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Archive for the ‘Mortgage’ Category

Home buyers often save rigorously for their home, forgoing expenditures and making sacrifices to pay down the mortgage and save for retirement. At retirement they get to enjoy their dream home debt-free. The only problem with this scenario for a lot of retirees is that they live on a fixed, and often not very large, income.

One option is to take a reverse mortgage – a loan against the home, which brings you money while you still live in your home. You can usually borrow between 10 to 40 percent of the value of your home depending on your age. A reverse mortgage loan requires no repayment for as long as you live in your home and you will never owe more than the value of your home.

This loan is different from a traditional mortgage in two ways. In order to qualify for a traditional mortgage, the bank checks your income to see how much you can afford to repay each month, but with a reverse mortgage there are no monthly repayments. With most loans, if you fail to make your repayments, you are in trouble. With a reverse mortgage, you don’t have any repayments. Thus, the debt grows larger as you keep getting cash advances and the interest is added to the amount you owe. This is why a reverse mortgage is called a “rising debt, falling equity” loan. As the amount you owe (your debt) grows larger, your equity (the value of your home less debt) is getting smaller.

You can receive income from your reverse mortgage in two ways. You can take the loan and invest it in an annuity. In turn, this annuity will provide you with income until your death. The second alternative is to receive monthly income from your reverse mortgage provider. Here you simply increase the size of your loan on a regular basis in order to receive income.

There is one big downside to all of this – you still owe money on your home. The total amount you will owe at the end of the loan will equal the loan plus all the interest accrued. All the interest can be a substantial amount of money.

Before you apply for a reverse mortgage, discuss your options with your family. Remember that a reverse mortgage will reduce the size of your final estate.

Job loss is a grim specter for a mortgage holder.  For most of us, that mortgage payment is at the top of the monthly bill payment list. You can talk almost any creditor into short term relief and even long term restructuring – the phone company, your car loan(s), credit card companies; they deal with delinquent payment plans daily.  Mortgage companies get nervous much more quickly, but most are willing to consider at least one skipped payment if your unemployment is for a short period.

Mortgage Insurance?

You may not remember this in the flurry of documents and signing sessions that accompanied your home purchase, but you may well have an insurance policy that protects your lender against mortgage default.  If you have a loan that is more than 80% of the home’s value when purchased, you probably are also paying for mortgage insurance.  It’s incorporated into that list of particulars you pay on every month: principal, interest, taxes, homeowner’s insurance – and mortgage insurance.  It’s meant to protect the lender; see what protection it provides for you.

Talk to your Lender

It is important to talk to your mortgage lender.  Job upheaval is sufficiently commonplace in this country that many mortgage holders have become flexible about restructuring loans, as long as you are prompt in informing them and honest about your job prospects.
A typical restructuring will allow for lesser payments until your income is reestablished, at which point the bank will again restructure to get you back on schedule. Keep in mind that prospective new employers are almost as likely to check your credit rating as prospective lenders.

Before you enter into discussions with your lender on this prospect, decide what you can afford.  Don’t be grateful for whatever is offered, and agree to a financing plan that you can’t meet.  Tell your lender that your maximum temporary mortgage payment has to be 60% of the norm, not the 75% they are proposing.  If you lose the house, it costs them money too.

Bankruptcy – The Poison Pill

The long term answer to keeping your home while unemployed is filing for bankruptcy.  The unattractive fallout from exercising this option is known to most of us, although the hard and fast rules have changed somewhat.  What used to be seven years of no credit at all has become credit card eligibility after two years.  Depending on the circumstances of your bankruptcy, you may be eligible for high risk auto loans and other debt within two to three years after bankruptcy.  That assumes, of course, that you have regained employment status and are once again making mortgage payments.  Also, bankruptcy has become so common that the Federal Government is on the verge of making it a much less attractive option for consumers.

Near Term Borrowing

With near-term unemployment and an unclear future, many people have put mortgage payments on their credit cards until the limits on those cards are reached.  It may blow holes in your credit rating, but it will keep you current on the mortgage and stave off bankruptcy.  You can attempt to obtain a home equity loan to fill the hole in your monthly budget, but those are much harder to come by when you’re unemployed.  If there are others in the household who are employed, the home equity loan may be a viable option.

Normally, banks and financial consultant will advice you to pay extra money into your mortgage. With this method, it will help you cut down the huge interest amount and reduce the period over which you pay back the loan.

For example, if you borrow $200 000 over 30 years at a rate of 5%, your monthly repayments would be around $1074. Over 30 years, you would actually pay $1074 x 360 (months), which is $386 640. That’s $186 640 in interest! What you have to do is to find an extra $246 a month, and pay $1320 a month into the mortgage, you’d cut 10 years off the repayment period – the loan would be fully paid in only 20 years. Moreover, your total payments would be $316 664, saving $69 756!

The flaw in this technique is that it ignores the time value of money. Everyone knows that money is worth less now than it was when they were younger. If you take that $1074 mortgage repayment, for instance, in 30 years time, when the last payment is due, it would only be worth $437 in today’s money.

A dollar now is always better than a dollar in a year’s time, or in 10 year’s time. You cannot simply subtract the mortgage interest amount for a 20 year mortgage from the interest on a 30 year mortgage. What you need to do is calculate the Present Value of each mortgage.

First method of repayment:
The Present Value of a 30 year mortgage with repayments of $1074 at a 5% interest rate is $200 066.

Second method of repayment:
The Present Value of a 20 year mortgage with repayments of $1320 at a 5% interest rate is $200 066.

The two repayment schemes are exactly equal. The $69 756 ‘saving’ in the interest rate is really just the effect of adding the extra $246 a month into the repayments – in fact, that $246 a month adds up to $59 040 over 20 years.

Let’s think this way. What if you took that $246 a month and invested it in, for example, mutual funds? If you could get a return of 10% p.a., after 20 years you would have $186 804. With inflation at 3%, that would be worth $102 597 in today’s money.

Why would the banks recommend that you pay off your mortgage quickly? Surely the longer the income stream lasts, the better? The banks love being able to prove that their recommendations will ‘save you money’. But in reality, the banks do understand the time value of money. They know the true value of that extra $246 a month that you’re giving them now, not in the future. And the shorter the time you take to repay the mortgage, the lower their risk, and the sooner their money comes back to them to be loaned out again.

There are some arguments for paying your mortgage back quickly – for one thing, the quicker you pay, the quicker your equity grows. But you should understand that every dollar you give the bank now is a dollar that you can’t invest. You then miss opportunity to invest and a return 10 percent or even 15 percent!