you may not even know you'll have to pay when getting a mortgage.
There are various times a lender may offer a 0% APR. The 0% APR is generally for a limited period of time, meaning the borrower may borrow the money for 12, 18, or even 24 months interest fee.
Once the time period has elapsed, interest becomes relevant with the loan and the borrower will be required to pay the interest expense associated with borrowing.
Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.
There are certainly a lot of terms and acronyms in the mortgage, finance, or lending field. As a borrower, it’s important to fully understand what these terms are, and how they can impact your monthly payments.
Remember, the interest rate is the cost to borrow the principal amount of the loan, but it does not factor in all expenses. For a more encompassing and detailed understanding of the borrowing cost, use the annual percentage rate, or APR.
The APR is the fully baked financial metric that factors in the all in cost of the loan. The APR will add in the interest, closing fees, and broker fees into one aggregated sum, and divide that amount over the lifetime of the loan. That payment is converted in a percentage, which you’ll know as the APR.
Purchasing a condominium is a home purchase; however, condo financing differs from conventional single-family home mortgages. Buying a condominium comes with its own set of rules and fees.
From requiring you to follow extra steps in underwriting to boasting specific rules in particular programs, novices stepping into the world of purchasing a condo need to take time to learn more about mortgages. Buyers should consider the ins and outs of condo living before applying for the mortgage.
Here we take a closer look at what condo mortgages are and why they cost higher.
Scoring a mortgage to purchase a condo is a lot different than obtaining a loan to buy a single-family home. Typically, condominium loans boast stricter requirements alongside higher price tags on standalone single-family dwellings.
It is primarily because the value of a condo is subject to many additional risk factors that are not under the borrower's control. Fannie Mae and Freddie Mac ask borrowers to meet higher eligibility standards on condo loans to mitigate the risks.
If you're planning to buy a condo, it's a good idea to familiarize yourself with rates and down payments. Let's take a closer look at why mortgage rates and down payments are higher for condos.
Mortgage rates for purchasing a condo are typically higher than on single-family homes. Even if a borrower purchases them on similar terms, condominium mortgage rates exceed conventional mortgages due to condo mortgages being riskier.
Typically, on mortgages that Fannie Mae backs up, the rate on a condo may vary from 0.125-0.250% (one-eighth to one-quarter percent) higher than what you'd pay on single-family homes. Fannie Mae requires lenders to pay an upfront fee of 0.75% of the total loan amount. Here lenders may boost the mortgage rate to cover this fee.
Moreover, borrowers may avoid higher rates by paying the total upfront fee or making down payments totaling up to 25% of the home's purchase price. Unfortunately, condo buyers may find it challenging to score larger down payments, especially if they're novices.
However, if you choose an FHA loan, you may make a smaller down payment of around 3.5% while paying rates similar to when you would pay with larger down payments. The drawback here is that FHA also charges an upfront mortgage insurance fee comprising 1.75% of the total amount, which Fannie Mae loans don't charge.
In addition to this, you'll learn that specific lenders charge higher mortgage rates in different states. Generally, the difference isn't that noticeable. However, you'll find that some states charge half a percent more than other states.
Here's the thing: to enjoy the best rates on Fannie Mae loans, borrowers need to offer at least 25% down on condominiums. On the flip side, homebuyers can get their hands on fantastic rates if they put down less than 20 percent.
Apart from that, specific lenders require borrowers to put down a minimum of 20 percent. However, this may vary from state to state – Florida and Nevada are known for the highest requirements. Some states allow you to enjoy down payments as low as 5% alongside stellar credits.
Moreover, FHA loans ensure down payments as low as 3.5 percent. However, you may still have to put down 10% if you're purchasing a condominium in areas that are newer but lack warranties of 10 years.
Typically homeowners utilize 'conforming' mortgage financing, which means that they're acquiring their loan from government-sponsored entities, Fannie Mae and Freddie Mac. It also indicates that their loan meets both groups' minimum standards.
Fannie Mae and Freddie Mac use 'warrantable' to classify the different condo projects and properties against which they'll provide a mortgage. On the flip side, the term 'non-warrantable' refers to Condo projects and properties that fail to meet Fannie Mae and Freddie's Mac warrantable standards. Let's discuss what classifies as warrantable and non-warrantable.
Fannie Mae and Freddie Mac consider condos warrantable if:
Condos are considered non-warrantable if:
Condos are an excellent investment; however, you must understand the hidden costs of buying one:
While condos promise a maintenance-free life, Home Owner's Association (HOA) or Property Owner’s Association (POA) charge condo owners a monthly, quarterly, or annual fee to cover the property's maintenance. These fees can sometimes increase monthly mortgages up to $500 per month and more!
Condo owners may have to deal with special assessments on top of mortgage payments, HOA dues, property taxes, and insurance. Special reviews refer to extra privileges that HOA requires to cover any unplanned expenses that may occur.
Luxury condos present alongside the beachfront offer fantastic aesthetic appeal. However, these homes usually require homeowners to pay an additional cost.
Today, more and more people are purchasing condos, from retirees to investors. It's no surprise that condos are growing in popularity for their benefits; ensuring you can enjoy a maintenance-free life and offering you the opportunity to build a community. You can even benefit from excellent amenities like fitness facilities, pools, spas, and even cafes!
While condo mortgage rates are different from single-family home loans, there are ways you can score fantastic interest rates. Make sure you spend some time contemplating other condos in various states before making your final purchase.
In today's day and age, there are a lot of reasons why homeowners are looking for new mortgage lenders. With mortgage rates dropping to historically low levels, now is a better time than ever to change your existing home loan.
If your new rate ends up being lower than your current rate, you will enjoy the luxury of reaping a considerable amount of money. Let’s explore what it takes to change your mortgage lender!
Well, can you actually change your mortgage lender? Here, we will discuss if it is even possible to change your lender, why you might consider switching lenders, and how to carry out the process if you qualify.
A mortgage lender refers to a financial institution or bank that offers home loans. In addition, mortgage lenders typically have specific borrowing guidelines. Doing so enables them to verify your creditworthiness as well as your ability to repay a loan.
Lenders are responsible for determining terms, repayment schedules, interest rates, and other critical aspects of mortgages. In the event that you're a borrower, you won't get to choose who services the lender’s loans.
This is usually due to how loans are handled once you pay yours off and close your loan entirely. After closing, it’s not uncommon for a lender to sell your loan to external companies. This often can be done without the approval of the borrower.
Some mortgage lenders boast the way they service their own loans. They will often handle the ongoing administration of the loans as well. So, although it’s rare, it is possible for mortgage lenders to service their own loans.
If you’re in search of a lender offering loans that they service, consider applying for a loan from one of the following banks:
When refinancing your mortgage, you don't need to stick with your existing lender. Here are the main reasons why you may want to switch to a new mortgage lender!
You may assume that switching lenders will enable you to score a better mortgage rate. This can actually be done with the help of an account in good standing as well as a solid history of on-time loan payments.
However, different mortgage lenders will boast various loans and borrowing requirements. For example, a lender you've never worked with may offer you a 3.2% rate on your mortgage refinance whereas your current lender may be offering a 3.35% interest rate. It’s all relative, and it doesn’t hurt to look around at interest rates being offered by other mortgage lenders.
Some homeowners may have a bad experience with their mortgage lender. If this is the case for you, there are some ways you can handle this situation.
Make sure you keep records of every interaction you have with your lender. Remember the names of the employees you spoke with, the date of the conversations, and what they told you.
In the event that the issues escalate, you'll have detailed notes to use as proof of mistreatment by your lender, which will make it easier to hold your mortgage lender accountable.
Before you start working with an organization, make sure you have a clear goal in mind. Get ready to articulate your desired outcome when speaking with potential lenders. That way, your lender will be on the same page as you, and if they go against your wishes, it will be in writing.
The Consumer Financial Protection Bureau (CFPB) allows customers to submit complaints online. Make sure you organize your receipts, conversation transcripts, and notes before setting out to file a complaint. The more organized and detailed your complaint is, the better the outcome will be!
Before you change your mortgage lenders, it’s important to understand the rules and regulations of the process.
Before you change your mortgage lender, it’s suggested that you make sure you have already been pre-approved by your new lender. The great thing about this is that the pre-approval process is not extensive. It’s usually done before you make the offer.
Assuming that you already have a mortgage, chances are you've gone through the pre-approval process before. So, all you have to do is repeat the process as soon as you're ready to change lenders.
When seeking a new mortgage lender, make sure you're transparent and let your real estate agent know. After you are pre-approved by the new lender, it’s important that you provide your real estate agent with your new pre-approval letter.
Changing your mortgage lender comes with several drawbacks, the most obvious of which is the delays. Here are a few other cons of switching mortgage lenders!
If you've scored a low rate with your most recent lender, it doesn't mean that your new lender will adhere to that same value. The quote you receive from your new mortgage lender will depend on the industry trends as well as your credit score.
These may change over time, and as such, they will differ from the rates you were quoted by previous lenders. Based on these two factors, your interest rate could end up being higher than prior loans, so getting a new lender can sometimes be detrimental in a financial sense.
Closing costs vary from lender to lender. Your new mortgage lender may charge additional fees or higher rates than you were used to with your previous lenders. For this reason, it's essential to compare the costs and fees of a potential lender before committing to making the switch.
It's likely that your previous mortgage lender already pulled your credit before starting the process for your loan. Lenders like to conduct credit checks before considering you for a loan because your interest rate will heavily rely on your credit score and subsequently influence the rate your new lender decides to offer to you.
All lenders will require an appraisal before they’ll consider issuing a loan. An appraisal tells the lender that their money will be easy to recover even if you’ve defaulted on a previous loan.
You will need to pay an additional service fee when the loan payment is made to cover the costs of the appraisal. You might also have to pay other fees that were already pre-paid with your old lender.
Despite the drawbacks of changing mortgage lenders, making the switch is still worthwhile because signing with a new mortgage lender also comes with numerous advantages. While your primary focus should be ensuring that you're as happy with your loan terms as you are with your new house, it's essential that you choose your lender wisely.
Consider shopping around for the best rates. Furthermore, make sure you compare each lender by asking about closing costs, additional fees, and customer service protocols.
After selecting a new lender, communicate the details of your new loans to your new agent, the escrow agent, the seller, and other involved parties. This way, you can foster a deep relationship with your lender and real estate agent which will lead to a foundation of trust.
When you’re in the process of buying a home, you’ll often work with a single real estate agent who will help you to find the perfect place for you and your family to call home. But did you know that there’s a way for real estate agents to share information with one another about available properties in order to better serve homebuyers and sellers?
This special arrangement is called a multiple listing service, also known as an MLS. With 64% of the National Association of Realtors claiming to use MLS listings regularly, the concept is very widespread.
Today, we’ll explore what an MLS entails and how it benefits real estate agents, buyers, and sellers alike.
Essentially, an MLS is a privatized database that can be accessed and edited by active real estate agents and brokers. The goal of a multiple listing service is to help real estate professionals connect their clients with high-quality listings that might fit their needs, even if they’re outside of the agent’s brokerage.
Though the concept of an MLS was originally created solely for real estate pros to share information with each other, the databases have developed over time to become an important resource that agents can use to share properties directly with their clients.
MLS listings will include vital information such as:
Depending on the MLS listing, other information will often be included as well, such as the age of the property or disclosures regarding the property’s condition. Information like this can give buyers a better understanding of what’s available in their desired area so that they can make more informed choices.
The databases include family homes and open properties as well as condos, foreclosures, and international properties. Rentals will occasionally be included as well.
If sellers do not list their properties through a real estate agent, their home will not be included on an MLS. Likewise, any property that is listed through an agent will be included on an MLS.
If you’re in the process of buying a home, know that the vast majority of properties for sale will be available for you and your agent to peruse together on a multiple listing service. Even so, MLS online listings aren’t the same as home-buying websites.
Real estate organizations across the country have been allocating millions of dollars toward the development of comprehensive, helpful multiple listing services. Some of this information gets forwarded to sites that list houses for sale, but the most complete and accurate information is often in the MLS.
Therefore, it benefits sellers, buyers, and real estate professionals to utilize an MLS for their buying and selling needs.
MLS databases allow the property seller’s real estate broker to achieve a wider reach for the property, increasing their chances of finding the right buyer and selling the property for the right price. Similarly, using an MLS can help a buyer’s broker widen the variety of options that they can show to their clients.
In a sale created from exposure via the MLS, both the buyer’s agent and the listing agent will share a piece of the commission. An MLS acts as a kind of neutralizer that allows both small and large real estate companies to interact with one another on an even playing field.
At the same time, sellers and buyers who don’t have real estate training will come away with a positive experience. It results in both parties getting to receive what they wanted at a price that’s fair for everyone involved.
Multiple listing services are reserved for sellers and serious buyers who are represented by an agent. A realtor license number is required for access. Real estate professionals pay dues regularly in order to keep up the legitimacy and accuracy of MLS databases.
However, many real estate companies will display current MLS listings right on their website for potential buyers to peruse. Should a potential client hire a real estate agent or broker for assistance in buying a property, they will gain access to the MLS that the company belongs to by way of their agent.
If you’re interested in buying a home, perusing an MLS is not your only option. There are several other popular real estate websites and apps available, including Zillow, Trulia, and Redfin. All of these alternatives allow potential buyers to find out what’s available in their area without requiring the services of a real estate agent.
Available homes can also be listed on sites dedicated to listings that are for sale by owner (FSBO). However, since these homes are sold without real estate representation, they won’t be available on an MLS. Instead, they may only be available on a limited number of third-party real estate sites.
Additionally, large real estate firms in busy markets will often have their own websites that are dedicated to their listings, which potential buyers are free to check at any point in time.
Pocket listings are properties that real estate agents keep “in their pocket” by only sharing them with specific potential buyers and a select few agents. In a sense, these listings are kept secret by not being included in any MLS listings or third-party real estate websites. Most pocket listing homes don’t even display a “For Sale” sign publicly.
Navigating the housing market can be difficult without the help of a real estate agent or a broker. Once you’ve hired a professional to aid you in the process, an MLS can be a crucial part of finding your family’s perfect home or securing the right buyer for your property!
If you find a property that you’re highly interested in buying but are concerned that the seller might choose another offer over your own, you may consider making a deposit in escrow to show that you’re committed to your offer. This deposit is called an “earnest money deposit,” and is a great way to back up your offer in a competitive housing market
Read our blog written specifically for homebuying beginners here.
Earnest money is typically deposited in an amount between 1 and 2% of the purchase price. It shows that you’re serious enough about your offer to give that money to the seller if you back out without good reason during the closing process. Earnest money isn’t a requirement, but it’s strongly recommended and shows your commitment to the seller.
Earnest money is delivered to a third party in an escrow account when you sign a sales contract or purchase agreement. If you purchase the home, the money is refunded to you or can go toward your down payment. If you back out for a reason that isn’t outlined as a contingency in the contract (which we’ll cover more in a minute), the seller will get to keep the earnest money.
As an example, say that Nathan wants to purchase a $150,000 condo. Since he’s buying in a competitive market and wants to make his offer stand out, he decides to indicate in his offer that he will make a deposit of 2% of the sale price ($3,000). When his offer is accepted, Nathan wires the money to an escrow company.
If Nathan’s home inspection covers a serious issue like a dangerous crack in the foundation, he can back out and receive his money back. If he decides to move forward to close on the property, the earnest money will either be refunded to him or will go towards his down payment. However, if Nathan were to find another property that he was more interested in, he would have to forfeit the $3,000 in earnest money in order to withdraw his offer.
Be sure not to confuse earnest money with the down payment on a house. The down payment money is brought as a cashier’s check to closing, and the amount depends on both the property type and the kind of financing used. Nathan might be able to use his earnest money as part or all of his down payment, but this isn’t a requirement.
As you can see from the example, a buyer may want to make a higher earnest money deposit when they are committed to buying or are shopping for houses in a highly competitive market. The minimum amount is 1% of the sale price, which is typically just a few thousand dollars at most.
Your real estate agent will be a great resource when it comes to deciding an earnest money amount and will use their expertise on local trends and competition to help you write your offer.
As we discussed, earnest money will either go towards a down payment if you close on the home or can be refunded if you decide to withdraw your offer for a reason outlined as a contingency in the buyer’s agreement.
There are several different types of contingencies that might be included in the agreement signed by you and the seller.
The home inspection contingency allows a buyer to withdraw earnest money if inspection findings reveal a problem with the property that costs too much to repair or that would make the home a bad purchase
Read our blog covering 8 budget-friendly DIY home improvements here.
An appraisal contingency ensures that the buyer can withdraw their offer and earnest money if their lender appraises the house and determines that it is worth significantly less than the same price.
A financing contingency is an important protection for the buyer that allows them to withdraw their offer and earnest money if they are unable to receive financing for the home. It also provides them with a predetermined amount of time in which they can look for financing.
Depending on the buyer’s finances, they may want to include a sale contingency, in which they can withdraw their offer if their current home or property doesn’t sell in a given time period.
Earnest deposits can range anywhere from a small amount to thousands of dollars. It’s important to take the right steps to protect your money in case you do want it refunded.
Escrow companies exist so that neither the buyer nor the seller has possession of cash or assets while a house is in the middle of the sale process. If you were to give earnest money to the seller and then ask for a refund if, for example, your first home were unable to sell, there’s more room for conflict than if the money is held by an objective third party.
Make sure that every relevant contingency is included in your buyer’s agreement. If you choose to forfeit contingencies, do your research beforehand to make sure you’re willing to take the chance of losing that deposit.
Your responsibilities don’t stop with a signed contract. Protect yourself by staying on track with next steps: securing the financing for the home and scheduling a home inspection. Delaying these processes or failing to be through might result in a loss of your earnest money or in making rushed decisions later on.
Make sure that every contingency and term is included in an agreement that is signed, in writing, by both you and the seller. It might seem simple to make promises and agreements in person or over the phone, but having written documentation will guarantee your financial security and will keep a record of the process.
Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.
Making an earnest money deposit is only one aspect of making an offer on a potential home. Working with a real estate agent ensures that you have help in deciding when earnest money is important and how much to offer as a deposit. Since market trends can change depending on property type and area, it’s important to find an agent who is specifically experienced in the kind of home you’re looking for and in your neighborhood of interest.
Considering the complexities of today’s real estate market, many potential buyers are asking themselves, “Should I buy a house now?” In many places, the current market is a seller’s market, which means that it’s easier than ever for people who are selling their properties to make a lot of money.
However, buyers may need additional financial support to meet a seller’s expectations. Enter the private mortgage. Real estate purchases financed by friends, family, and private institutions come attached to fewer strings than traditional bank mortgages. Private mortgages also allow for greater flexibility in today’s challenging market.
You do not apply for a private mortgage through a bank or a mortgage lender. Instead, private mortgages are just that — private. When you reach out to family, friends, and business acquaintances for support with purchasing your new home, you can benefit from a non-institutionalized private mortgage.
The informal nature of these loans can benefit the borrower immensely but it can also put additional stress on personal relationships. To successfully establish a private mortgage, it’s in the best interest of the borrower to create an interest-forward contract, like a mortgage note or comparable contract, which will ensure that no one ends up getting shorted.
Private mortgages aren’t single-use loans. Borrowers can use these mortgages to purchase a new property or refinance an existing property!
The housing market is in a tricky place as of 2022. It is a seller’s market, which means that buyers need to step up their game if they want to purchase the property of their dreams.
Parties that are interested in securing a private loan should express their interest early on so that they are prepared to make an offer when the right multi-family or residential property comes along.
People who are interested in commercial investments can lean into the potential financial gain of those properties to more effectively secure the financing they need from private sources, too.
Feeling confined by a traditional mortgage? Private mortgage lenders can help borrowers rather than the lenders or banks that the borrowers have worked with in the past.
Private mortgages are popular with lenders and borrowers alike for a myriad of reasons, including the following!
Private mortgages come with higher-than-average interest rates. As such, private lenders can more easily make money off of their investments.
Borrowers may have specific benefits, too, which include shorter approval times and the ability to buy a house with the intention of flipping it.
While private mortgage lenders will still want to consider a borrower’s credit score and pay-back history, the loan approval rates between family and friends tend to be a lot faster than when you apply for loans through banks.
Banks and public lenders require a significant amount of documentation before they will approve a mortgage. With a borrower’s loved ones, their relationship with the borrower will be enough of a character reference for them to base their decision off of.
Buying a house with the intention of flipping it is easier with a private mortgage than with a bank. If borrowers can sell the homes that they finance and flip them for more than the cost of their private mortgage, then they can make a profit on their work without worrying about the limitations and regulations set by a traditional bank.
Banks and public mortgage lenders have risen in popularity for a reason. These institutions have established, federally-directed policies that protect both themselves and their borrowers.
Parties that pursue a private mortgage, both as lenders and borrowers, may subsequently face challenges that the world of public financing doesn’t experience.
There are several drawbacks to choosing a private mortgage as a lender. These downsides include a short payback period and the potential to default on the loan.
One of the greatest private mortgage lender benefits is the chance to arrange for a substantial interest rate. However, the mortgage’s short payback period means that lenders won’t have the chance to benefit from the additional income for too long.
Lenders need to plan out their future finances with care if they want to make the most of a borrower’s interest.
There is always a chance that, despite the financial support that a lender offers, the borrower may default on their mortgage. While the borrower has the opportunity to declare bankruptcy, lenders who are interested in regaining the investments they lost may have to undergo a complicated and costly legal process.
Likewise, there are several drawbacks of a private mortgage for borrowers. These include an even shorter payback period and higher interest rates.
Traditional mortgages often allow the borrower to pay back the loan and the interest over a term of thirty years or more. But this isn’t the case with private mortgages which have a notably shorter payback period.
As such, borrowers will need to manage their finances carefully to prevent bankruptcy as the result of taking out a substantial loan.
Even though they are established in an informal environment, private mortgages still require paperwork in order to protect a private mortgage lender’s interest. As such, these loans will also likely include interest.
While borrowers can avoid the complexity of working with a bank or other institution, they’ll face interest rates that are substantially higher if they choose to go the route of a private mortgage. This cost can transform a borrower’s financial plans both for the immediate future and for life down the road.
Borrowers and lenders alike can use private mortgages to their advantage. To ensure a mutually beneficial arrangement, both parties may want to establish an interest rate in writing and plan for things to go awry.
All lenders establishing private loans must require their borrowers to pay interest equal to the IRS Applicable Federal Rate. Many lenders are encouraged to charge more, both for the borrower’s tax benefits and for their own financial gain. With that being said, the exact amount of interest that a private mortgage lender charges is up to the individual.
Both the borrower and the lender will then want to establish their fixed tax rate in writing to ensure that it’s easier to report on legal financial documents. It will also prevent either party from attempting to change the fixed rate later on down the road.
Lenders and borrowers alike face a distinct risk of financial disaster if they improperly handle a private mortgage. That’s why both parties will want to establish contingency plans during their initial conversations.
Writing in provisions for borrower defaults and missed payments can keep the relationship between a borrower and lender civil without compromising either party’s financial standing.
Private mortgages benefit lenders and borrowers alike. As long as all parties involved in the process make financially-sound decisions, you won’t need to ask yourself, “Should I buy a house now?” for long. Sit down with your friends, family, or a private institution to determine whether a private mortgage lender agreement can help you purchase the property of your dreams.
If you’re looking to buy a house, and do not have a mountain of cash saved up, you’ll need to consider getting a mortgage to help you finance this large expense.
But what exactly is a mortgage? Simply put, a mortgage is a debt instrument used to purchase real estate. A lender will loan a borrower money, and the borrower is obligated to pay the lender back.
An agreed upon repayment plan is established between both parties, and various terms and conditions must be met.
If you're wondering, how does a mortgage work - we’ll start at a high level and break it down step by step. A borrower borrows money from a mortgage lender and agrees to pay the mortgage lender back the full amount of the loan, plus any interest expense. The lender conducts their own research on the borrower before agreeing to lend them money.
There’s a lot of parties and terminology involved in the process.
The first step in getting a mortgage is to work with a licensed loan officer. Be sure whoever you are working with is licensed and registered to sell mortgages.
Loan officers help answer how to get a mortgage, and they’ll assist you with a variety of tasks. They’ll help you determine which mortgage works best for you, will shop for the best interest rate, and will even assist you with all the paperwork you need to complete. We’ll get into more of these details below.
You can select from a variety of mortgage options, each of them serves a purpose. A common option is a fixed-rate 30-year mortgage. This means for the duration of the loan, 30 years, the borrower will pay a fixed interest rate and payment each month. This fixed rate concept can also be applied to other mortgage options, such as a 15-year mortgage.
The following are some common words associated with mortgages and mortgage transactions.
A down payment is simply the amount of money you put down on your home. If the price of the home is $300,000 and you put down $30,000 as your down payment, you put down 10%. Various mortgage types will require a specific percentage for a down payment.
The interest rate is what the lender charges you for borrowing their money, in addition to the principal balance. This rate is referenced as a percentage. For example, a borrower with a fixed interest rate of 3.5% will pay that flat borrowing fee for the life of their loan.
Your loan can have a fixed interest rate, meaning it doesn’t change for the duration of the loan. Or, your loan may have an adjustable interest rate, meaning it can change over time. The lower the rate, the more favorable borrowing money is.
What's the difference between an interest rate and an annual percentage rate (APR)? Find out here!
This is a trickier concept, but amortization is the process of gradually writing off the initial cost of an asset. Remember, someone gets a mortgage for a given period of time. In the early years of the mortgage, the borrower’s payments fund mostly interest expenses.
As the years progress, the borrowers interest expense lessens, and more of their monthly mortgage payment is allocated to the principal balance. Visually seeing this may help paint a clearer picture.
Escrow is another common term used in the mortgage or real estate industry. Escrow is a contractual arrangement where a legal third party receives, holds, and distributes property or money for two parties. Escrow is essentially an unbiased middleman between the buyer and seller, or the buyer and an insurance company.
A buyer gives the escrow agent money to hold, and the homeowner selling their home gives the escrow agent the home. When the sale is finalized, the escrow agent gives the new homebuyer the home and the former owner the money. If the deal doesn't go through, the escrow agent is obligated to give the buyer back their money and the home goes back to the seller.
If you’re curious how to calculate a mortgage payment, there are a few components that give you the final monthly number.
The principal balance is the initial balance of the loan. Using the same example as above, if the home was $300,000 and your down payment was $30,000, or 10 percent, you borrowed a total of $270,000 from the lender - which is the principal balance. Each mortgage payment reduces the outstanding principal balance. The more principal balance you reduce, the more equity you have in your home.
Interest is the fee a lender charges you for borrowing the principal balance. The lower the fee is, the less money you pay. If you have a great credit score, a low debt to income ratio, and put down a sizable down payment, you’ll likely have a more favorable, or lower, interest rate. If your credit score is less than average, and you’re not putting down a large down payment, you may have a higher interest rate.
The interest rate changes with various government involvement and economic conditions. But if you have a fixed rate interest rate, you’re locked into that rate for the life of the loan. Only when your mortgage is an adjustable rate mortgage do you have to worry about your payments being volatile.
Taxes vary by state, county or even on a town level. The tax rate is also referred to as a mill rate. Some mortgage companies allow you to roll your tax expense into the monthly mortgage payment, utilizing the escrow system we discussed above. If your taxes aren’t rolled into the monthly payment, you’ll be responsible for paying your town directly.
Similar to car insurance, you must carry insurance on your home. How much you pay in insurance will vary, just as it does on a car. Variables that impact the insurance expense include; crime rate in the area, if the house has a pool, if the house is in a flood zone, and the value of the property.
Mortgages are not one size fits all. There are various types of mortgages you can choose from. Each one has a purpose; your goals, financial situation and comfort level will dictate which loan is right for you.
A conventional mortgage is a loan that is not secured by a government agency. Conventional mortgages are common, but they typically come with a higher interest rate as they are not insured by the federal government. A private lender, or Fannie and Freddie Mac issue conventional mortgages.
There are three government agencies that can issue a mortgage.
A jumbo loan is used to purchase homes that cost more than what a conforming loan allows. This amount is variable depending on where you live, and can change year over year.
A fixed rate mortgage is when the interest rate on the loan remains the same throughout the duration of the loan. This can be a fixed rate 15 year mortgage, 20 year mortgage, or even 30 years. The interest rate will not change, which makes budgeting easier.
An adjustable rate mortgage is the opposite of fixed rate. When you have an adjustable rate mortgage, your interest expense can go up or down throughout the life of the mortgage. Considering the rate can fluctuate, it makes budgeting a bit more difficult.
Now with a better understanding of the various types of mortgages, how much mortgage can I afford may be the next question on your mind! Remember, the mortgage payment consists of; principal, interest, taxes and insurance. Let’s visit the qualification process.
A lender (or bank) takes a lot of financial variables into consideration when determining your maximum monthly mortgage payment including: your debt to income ratio; credit score; annual household income; and your income potential. Two people with the exact same income can qualify for different mortgage amounts.
Person A makes $80,000/year, has no debt and a high credit score. Person B makes $80,000/year, has a high debt-to-income ratio, and a lower credit score. The lender is likely more inclined to lend person A more money, as they have more confidence person A has the ability to pay them back.
Your lender, and various financial calculators, can figure out what your monthly mortgage payment is. But, it’s important to fully understand what that number is made up of.
Remember, your mortgage payment consists of; principal, interest, taxes, homeowners insurance, and potentially mortgage insurance. You’ll have to understand what the annual amount of each of those expenses are and divide by 12 to get your monthly rate.
The formula can get a bit complex considering the math you’ll have to do on the interest rate. It’s best to know what variables make up your mortgage amount and leverage an online calculator to get the final amount.
Wondering what fees and costs you'll have to pay at closing? Find out here.
Getting a mortgage doesn’t need to be complicated. In fact, in today’s modern world, you can get a mortgage right from the comfort of your own home.
The first step is to get pre approved for a loan. To do this, find a trustworthy lender you’re comfortable working with. All lenders will require a bit of paperwork from you. This includes bank records, pay stubs, insight into your expenses, identification, etc. Supply the lender with accurate records, and within a few days you’ll be pre approved for a specific mortgage amount. You’re now ready to start shopping for a home!
Armed with the pre approval letter, real estate agents will be willing to take you on as a client. The pre approved letter helps you and the real estate agent determine what homes are in your price range.
You can look for homes in your desired price range and area from just about anywhere. Zillow and Trulia are popular real estate sites that will show you homes based on whatever criteria you give them.
Once you find the right place to call home, it's now time to finalize your loan. You’ll submit an offer to the seller, and if they accept, you’re ready to progress to the next step. Pending approval, you’ll go back to your lender and begin the loan finalization process. This includes getting the home appraised, inspected, and one final review of your financials.
The lender wants to be certain your debt to income, and credit score, remains aligned with what they saw when you were pre approved.
If everything aligns, you’ll be ready to close. Generally speaking, there is a bit of a waiting period between submitting your offer, getting it accepted, and officially closing on the loan. Both the buyer and the seller will agree to a closing date at some point in the near future. Once that day comes, you’ll do one final walk through of the home before officially closing.
Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.
A mortgage is a debt instrument used to help finance real estate purchases. Everyone has a different financial history, and various financial goals, so there are many different mortgage options you can choose from. Some mortgages have an adjustable rate, whereas some mortgages have a fixed interest rate. The duration of the loan can vary as well.
Buying a house and obtaining a mortgage is a huge financial decision. It’s best to work with a professional throughout each process. They’ll help answer any questions that come up along the way, and will provide guidance where appropriate. Be sure to only work with licensed mortgage brokers when applying for a loan.
A bridge loan is a short-term loan a borrower may use while a more long-term financing contract is finalized. Bridge loans are common in real estate when someone needs to buy a new house before their existing house has sold.
These short term loans typically come with a higher interest rate. Additionally, many banks will require some sort of collateral from the borrower before the loan is issued.
We’ll cover everything you need to know about bridge loans below.
Although bridge loans may also apply to the business world, they are more commonly associated with real estate transactions. As the name suggests, these loans are designed to bridge the gap, and fill the cash constraints, someone may feel when they are both buying and selling a home at the same time.
Someone wishing to get a bridge loan first needs to find a lender who offers this financing program. The first place to check would be with your existing mortgage company.
Once you find a lender who offers bridge loan financing options, it’s time to get all the paperwork needed for the lender. Lenders will want to know the details of your existing property. For example, lenders will want to know how much you owe on your existing property, when you plan on selling it, and what price you plan on selling it for. Additionally, they’ll want to know the details on the property you’re looking to purchase.
Lenders will of course pull an up to date credit report, and will require you to provide them with proof of income. With all of this information, a lender can successfully calculate the financial ratios they use to determine if you qualify for a bridge loan, and how much loan you qualify for.
Securing financing via a bridge loan doesn’t take too long! Generally speaking, you should be able to have your loan finalized within 30 days. Hard money lenders can typically finalize a loan even quicker
We wrote a whole blog explaining ways to speed up the mortgage process, read it here.
Bridge loans can be more challenging to qualify for since you typically need to have a good to excellent credit score (740+ credit score) to qualify - but all lenders have their own unique qualifications. One of the most important variables a bank will review during your application process is your debt to income ratio.
This variable is increasingly more important on bridge loans as the borrower will be paying for two mortgages at the same time.
Banks want to be fully confident adding another mortgage payment to the borrower will not cause them to default on any existing loans. One's income needs to be high enough to provide them with the financial breathing room and stability through the double financing period.
Below is a comparison table of bridge loan qualifiers vs a traditional home loan.
Loan TypeCredit Score NeededDTI (Debt-to-Income) PercentageInterest RateBridge LoanGood to excellent - 740+ credit score is ideal, but all lenders can have different requirements.Because a person taking out a bridge loan is considered a temporary loan until their home sells, many bridge loan lenders will allow applicants with a DTI of 50% or less to be considered.Rates vary by applicants and timing, but are usually higher than the current mortgage rate.
Applicants can expect rates of 8.5-10.5% or more.MortgageVarying credit score is needed depending on your loan type.
Some mortgage loans can accept applicants in the 580 range while most conventional loan lenders prefer a credit score of 620 or higher.Depending on their mortgage you apply for, the DTI requirement can change by several percentage points.
Preferred DTI is around 43%, but some lenders can provide financing for applicants with DTI up to 50%Mortgage rates vary by time and applicant.
The current mortgage rate is between 4.9% - 6.5%+
Bridge loans provide the borrower with a great deal of convenience. In the finance or lending world, convenience comes at a premium. The interest rate on a bridge loan is directionally aligned with the interest rate on conventional lending, however, bridge loans will have a higher interest rate by a few percentage points.
The higher interest rate makes sense from a banking perspective. Banks need to take on risk to issue these loans, and they are short term in nature. In order for a bank to make as much money back as possible, and justify the risk in lending, they simply need to charge a higher interest rate
What's the difference between an interest rate and APR? Don't know? Read our blog all about it here.
The actual borrowing amount may vary between different lenders, however, as a rule of thumb most bridge loans will allow one to borrow up to 80% of the home’s value.
Bridge loans are certainly a powerful tool made available to the real estate industry. Now with a better understanding of what this tool is and how it works, let’s dive into some pros and cons.
Many borrowers appreciate a bridge loan for the following reasons.
Bridge loans provide individuals with flexibility. They can buy a new house before their existing house sells. This not only adds convenience, it can also help someone move into their dream home. In a competitive real estate market, that dream home may not be available for long.
Some bridge loans do not require the monthly payment for a few months. If you happen to secure lending from a lender who doesn’t require immediate monthly payments, you’re in luck. You’ll be able to buy the house you want without the immediate financial pressure two loans could have on your finances.
Generally speaking, securing financing via a bridge loan can be done in a shorter period of time. Instead of waiting on a HELOC, or other financing options, lenders who issue bridge loans are well aware the borrower needs the loan now and plans accordingly. This urgency comes at a premium, which we’ll discuss below.
There are three major drawbacks of a bridge loan.
You may be wondering, are bridge loans a good idea? Unfortunately the answer isn’t yes or no. A bridge loan is a great financial tool to have in your tool chest, but it certainly comes at an increased cost and risk. If you need the money quickly to move into your dream house, a bridge loan may be the only option.
However, a bridge loan is not the only option when it comes to buying a new home while you wait on your existing home to sell.
Is there an alternative to a bridge loan? Absolutely. Instead of choosing a bridge loan, many people choose to go with a home equity line of credit, a home equity loan, or even a 80-10-10 loan.
A home equity line of credit, also known as a HELOC, is very similar to a credit card in how they function. A borrower is approved for a specific amount or credit limit, but the borrower does not need to use the full amount. A borrower will only pay interest on the debt they used, and they can draw against their credit line in various increments.
Another common option would be a home equity loan. This is very similar to a home equity line of credit, however, the money is given in one lump sum. Some of the major advantages are; there are lower closing costs associated with home equity loans. Additionally, home equity loans have lower interest rates and even offer extended repayment terms.
A 80-10-10 loan option is when someone has enough cash to cover a 10% down payment. Instead of financing 90% of the home in one mortgage, the buyer will choose to take out two mortgages. The first mortgage is for 80% of the home value, and the second mortgage is for 10%. Therefore, the buyer is able to avoid paying private mortgage insurance, and can use this option if they are unable to make a larger down payment as their existing home hasn’t sold yet.
Our Mortgage Learning Center features blogs on a wide range of mortgage and refinancing topics.
A bridge loan is a financial instrument that provides financing to individuals as they secure a longer term financing option. In the real estate world, these loans are common when someone is selling their existing house, and buying a new house, simultaneously.
Bridge loans provide the borrower with money in as little as a few days, resulting in tremendous flexibility. This flexibility comes at a premium, and one should expect to pay a high closing cost, and interest rate, on this short term loan.
There are other financing options available in the marketplace. Home equity lines of credit, home equity loans, and even 80-10-10 loans should all be considered before deciding if a bridge loan is the right option.
Have you decided this is the year to buy a new home? Good for you! When you begin your research for the right mortgage loan for you, you’re going to be focused on finding the lowest terms and interest rates for which you qualify. It’s no surprise, then, that for many soon to be homeowners, the lower payments available with a balloon mortgage are alluring. Balloon mortgages have some great benefits for the buyer, but they also come with significant risks as well. Before you become convinced that a balloon mortgage is the right option, it’s important to do your homework.
Balloon mortgages get their name from the fact they include a lump sum payment - or “balloon” payment - at the end of the loan. Balloon mortgages also differ from traditional mortgages in that they are a shorter loan; usually no more than 10 years, unlike a traditional loan of 15 to 30 years. The monthly payments are smaller for balloon mortgages than in traditional loans because they are either partially or entirely comprised of interest payments only, rather than the combination of interest and principal payments one makes on a traditional mortgage loan. While the interest-only payments alone can be very appealing, it’s important to look at all the angels on a balloon mortgage before determining if it is the right solution for you.
In a traditional mortgage, the loan is amortized over the length of the loan (typically a 15- or 30-year term), which is a fancy word for saying that the principal and the interest of the loan will be paid in full at the end of the loan’s term. With a balloon mortgage, there is no amortization.
The borrower makes a small monthly payment, based upon the fact they are only paying the interest due on the loan or a small amount of the principal and a majority of interest. While small payments may sound like a great benefit, they can amount to one big drawback; a large sum payment due at the end, typically tens or even hundreds of thousands of dollars. While there’s typically no penalty for making payments toward the balloon amount early, the large sum can make it challenging for home owners to meet the terms of the loan, and so they usually sell the home to pay back the amount due.
So how does a balloon mortgage work? Balloon payments can function in a couple of different ways. The two varieties include interest only balloon mortgages and interest with small principal payment balloon mortgages.
Let’s say you are interested in a 10-year fixed-rate, interest-only balloon mortgage for an amount of $150,000 at an interest rate of 5%, and you have a down payment of $5,000. In this scenario, you would be looking at a monthly mortgage payment of around $780.00. That’s a reasonable payment, right? It certainly is, but don’t forget, all you’re paying is interest; none of that amount goes to principal, and when the 10 years is over, you still have to pay all that untouched principal back to the tune of roughly $120,000.
Even with a balloon mortgage where you had the same terms as above but were paying an additional amount of $500 a month toward the principal, you’d still be looking at a balloon payment amount of approximately $40,000 at the end. That’s a significant amount of money to come up with for anyone. This is why most borrowers typically end up selling the property at the end of the loan.
When it’s time to pay the piper, the borrower is expected to pay the balloon payment amount to settle the mortgage, and as we’ve seen, that can be a hefty bill. However, there are a few other options available to settle the mortgage other than writing a large check.
One of the more common solutions to dealing with a large payment is refinancing the remaining balloon payment into a new mortgage either with the original lender, or with a new one. If you were diligent about making your payments on time, have maintained a healthy credit score, and the home itself is of greater value than the amount owed, chances are good you would be able to utilize this option.
It’s also possible your balloon mortgage might include an option to delay the payment provided there is no additional mortgage on the property and you’ve been diligent about making all your previous payments on time.
You can, but you’ll want to check the terms of your mortgage and see if there is a penalty for doing so before you do. When you make the balloon payment early, the mortgage lender loses out on the interest they would have made on your monthly payments, so it’s possible they could have a penalty clause for early payment.
If your mortgage does have a penalty clause, however, it’s still worth getting out your calculator and doing some math. Depending on where you are in the mortgage schedule, it’s possible that the penalty charge might be a better savings for you than continuing to pay the remaining interest payments, so weigh the difference when determining your actions.
Prior to the mortgage crisis of 2008, balloon mortgages were much more prevalent, in part because of more lax qualifying processes that led to borrowers seeking homes that would normally be out of their price range. While balloon mortgages are still available and even make sense in some circumstances, there are drawbacks, and it’s important to take a look at these when deciding if a balloon mortgage is for you.
Balloon mortgages seem like an ideal scenario going in, but they can be very difficult to get out of. Many borrowers who decide to pursue a balloon mortgage go into the loan thinking they will have years of low monthly payments and then easily convert to a standard fixed-rate or adjustable rate mortgage prior to the lump sum payment coming due. Unfortunately, this isn’t always the case. If the value of your home has depleted since you purchased it or if your financial circumstances have changed, refinancing can be a difficult proposition.
These potential hiccups create real risks of foreclosure for both borrowers and lenders. While qualifying for a balloon mortgage is easy, extricating yourself from one can be troublesome.
If you go into a balloon mortgage thinking it will be a cinch to refinance your loan to a standard mortgage prior to the lump sum coming due, think again. Just like traditional mortgages, refinancing rules have become more rigid since the subprime mortgage crisis, and most expect the borrower to have at least 20% equity in their home in order to qualify. If you had a small down payment and have been paying an interest only balloon mortgage for years, you won’t be anywhere close to having 20% equity in your property. While programs like HARP (Home Affordable Refinance Program) might be able to offer some assistance, this program also has some specific qualifying standards.
While some groups warned about the impending subprime mortgage crisis, many borrowers were caught completely unprepared when the bottom fell out. Changes in the market and fluctuating property values can happen quickly, and if you have an interest only balloon mortgage, you can end up being upside down on your loan because of them. Refinancing a loan can prove exceptionally challenging in these circumstances.
Building equity is a valuable part of home ownership as is building your own investment in the property. One of the biggest drawbacks of an interest only mortgage is that if you’re not paying any principal on your loan, you’re not building any equity in your home. This makes refinancing or qualifying for a different mortgage difficult, and does little to boost your own financial position.
While there are many drawbacks to a balloon mortgage, they exist for a reason, and can be a very smart choice for someone in the right position to make the most of their benefits.
If you’ve grown tired of renting and don’t have a significant downpayment saved, a balloon mortgage can be a smart way to get into the home you’ve always wanted. It’s also a valid choice if you’re working on getting your finances in order, as balloon mortgages don’t have the same stringent credit requirements that more traditional loan programs have.
The feature that attracts most people to balloon mortgages is that they offer considerably lower monthly payments than traditional mortgages. If you’re working on getting other bills paid down or the house you purchased needs some significant renovations and upgrades, paying smaller mortgage payments for several years can free up the cash flow needed to achieve these goals while still providing the luxury of being a homeowner.
Another draw of a balloon mortgage? Their shorter loan terms. Most balloon mortgages are for five, seven, or ten years at most. If you know you’re only going to be in a home for a few years, having small monthly payments and selling the home before the balloon amount comes due could be a winning solution for you. If you’re confident you will be able to pay the balloon payment at the end of the loan, balloon mortgages also make sense, because you will own your home free and clear within a relatively short time.
While balloon mortgages are certainly not for everyone, they can be a great fit for people in specialized circumstances and for those who are confident the large balloon payment won’t be an issue.
For real estate investors, balloon mortgages can be a great solution. They allow for small monthly payments, a short-term loan, and the bandwidth to pay off the remainder of the mortgage once they’ve sold or “flipped” the house.
Buyers who plan to receive a large sum of money from an inheritance or an investment in the near future and are looking for a shorter term commitment to a house will also likely find that balloon mortgages could be the golden ticket to home ownership, as they can plan the terms of the large sum payment to coincide with their windfall.
Ultimately, balloon loans are like a pair of running shoes: wonderful when they fit perfectly, troublesome when the fit is just a little off. There is no doubt that they are a great deal riskier than traditional loans, but if you’re ideally looking to have the lowest payments possible and are comfortable with either paying the large balloon payment or finding a way to refinance it, it could be the ideal solution for you.
*Does not apply to third party fees and closing costs.
Chicago Mortgage Solutions LLC, DBA, ZeroMortgage, NMLS 7872. 1051 Perimeter Drive, Suite 670, Schaumburg, Illinois 60173. 847-999-RATE. Chicago Mortgage Solutions LLC is licensed in the following states: AL, AR, AZ, CA- Licensed by the Department of Financial Protection and Innovation under the California Finance Law License., CA- Licensed by the Department of Financial Protection and Innovation under the Residential Mortgage Lending Act, CO, CT, DC, DE, FL, GA- Georgia Residential Mortgage Licensee., IA, IL- Illinois Residential Mortgage Licensee., IN, KS, KY, LA, ME, MD, MI, MN, MS, MT, ND, NE, NC, NH, NM, NV, OH, OK, OR, PA, RI-Rhode Island Licensed Lender, SC, SD, TN, TX, VA, WI, WV and WY. All Loans are Subject to Credit and Property Approval. “THIS IS AN ADVERTISEMENT. YOU ARE NOT REQUIRED TO MAKE ANY PAYMENT OR TAKE ANY OTHER ACTION IN RESPONSE TO THIS OFFER”. Equal Opportunity Housing Lender.
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