Getting A Loan

Here you will find a nice selection of guides pertaining to several loan options you should consider before making a decision on getting a loan.

Financial Guides

If you’ve been thinking about buying a home, you may wonder how to select the right financing for your budget and needs. This Financial Guide will explain the basics of most of the mortgage loans that are available today.

If you’ve been thinking about buying a home, you may be wondering how to select the best way to finance your purchase. With so many choices available–from traditional fixed rate loans to adjustable rate loans and reverse mortgages–it’s more important than ever to educate yourself in order to find the right mortgage for your needs.

Traditional Mortgage

Many people prefer a traditional or a fixed-rate mortgage with fixed monthly payments, a fixed interest rate, and full amortization (or transfer of equity) over a period of 20 to 30 years. Because the interest rate is fixed, monthly payments that remain constant over the life of the loan and there is a maximum (and known) amount on the total amount of principal and interest that you pay during the loan. Traditionally, these mortgages have been long-term. As the loan is repaid, ownership shifts gradually from lender to buyer. These features work in the buyer’s favor because inflation makes your payments seem less and your property worth more. So, although the payments seem hard to meet, at first, that monthly payment becomes easier over time.

Example: You borrow $50,000 at 8 percent for 30 years. Your monthly payments on this loan would be $366.89. Over 30 years, your total obligation for principal and interest would never exceed this fixed, predetermined amount.

Tip: Fixed rate mortgages are usually available at higher rates than many other types of loans. But if you can afford the monthly payments, inflation, and tax deductions may make a fixed rate mortgage a good financing method, particularly if you are in a high tax bracket and need the interest deductions.

Non-Traditional Mortgages

On the other hand, many home financing plans today differ materially from traditional mortgages. They may help you buy a home you couldn’t otherwise afford, but they may also involve greater risks for buyers. For example, the interest rate and monthly payments may change during the loan to reflect what the market will bear. Or the interest rate may fluctuate while the payments stay the same, and the amount of principal paid off may vary. The latter approach allows the lender to credit a greater portion of the payment to interest when rates are high.

Some plans also offer below-market interest rates, but they may not help you build up equity.

When shopping for financing sources today, keep the following in mind:

  • The sales price minus your down payment, i.e., the amount you finance
  • The length, or maturity, of the loan
  • The size of the monthly payments
  • The interest rate or rates
  • Whether the payments or rates may change
  • How often and how much the payments or rates may change
  • Whether there is an opportunity for refinancing the loan when it matures, if necessary

These concepts will be discussed in greater detail as we explore the different types of non-traditional financing.

15-Year Mortgage

The 15-year mortgage is a variation of the fixed-rate mortgage that is becoming increasingly popular. This mortgage has an interest rate and monthly payments that are constant throughout the loan. But, unlike other plans, this loan is fully paid off in only 15 years. And, it is usually available at a slightly lower interest rate than a longer-term loan. But it also requires higher payments.

In the 15-year mortgage, you pay off the loan balance faster than a long-term loan. Because of this, a smaller proportion of each of your monthly payments goes to interest.

Tip: If you can afford the higher payments, this plan will save you interest and help you build equity and own your home faster. The downside, however, is that you are paying less interest and you may also have fewer tax deductions.

Adjustable-Rate Mortgage (ARM)

If you see an ad for a low-rate mortgage, it might be for an adjustable rate mortgage (ARM). These loans may have low rates for a short time-maybe only for the first year. After that, the rates can be adjusted on a regular basis. This means that the interest rate and the amount of the monthly payment can go up or down.

With an adjustable-rate mortgage, your future monthly payment is uncertain. Some types of ARMs put a ceiling on your payment increase or rate increase from one period to the next. Virtually all must put a ceiling on interest-rate increases over the life of the loan.

Tip: Whether an ARM mortgage is right for you depends on your financial situation and the terms of the ARM. ARMs carry risks in periods of rising interest rates, but can be cheaper over a longer term if interest rates decline. You will be able to answer the question better once you understand more about adjustable-rate mortgages.

Today, many loans have interest rates (and monthly payments) that can change from time to time. To compare one ARM with another or with a fixed-rate mortgage, you need to know about indexes, margins, discounts, caps, negative amortization, and convertibility. You need to consider the maximum amount your monthly payment could increase.

Most important, you need to compare what might happen to your mortgage costs with your future ability to pay.

Interest Rate Variation. Adjustable rate mortgages have an interest rate that increases or decreases over the life of the loan based upon market conditions. Some lenders refer to adjustable rates as flexible or variable.

Caution: Because adjustable rate loans can have different provisions, evaluate each one carefully.

In most adjustable rate loans, your starting rate, or “initial interest rate,” will be lower than the rate offered on a standard fixed rate mortgage. This is because your long-term risk is higher your rate can increase with the market so the lender offers an inducement to take this plan.

Changes in the interest rate are usually governed by a financial index. If the index rises, so may your interest rate. If it falls, your interest rate also falls.

Rate Caps. To build predictability into your adjustable rate loan, some lenders include provisions for rate caps that limit the amount of any interest rate change. These provisions limit the amount of your risk. A periodic rate cap limits the amount the rate can increase at any one time. Because they limit the lender’s return, capped rates may not be available through every lender.

Example: Your mortgage provides that even if the financial index it’s tied to increases 2 percent in one year, your rate can only go up 1 percent. An aggregate rate cap limits the amount the rate can increase over the entire life of the loan. This means that even if the index increases 2 percent every year, your rate cannot increase more than 5 percent over the entire loan.

Many flexible rate mortgages offer the possibility of rates that may go down as well as up. In some loans, if the rate can only increase 5 percent, it may only decrease 5 percent. If no limit is placed on how high the rate can go, there may be a provision that also allows your rate to go down along with the index.

Payment Caps

If the interest rate on your adjustable rate loan increases and your loan has a payment cap, your monthly payments may not rise, or they may increase by less than changes in the index would require.

Example: Your mortgage provides for unlimited changes in your interest rate, but your loan has a $50 per year cap on payment increases. You started with an 8 percent rate on your $75,000 mortgage and a monthly payment of $550.33. Now assume that your index increases 2 percentage points in the first year of your loan. Because of this, your rate increases to 10 percent, and your payments in the second year rise to $658.18. Because of the payment cap, however, you’ll only pay $600.33 per month in the second year.

Caution: If your payment-capped loan results in monthly payments that are lower than your interest rate would require, you still owe the difference. Negative amortization may take place to ensure that the lender eventually receives the full amount. In most payment-capped mortgages, the amount of principal paid off changes when interest rates fluctuate.

Thus in the above example, your monthly payment should increase to $658.18, but because of a cap, it increases to only $600.33. Because this change in interest rates increases your debt, the lender may now apply a larger portion of your payment to interest. If rates get very high, even the full amount of your monthly payment won’t be enough to cover the interest owed; the additional amount of interest you owe will be added to the principal. This means you now owe and eventually will pay interest on interest.

Negative Amortization. If your ARM contains a payment cap be sure to find out about “negative amortization.” Negative amortization means the mortgage balance is increasing and occurs whenever your monthly mortgage payments are not large enough to pay all of the interest due on your mortgage.

Because payment caps limit only the amount of payment increases, and not interest-rate increases, payments sometimes do not cover all of the interest due on your loan. This means that the interest shortage in your payment is automatically added to your debt, and interest may be charged on that amount. You might, therefore, owe the lender more, later in the loan term than you did at the start. However, an increase in the value of your home may make up for the increase in what you owe.

Prepayment and Conversion

If you get an ARM and your financial circumstances change, you may decide that you don’t want to risk any further changes in the interest rate and payment amount. When you are considering an ARM, ask for information about prepayment and conversion.

  • Prepayment. Some agreements may require you to pay special fees or penalties if you pay off the ARM early. Many ARMs allow you to pay the loan in full or in part without penalty whenever the rate is adjusted. Prepayment details are sometimes negotiable. If so, you may want to negotiate for no penalty, or for as low a penalty as possible.
  • Conversion. Your agreement with the lender can have a clause that lets you convert the ARM to a fixed-rate mortgage at designated times. When you convert, the new rate is generally set at the current market rate for fixed-rate mortgages. The interest rate or up-front fees may be somewhat higher for a convertible ARM. Also, a convertible ARM may require a special fee at the time of conversion.

Variations of Adjustable Rate Mortgages. Another variation of the adjustable rate mortgage is to fix the interest rate for a period of time, 3 to 5 years, for example, with the understanding that the interest rate will then be renegotiated. These variations are:

  • Rollover mortgages are loans with periodically renegotiated rates. Such loans make monthly payments more predictable because the interest rate is fixed for a longer time.
  • Pledged account buy-down mortgage is another variation with an adjustable rate. This plan was introduced by the Federal National Mortgage Association (Fannie Mae), which buys mortgages from lenders and provides a major source of money for future mortgage offerings. In this plan, a large initial payment is made to the lender at the time the loan is made. The payment can be made by the buyer, the builder, or anyone else willing to subsidize the loan. The payment is placed in an account with the lender where it earns interest. This plan helps lower your interest rate for the first year.

Tip: This plan may not include any payment or rate caps other than those in the first years. But, there also may not be negative amortization, so possible increases in your total debt may be limited. Because of the buy-down feature, some buyers may be able to qualify for this loan that otherwise would not be eligible for financing.

Shopping for a Mortgage

When shopping for any type of adjustable rate mortgage, always remember to ask about the following:

  • The initial interest rate
  • How often the rate may change
  • How much the rate may change
  • The initial monthly payments
  • How often payments may change
  • How much the payments may change
  • The mortgage term
  • How often the term may change
  • How much the term may change
  • The index that rate, payment, or term changes are tied to
  • The limits, if any, on negative amortization

Balloon Mortgage

Balloon mortgages have a series of equal monthly payments and a large final payment. Although there usually is a fixed interest rate, the equal payments may be for interest only. The unpaid balance, frequently the principal or the original amount you borrowed, comes due in a short period, usually 3 to 5 years.

Example: You borrow $30,000 for 5 years. The interest rate is 13 percent, and the monthly payments are only $325. But in this example, the payments cover interest only, and the entire principal is due at maturity in 5 years. That means you’ll have to make 59 equal monthly payments of $325 each and a final balloon payment of $30,325. If you can’t make that final payment, you’ll have to refinance (if refinancing is available) or sell the property.

Some lenders guarantee refinancing when the balloon payment is due, although they do not guarantee a certain interest rate. The rate could be higher than your current rate. Other lenders do not offer automatic refinancing.

Tip: Without such a guarantee, you could be forced to start the whole business of shopping for housing money once again, as well as paying closing costs and front-end charges a second time.

A balloon note may also be offered by a private seller who is continuing to carry the mortgage he or she took out when purchasing the home. It can be used as a second mortgage where you also assume the seller’s first mortgage.

Graduated Payment Mortgage

Graduated payment mortgages (GPM) are designed for home buyers who expect to be able to make larger monthly payments in the near future. During the early years of the loan, payments are relatively low. They are structured to rise at a set rate over a set period, say 5 or 10 years. Then they remain constant for the duration of the loan.

Even though the payments change, the interest rate is usually fixed. So during the early years, your payments are lower than the amount dictated by the interest rate. During the later years, the difference is made up by higher payments. At the end of the loan, you will have paid off your entire debt.

Tip: One variation of the GPM is the graduated-payment, adjustable-rate mortgage. This loan also has graduated payments early in the loan. But, like other adjustable rate loans, it ties your interest rate to changes in an agreed-upon index. If interest rates climb quickly, greater negative amortization occurs during the period when payments are low. If rates continue to climb after that initial period, the payments will, too. This variation adds increased risk for the buyer. But if interest rates decline during the life of the loan, your payments may as well.

Growing-Equity Mortgage (GEM)

The growing equity mortgage (GEM) is tailored for first-time homebuyers or young families whose incomes are likely to rise. These mortgages combine a fixed interest rate with a changing monthly payment. The interest rate is usually a few percentage points below market. Although the mortgage term may run for 30 years, the loan will frequently be paid off in less than 15 years because payment increases are applied entirely to the principal.

Monthly payment changes are based on an agreed-upon schedule of increases or an index.

Example: A GEM uses the U. S. Commerce Department index that measures after-tax, per capita income and your payments increase at a specified portion of the change in this index, say 75 percent. In this example, let’s assume that you’re paying $500 per month for your mortgage. If the index increases by 8 percent, you will have to pay 75 percent of that, or 6 percent, additional. Your payments will increase to $530, and the additional $30 you pay will be used to reduce your principal.

With this approach, your income must be able to keep pace with the increased payments. The plan does not offer long-term tax deductions. However, it can permit you to pay off your loan and acquire equity rapidly.

Shared Appreciation Mortgage (SAM)

In the shared appreciation mortgage (SAM), you make monthly payments at a relatively low-interest rate. You also agree to share with the lender a sizable percent (usually 30 to 50 percent) of the appreciation in your home’s value when you sell or transfer the home, or after a specified number of years.

Because of the shared appreciation feature, monthly payments in this plan are lower than in many other plans. However, you may be liable for the dollar amount of the property’s appreciation even if you do not wish to sell the property at the agreed-upon date.

Tip: Unless you have the cash available, this could force an early sale of the property. Also, if property values do not increase as anticipated, you may still be liable for an additional amount of interest.

There are many variations of this idea, called housing equity plans in the US. Some are offered by lending institutions and others by individuals.

Example: Suppose you’ve found a home for $100,000 in a neighborhood where property values are rising. If the local savings and loan is charging 9 percent on home mortgages, and assuming you paid $20,000 down and chose a 30-year term, your monthly payments would be $643.70, or about twice what you can afford. But a friend offers to help. Your friend will pay half of each monthly payment, or $321.85 for 5 years. At the end of that time, you both assume the house will be worth at least $125,000. You can sell it, and your friend can recover his or her share of the monthly payments to date plus half of the appreciation. Or, you can pay your friend that same sum of money and gain increased equity in the house.

Another variation may give your partner tax advantages during the first years of the mortgage, after which the partnership is dissolved. You can buy out your partner or find a new one. Your partner helps make the purchase possible by putting up a sizable down payment and/ or helping make the monthly payments. In return, your partner may be able to deduct a certain amount from his or her taxable income.

Shared appreciation and shared equity mortgages were partly inspired by rising interest rates and partly by the notion that housing values would continue to grow over the years to come. If property values fall, these plans may not be available.

Tip: Before proceeding with this type of plan, check with a tax advisor to determine deductibility of interest.

Assumable Mortgage

An assumable mortgage is a mortgage that can be passed on to a new owner at the previous owner’s interest rate.

During periods of high rates, most lending institutions are reluctant to permit mortgage assumptions, preferring to write a new mortgage at the market rate. Some buyers and sellers are still using assumable mortgages, however. This has recently resulted in many lenders calling in the loans under “due on sale” clauses. Because these clauses have increasingly been upheld in court, many mortgages are no longer legally assumable. Be especially careful, therefore, if you are considering a mortgage represented as assumable.

Tip: Read the contract carefully and have an attorney or other expert check to determine if the lender has the right to raise your rate in this mortgage.

Seller “Take-Back” Mortgages

This mortgage, provided by the seller, is frequently a second trust and is combined with an assumed mortgage. The second trust (or second mortgage) provides financing in addition to the first assumed mortgage, using the same property as collateral. (In the event of default, the second mortgage is satisfied after the first).

Seller take-backs frequently involve payments for interest only, with the principal due at maturity. Some private sellers are also offering first trusts as take-backs. In this approach, the seller finances the major portion of the loan and takes back a mortgage on the property.

Tip: Another development now enables private sellers to provide this type of financing more frequently. Previously, sellers offering take-backs were required to carry the loan to full term before obtaining their equity. However, now, if an institutional lender arranges the loan, uses standardized forms, and meets certain other requirements, the owner take-back can be sold immediately to Fannie Mae. This approach enables the seller to obtain equity promptly and avoid having to collect monthly payments.

Wraparound Mortgage

Another variation on the second mortgage is the wraparound. Wraparounds may cause problems if the original lender or the holder of the original mortgage is not aware of the new mortgage. Upon discovering this arrangement, some lenders or holders may have the right to insist that the old mortgage be paid off immediately.

Land Contract

Borrowed from commercial real estate, this plan enables you to pay below-market interest rates. The land contract or installment sale agreement as it is also known permits the seller to hold onto his or her original below-market rate mortgage while “selling” the home on an installment basis. The installment payments are for a short term and may be for interest only. At the end of the contract the unpaid balance, frequently the full purchase price, must still be paid.

Caution: The seller continues to hold title to the property until all payments are made. Thus, you, the buyer, acquire no equity until the contract ends. If you fail to make a payment on time, you could lose a major investment.

Buy-Downs

A buy-down is a subsidy of the mortgage interest rate that helps you meet the payments during the first few years of the loan. There are several things to think about in buy-downs:

  1. Consider what your payments will be after the first few years. If this is a fixed rate loan, the payments in the above example will jump to the rate at which the loan was originally made. If this is an adjustable rate loan, and the index to which your rate is tied has risen since you took out the loan, your payments could go up even higher.
  2. Check to see whether the subsidy is part of your contract with the lender or with the builder. If it’s provided separately by the builder, the lender can still hold you liable for the full interest rate, even if the builder backs out of the deal or goes out of business.
  3. See if the sales price has been increased to cover a builder’s interest subsidy. A comparable home may be selling around the corner for less. At the same time, competition may have encouraged the builder to offer you genuine savings. It pays to check around.

There are also plans called consumer buy-downs. In these loans, the buyer makes a sizable down payment, and the interest rate granted is below market. In other words, in exchange for a large payment at the beginning of the loan, you may qualify for a lower rate on the amount borrowed. Frequently this type of mortgage has a shorter term than those written at current market rates.

Rent with Option to Buy

In a climate of changing interest rates, some buyers and sellers are attracted to a rent-with-option-to-buy arrangement. In this plan, you rent property and pay a premium for the right to purchase the property within a limited time period at a specific price. In some arrangements, you may apply part of the rental payments to the purchase price.

This approach enables you to lock in the purchase price. You can also use this method to buy time in the hope that interest rates will decrease. From the seller’s perspective, this plan may provide the buyer time to obtain sufficient cash or acceptable financing to proceed with a purchase that may not be possible otherwise.

Reverse Mortgage

If you already own your home and need to obtain cash, you might consider the reverse annuity mortgage (RAM) or equity conversion. In this plan, you obtain a loan in the form of monthly payments over an extended period of time, using your property as collateral. When the loan comes due, you repay both the principal and interest.

A RAM is not a mortgage in the conventional sense. You can’t obtain a RAM until you have paid off your original mortgage. Suppose you own your home and you need a source of money. You could draw up a contract with a lender that enables you to borrow a given amount each month until you’ve reached a maximum of, for example, $10,000. At the end of the term, you must repay the loan. But remember, if you do not have the cash available to repay the loan plus interest, you will have to sell the property or take out a new loan.

Some Cautions

Before going ahead with a creative home loan, have a lawyer or other expert help you interpret the fine print. You should consider some of the situations you could face when paying off your loan or selling your property. And make sure you understand the terms of your agreement such as acceleration clauses, due on sale clauses, and waivers.

Tip: In addition to any legal issues, financial considerations also come into play. Therefore, financial guidance is suggested helping before a final decision on the type of mortgage to take.

Acceleration Clause

An acceleration clause allows the lender to speed up the rate at which your loan comes due. Suppose you’ve missed a payment, and your contract gives the lender the right to “accelerate” the loan when a payment is missed. This means that the lender now has the power to force you to repay the entire loan immediately.

Sample acceleration clause: “In the event any installment of this note is not paid when due, time being of the essence, and such installment remains unpaid for thirty (30) days, the Holder of this Note may, at its option, without notice or demand, declare the entire principal sum then unpaid, together with secured interest and late charges thereon, immediately due and payable. The lender may without further notice or demand invoke the power of sale and any other remedies permitted by applicable law.”

Note: The use of the term without notice above. If this contract provision is legal in your state, you have waived your right to notice. In other words, you’ve given up the right to be notified of some occurrence, for example, a missed payment. If you’ve waived your right to notice of delinquency or default, and you’ve made a late payment, action may be initiated against you before you’ve been told; the lender may even start to foreclose.

Tip: Know whether your contract waives your right to notice. If so, obtain a clear understanding in advance of what you’re giving up. Try to get the clause removed. Have your attorney check state law to determine if the waiver is legal.

Due-On-Sale-Clause

A due on sale clause gives the lender the right to require immediate repayment of the balance you owe if the property changes hands. Here’s an example of a due on sale clause: “All or any part of the Property or an interest therein is sold or transferred by Borrower without Lender’s prior written consent…or, “Lender may, at Lender’s option, declare all the sums secured by this Mortgage to be immediately due and payable.”

Due on sale clauses have been included in many mortgage contracts for years. They are being enforced by lenders increasingly when buyers try to assume sellers’ existing low rate mortgages. In these cases, the courts have frequently upheld the lender’s right to raise the interest rate to the prevailing market level. So be especially careful when considering an “assumable mortgage.” If your agreement has a due on sale provision, the assumption may not be legal, and you could be liable for thousands of additional dollars.

Mortgage Terms

To buy or sell a home today, it’s important to know the vocabulary. Understanding terms like amortization or appreciation can save you time and money; it can also prevent you from obtaining a mortgage ill-suited to your needs.

When you first buy a home you’re likely to make a down payment on the property. However, because you financed the purchase, you are now in debt and the lender owns most of the property’s value. In traditional mortgages, the monthly payments on the loan are weighted. During the first years, the monthly payment is largely interest; in time, more of each payment is credited to the loan itself, or the principal.

Gradually, as you pay off principal, you build up equity or ownership. Your equity also increases if the value of the home increases. This process of gradually obtaining equity and reducing debt through payments of principal and interest is called amortization.

Repaying debt gradually through payments of principal and interest is called amortization. Today’s economic climate has given rise to a reverse process called negative amortization. This means that you are losing, not gaining, value, or equity because your monthly payments may be too low to cover the interest rate agreed upon in the mortgage contract. Instead of paying the full interest costs now, you’ll pay them later, either in larger payments or in more payments. You will also be paying interest on that interest.

In other words, the lender postpones collection of the money you owe by increasing the size of your debt. In extreme cases, you may even lose the equity you purchased with your down payment, leaving you in worse financial shape a few years after you purchase your home than when you bought it.

Example: Suppose you signed an adjustable rate mortgage for $50,000 in 1996. The index established your initial rate at 9.15 percent. It nearly doubled to 17.39 percent by 1999. If your monthly payments had kept pace with the index, they would have risen from $408 to $722. But because of a payment cap, they stayed at $408. By 1999, your mortgage had swelled from $50,000 to $58,350, even though you had dutifully paid $408 every month for 48 months. In other words, you paid out $20,000 but you were $8,000 more in debt than you were three years earlier. During the next few years despite the fact that the index fell gradually, you were still paying off the increases made to your principal from earlier years.

Certain loans, such as graduated payment mortgages, are structured so that you regain the lost ground with payments that eventually rise high enough to fully pay off your debt. And you may also be able to pay off the extra costs if your home is gaining rapidly in value or if your income is rising fast enough to meet the increased obligation. But if it isn’t, you may realize a loss if, for example, you sign a below-market adjustable rate mortgage in January and try to sell the home in August when interest rates are higher. You could end up owing more than you’d make on the sale.

If you bought your home when mortgage rates were higher than today’s rates are, or have an adjustable-rate loan and would like to change it to a fixed rate, then you are probably a candidate for refinancing your mortgage. Here are some factors to consider when deciding whether to refinance and how to get the best deal.

If you decide to refinance your mortgage, you can expect the process to be similar to what you went through in obtaining the original mortgage because in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures and the same types of costs the second time around. In this Financial Guide, we will give you some pointers on how to get the best possible deal.

Who Can Benefit From Refinancing?

Refinancing does not make good financial sense for everyone. A general rule of thumb is that refinancing is worthwhile if the current interest rate on your mortgage is, at least, two percentage points higher than the prevailing market rate. This figure is generally accepted as the safe margin when balancing the costs of refinancing a mortgage against the savings. However, a rule of thumb is not ironclad: every individual’s circumstances need to be analyzed. If your loan amount and the particular circumstances warrant it, you might choose to refinance a loan that is only 1-1/2 percentage points higher than the current rate.

Tip: Lenders may be offering zero point loans and low-cost refinancing. Therefore, even if your rate change is less than one percentage point, you may be able to save some money by refinancing.

Most experts say that it takes at least three years to fully realize the savings from a lower interest rate, given the costs of refinancing. You may find, however, that you could recoup the refinancing costs in a shorter time than three years. Again, every homeowner’s circumstances should be analyzed individually. Generally, refinancing is a good idea if you:

  • Want to get out of a high-interest rate loan to take advantage of lower rates. (This is a good idea only if you intend to stay in the house long enough to make the additional fees worthwhile.)
  • Want to convert to an ARM with a lower interest rate or more protective features (such as a better rate and payment caps) than the ARM you currently have.
  • Want to build up equity more quickly by converting to a loan with a shorter term.
  • Want to draw on the equity built up in your home to get cash for a major purchase or for your children’s education.
  • Have an adjustable-rate mortgage (ARM) and want a fixed-rate loan in order to know exactly what the mortgage payment will be for the life of the loan.

Tip: If you decide that refinancing is not worth the costs, ask your lender whether you may be able to obtain all or some of the new terms you want by agreeing to a modification of your existing loan instead of a refinancing.

How to Go About Making the Decision

Talk to several lenders to find out what the current rates are and what costs are associated with refinancing. These costs (explained in more detail below) include appraisals, attorney’s fees, and points. Once you know what the costs will be, determine what your new payment would be if you refinanced. You can then estimate how long it will take to recover the costs of refinancing by dividing your closing costs by the difference between your new and old payments.

Be aware that the amount of money that you ultimately save depends on many factors, including your total refinancing costs, whether you sell your home in the near future, and the effects of refinancing on your taxes.

If you are thinking of refinancing an adjustable rate mortgage (ARM), you should also consider these questions:

  • Is the next interest rate adjustment on your existing loan likely to increase your monthly payments substantially? Will the new interest rate be two or three percentage points higher than the prevailing rates being offered for either fixed-rate loans or other ARMs?
  • If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term? Will refinancing to a new ARM or a fixed-rate loan enable you to pay your loan in full by the end of the term?

You also might want to consider refinancing if you have an adjustable rate mortgage with high or no limits on interest rate increases. You might want to switch to a fixed-rate mortgage or to an adjustable-rate mortgage that limits changes in the rate at each adjustment date as well as over the life of the loan.

How to Determine Your Refinancing Costs

When you refinance your mortgage, you usually pay off your original mortgage and sign a new loan. With the new loan, you again pay most of the same costs you paid to get your original mortgage, including settlement costs, discount points, and other fees. You may also be charged a penalty for paying off your original loan early, called a prepayment penalty if such a practice is not prohibited by your state.

The total expense for refinancing a mortgage depends on the interest rate, number of points, and other costs required to obtain a loan. You should plan on paying an average of 3 to 6 percent of the outstanding principal in refinancing costs, plus any prepayment penalties and the costs of paying off any second mortgages that may exist.

Tip: When shopping for a lender, ask each one for a list of charges and costs you must pay at closing. Some lenders may require that some of these costs be paid at the time of application.

The fees described below are the ones that you are most likely to encounter in a refinancing. (Some of the costs are expanded on in the paragraphs that follow.) Because costs may vary significantly from area to area and from lender to lender, the following chart should be regarded only as an estimate. Your actual closing costs may be higher or lower than the ranges indicated below.

  • Application Fee $ 75 to $300
  • Appraisal Fee $300 to $700
  • Survey Costs $150 to $400
  • Homeowners Hazard Insurance $300 to $1,000
  • Lenders Attorney’s Review Fees $500 to $1,000
  • Title Search & Title Insurance $700 to $900
  • Home Inspection Fees $175 to $350
  • Loan Origination Fees 1% – 2% of loan
  • Mortgage Insurance 0.5% to 1.0%
  • Points 1% to 3%

Tip: To save on some of these costs, check with the lender who holds your current mortgage. The lender may be willing to waive some of them, especially if the work relating to the mortgage closing is still current (such as the fees for the title search, surveys, inspections, and so on).

Let’s look at some of these costs in greater detail:

Application Fee. This charge imposed by your lender covers the initial costs of processing your loan request and checking your credit report.

Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company that insures the policyholder in a specific amount for any loss caused by discrepancies in the title to the property.

Tip: Be sure to ask the title insurance company carrying the present policy if it can re-issue your policy at a re-issue rate. You could save up to 70 percent of what it would cost you for a new policy.

Lender’s Attorney’s Review Fees. The lender will usually charge you for fees paid to the lawyer or company that conducts the closing for the lender. Settlements are conducted by lending institutions, title insurance companies, escrow companies, real estate brokers, and attorneys for the buyer and seller. In most situations, the person conducting the settlement is providing a service to the lender. You may also be required to pay for other legal services relating to your loan which are provided to the lender.

Tip: You may want to retain your own attorney to represent you at all stages of the transaction, including settlement.

Loan Origination Fees. The origination fee is charged for the lender’s work in evaluating and preparing your mortgage loan.

Points. Points are prepaid finance charges imposed by the lender at closing to increase the lender’s yield beyond the stated interest rate on the mortgage note. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. The total number of points a lender charges will depend on market conditions and the interest rate to be charged. To give you the lowest rate offered, most lenders will charge several points, and the total cost can run between three and six percent of the total amount you borrow. For example, on a $100,000 mortgage, the lender might charge you between $3,000 and $6,000. However, some lenders may offer zero points at a higher interest rate, which may significantly reduce your initial costs although your payments may be somewhat higher.

Tip: In some cases, the points you pay can be financed by adding them to the loan amount. This means that the points will be added to your loan balance, and you will pay a finance charge on them. Although this may enable you to get the financing, it also will increase the amount of your monthly payments.

Tip: To decide what combination of rate and points is best for you, balance the amount you can pay up front with the amount you can pay monthly. The less time you keep the loan, the more expensive points become. If you plan to stay in your house for a long time, then it may be worthwhile to pay additional points to obtain a lower interest rate.

Appraisal Fee. This fee pays for an appraisal which is a supportable and defensible estimate or opinion of the value of the property.

Prepayment Penalty. A prepayment penalty on your present mortgage could be the greatest deterrent to refinancing. The practice of charging money for an early payoff of the existing mortgage loan varies by state, type of lender, and type of loan. Prepayment penalties are forbidden on various loans including loans from federally chartered credit unions, FHA and VA loans, and some other home-purchase loans. The mortgage documents for your existing loan will state if there is a penalty for prepayment. In some loans, you may be charged interest for the full month in which you prepay your loan.

Miscellaneous. Depending on the type of loan you have and other factors, another major expense you might face is the fee for a VA loan guarantee, FHA mortgage insurance, or private mortgage insurance. There are a few other closing costs in addition to these.

How Does Refinancing Affect Your Tax Situation?

With a lower interest rate on your home loan, you will have less interest to deduct on your income tax return. That, of course, may increase your tax payments and decrease the total savings you might obtain from a new, lower-interest mortgage.

Interest (points) paid up front for refinancing must be deducted over the life of the loan, not in the year you refinance unless the loan is for home improvements. This means that if you paid a certain number of points, you would have to spread the tax deduction for those points over the life of the loan. If, however, the refinancing is for home improvements (or a portion of the loan is for this purpose) you may be able to deduct the points (or a portion of the points) under certain circumstances.

If you are thinking about refinancing your mortgage, you might want to consider other types of mortgages. For example, you might want to look into a 15-year, fixed-rate mortgage. In this plan, your mortgage payments are somewhat higher than a longer-term loan, but you pay substantially less interest over the life of the loan and build equity more quickly. Of course, this also means you have less interest to deduct on your income tax return.

Tips for Getting the Best Deal

Here are some tips for getting the best deal when refinancing of your mortgage:

1. Shop Around

If you decide to refinance your mortgage, it pays to shop around by calling several lending institutions to find out what interest and fees they charge. This helps you get the best deal available. Also, ask each about their “annual percentage rate” (APR) and compare them. The APR will tell you the total credit costs of the refinancing, including interest, points, and other charges.

Tip: You do not have to refinance your mortgage with the same lender that provided your original mortgage. However, to keep your business, some lenders will offer their original mortgage customers the incentive of lower mortgage interest rates, sometimes with reduced closing costs.

2. Obtain a “Lock-In” or Guarantee

If you decide to apply for refinancing with a particular lender, and if you do not want to let the interest rate float until closing, then get a written statement guaranteeing the interest rate and the number of discount points that you will pay at closing. This binding commitment, or lock-in, ensures that the lender will not raise these costs even if rates increase before you settle on the new loan. You might also consider requesting an agreement where the interest rate can decrease but not increase before closing. If you cannot get the lender to put this information in writing, you may want to choose one that will.

Most lenders place a limit on the length of time (60 days for example) that they will guarantee the interest rate. You must sign the loan during that time or lose the benefit of that particular rate. Because many people are refinancing their mortgages, there may be a delay in processing the papers. Therefore, contact your loan officer periodically to check on the progress of your loan approval and to see if additional information is needed

3. Review the Disclosure Form

When refinancing, the lender must give you a written statement of the costs and terms of the financing before you become legally obligated for the loan. This is required under the Truth in Lending Act. Typically, you receive this information around the time of settlement, although some lenders provide it earlier. Review this statement carefully before you sign the loan. The disclosure tells you the APR, finance charge, amount financed, payment schedule, and other important credit terms.

4. Be Aware Of Your Right to Rescind

If you refinance with a different lender, or if you borrow beyond your unpaid balance with your current lender, you also must be given the right to rescind the loan. In these loans, you have the right to rescind or cancel the transaction within three business days following settlement, receipt of your Truth in Lending disclosures, or receipt of your cancelation notice, whichever occurs last.

5. Find Out If the Application Fee Is Refundable

When you apply for a mortgage, some lenders require you to pay a special charge to cover the costs of processing your application. The amount of this fee varies but generally is in the range of $75 to $300. Usually, you must pay this charge at the time you file the application. Some lenders do not refund this application fee if you are not approved for the loan or if you decide not to take it.

If you elect to cancel the transaction within three business days after you close the loan, as discussed above, you are entitled to a refund of all costs and charges imposed for the credit transaction.

Tip: Before you apply for a mortgage, ask lenders whether they charge an application fee. If they do, find out how much it is and under what circumstances and to what extent it is refundable.

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As you can see, there are many financial factors to consider when refinancing a mortgage, so you may want to think about getting professional guidance if you’re considering your refinancing options.

Sample Refinancing Savings

The charts below illustrate the monthly and yearly differences in your mortgage payments if you refinanced to a 6 or an 8 percent, 30-year fixed-rate mortgage for $75,000. Remember, however, that the actual amount you may save by refinancing depends on many factors, such as your tax bracket and how long you plan to remain in your home.

Your Present Mortgage Rate Current Monthly Payment Monthly Payment at 8% Monthly Difference in Payment at 8% Annual Difference in Payment at 8%
9% 603 550 53 636
9.5% 631 550 81 972
10% 658 550 108 1296
10.5% 686 550 136 1632
11% 714 550 16 1968
11.5% 743 550 193 2316
12% 771 550 221 2652
Your Present Mortgage Rate Current Monthly Payment Monthly Payment at 6% Monthly Difference in Payment at 6% Annual Difference in Payment at 6%
9% 603 450 153 1836
9.5% 631 450 181 2172
10% 658 450 208 2496
10.5% 686 450 236 2832
11% 714 450 264 3168
11.5% 743 450 293 3516
12% 771 450 321 3852

By using the equity in your home, you may qualify for a home equity line of credit (HELOC), a sizable amount of credit that is available to you to use when you need it, and, at a relatively low interest rate. Furthermore, under the tax law, and depending on your specific situation, you may be allowed to deduct the interest because the debt is secured by your home. This Financial Guide provides the information you need to determine which home equity loan is right for you.

Before signing for a home equity loan, such as a line of credit, carefully weigh the costs of a home equity debt against the benefits. If you are thinking of borrowing, your first step is to figure out how much it will cost you and whether you can afford it. Then shop around for the best terms, i.e., those that best meet your borrowing needs without posing an undue financial risk. And, remember, failure to repay the line of credit could mean the loss of your home.

What Is a Home Equity Line Of Credit (HELOC)?

A home equity line of credit (also called a home equity plan) is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer’s largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills–not for day-to-day expenses.

With a HELOC, you are approved for a specific amount of credit, which is referred to as your credit limit. A line of credit is the maximum amount you can borrow at any one time while you have the home equity plan.

Many lenders set the credit limit on a home equity line by taking a percentage (75 percent in this example) of the appraised value of the home and subtracting the balance owed on the existing mortgage. For example:

Appraisal of home $100,000
Percentage x 75%
Percentage of appraised value $75,000
Less mortgage debt – – 40,000
Potential credit line $35,000

In determining your actual credit line, the lender will also consider your ability to repay by looking at your income, debts, and other financial obligations, as well as your credit history.

Home equity plans often set a fixed time during which you can borrow money, such as ten years. When this period is up, the plan may allow you to renew the credit line. But in a plan that does not allow renewals, you will not be able to borrow additional money once the time has expired. Some plans may call for payment in full of any outstanding balance. Others may permit you to repay over a fixed time.

Once approved for the home equity plan, you will usually be able to borrow up to your credit limit whenever you want. Typically, you will be able to draw on your line by using special checks.

Under some plans, borrowers can use a credit card or other means to borrow money and make purchases using the line. However, there may be limitations on how you use the line. Some plans may require you to borrow a minimum amount each time you draw on the line–for example, $300–and to keep a minimum amount outstanding. Some lenders also may require that you take an initial advance when you first set up the line.

What to Look For

If you decide to apply for a HELOC, look carefully at the credit agreement. Examine the terms and conditions of various plans, including the annual percentage rate (APR) and the costs you will pay to establish the plan.

Tip: The disclosed APR will not reflect the closing costs and other fees and charges, so compare these costs, as well as the APRs, among lenders.

Interest Rate Charges and Plan Features

Home equity plans typically involve variable interest rates rather than fixed rates. A variable rate must be based on a publicly available index (such as the prime rate published in some major daily newspapers or a U.S. Treasury bill rate). The interest rate will change, mirroring fluctuations in the index.

To figure the interest rate that you will pay, most lenders add a margin, such as 2 percentage points, to the index value.

Tip: Because the cost of borrowing is tied directly to the index rate, find out what index and margin each lender uses, how often the index changes, and how high it has risen in the past.

Sometimes lenders advertise a temporarily discounted rate for home equity lines-a rate that is unusually low and often lasts only for an introductory period, such as six months.

Variable rate plans secured by a dwelling must have a ceiling (or cap) on how high your interest rate can climb over the life of the plan. Some variable-rate plans limit how much your payment may increase, and also how low your interest rate may fall if interest rates drop.

Some lenders may permit you to convert a variable rate to a fixed interest rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

Agreements generally will permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable-rate plans may not allow you to get additional funds during any period the interest rate reaches the cap.

Costs of Obtaining a Home Equity Line

Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home, such as:

  • A fee for a property appraisal, which estimates the value of your home
  • An application fee, which may not be refundable if you are turned down for credit
  • Up-front charges, such as one or more points (one point equals one percent of the credit limit)
  • Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes
  • Yearly membership or maintenance fees

You also may be charged a transaction fee every time you draw on the credit line.

You could find yourself paying hundreds of dollars to establish the plan. If you were to draw only a small amount against your credit line, those charges, and closing costs would substantially increase the cost of the funds borrowed.

On the other hand, the lender’s risk is lower than for other forms of credit because your home serves as collateral. Thus, annual percentage rates for home equity lines are generally lower than rates for other types of credit.

The interest you save could offset the initial costs of obtaining the line. In addition, some lenders may waive a portion or all of the closing costs.

How will You Repay Your Home Equity Plan

Before entering into a plan, consider how you will pay back any money you might borrow. Some plans set minimum payments that cover a portion of the principal of the amount you borrow plus accrued interest. But, unlike the typical installment loan, the portion that goes toward principal may not be enough to repay the debt by the end of the term. Other plans may allow payments of interest alone during the life of the plan, which means that you pay nothing toward the principal. If you borrow $10,000, you will owe that entire sum when the plan ends.

Regardless of the minimum payment required, you can pay more than the minimum and many lenders may give you a choice of payment options. Consumers often will choose to pay down the principal regularly as they do with other loans. For example, if you use your line to buy a boat, you may want to pay it off as you would a typical boat loan.

Whatever your payment arrangements during the life of the plan–whether you pay some, a little, or none of the principal amount of the loan–when the plan ends you may have to pay the entire balance owed all at once. You must be prepared to make this balloon payment by either refinancing it with the lender, obtaining a loan from another lender, or some other means. If you are unable to make the balloon payment, you could lose your home.

With a variable rate, your monthly payments may change. Assume, for example, that you borrow $10,000 under a plan that calls for interest-only payments. At a 10 percent interest rate, your initial payments would be $83 monthly. If the rate should rise over time to 15 percent, your payments will increase to $125 per month.

Even with payments that cover interest plus some portion of the principal, there could be a similar increase in your monthly payment, unless the agreement calls for keeping payments level throughout the plan.

When you sell your home, you probably will be required to pay off your home equity line in full. If you are likely to sell your house in the near future, consider whether it makes sense to pay the up-front costs of setting up an equity credit line. Also, keep in mind that leasing your home may be prohibited under the terms of your home equity agreement.

Line Of Credit vs. Traditional Second Mortgage

If you are thinking about a home equity line of credit, you also might want to consider a more traditional second mortgage loan. This type of loan provides you with a fixed amount of money repayable over a fixed period. Usually, the payment schedule calls for equal payments that will pay off the entire loan within that time.

Tip: Consider a traditional second mortgage loan instead of a home equity line of credit if, for example, you need a set amount for a specific purpose, such as an addition to your home.

When deciding which type of loan best suits your needs, consider the costs under the two alternatives. Look at the APR and other charges.

Tip: Do not simply compare the APR for a traditional mortgage loan with the APR for a home equity line of credit because the APRs are figured differently. For a traditional mortgage, the APR takes into account the interest rate charged plus points and other finance charges. The APR for a HELOC, on the other hand, is based on the periodic interest rate alone and does not include points or other charges.

How to Compare Costs

The Truth in Lending Act requires lenders to disclose the important terms and costs of their home equity plans, including the APR, miscellaneous charges, the payment terms, and information about any variable-rate feature. In general, neither the lender nor anyone else may charge a fee until after you have received this information. Use these disclosures to compare the costs of home equity loans.

You usually get these disclosures when you receive an application form, and you will get additional disclosures before the plan is opened. If any term has changed before the plan is opened (other than a variable-rate feature), the lender must return all fees if you decide not to enter into the plan because of the changed term.

Caution: When you open a home equity line of credit the transaction puts your home at risk. For your principal dwelling, the Truth in Lending Act gives you three days from the day the account was opened to cancel the credit line. This right allows you to change your mind for any reason. You simply inform the creditor in writing within the three-day period. The creditor must then cancel the security interest in your home and return all fees-including any application and appraisal fees-paid in opening the account.

The Finance Charge and the Annual Percentage Rate (APR)

Credit costs vary. By remembering two terms, you can compare credit prices from different sources. Under Truth in Lending, the creditor must tell you-in writing and before you sign any agreement-the finance charge and the annual percentage rate.

The finance charge is the total dollar amount you pay to use credit. It includes interest costs, and other costs, such as service charges and some credit-related insurance premiums. For example, borrowing $10,000 for a year might cost you $1,000 in interest. If there were also a service charge of $100, the finance charge would be $1,100.

The annual percentage rate (APR) is the percentage cost (or relative cost) of credit on a yearly basis. This is your key to comparing costs, regardless of the amount of credit or how long you have to repay it:

Example: You borrow $10,000 for one year at a 10 percent interest rate. If you keep the entire $10,000 for the whole year and then pay back 11,000 at the end of the year, the APR is 10 percent. On the other hand, if you repay the $10,000, and the interest (a total of $11,000) in 12 equal monthly installments, you don’t really get to use $10,000 for the whole year. In fact, you get to use less and less of that $10,000 each month. In this case, the $1,000 charge for credit amounts to an APR of 18 percent.

All creditors including banks, stores, car dealers, credit card companies, and finance companies must state the cost of their credit in terms of the finance charge and the APR. Federal law does not set interest rates or other credit charges. But it does require their disclosure so that you can compare credit costs. The law says that these two pieces of information must be shown to you before you sign a credit contract or before you use a credit card.

Comparing Loan Terms

Even when you understand the terms a creditor is offering, it is easy to underestimate the difference in dollars that different terms can make. Consider the three credit arrangements below. Suppose you are going to borrow $6,000. How do these choices stack up? The answer depends partly on what you need.

The lowest cost loan is available from Lender A.

  APR   Length of Loan Monthly Payments Total Finance Charges Total of Payments
Creditor A 14% 3 years $205.07 $1,382.52 $7,382.52
Creditor B 14% 4 years $163.96 $1,870.08 $7,870.08
Creditor C 15% 4 years $166.98 $2,015.04 $8,015.04

If you were looking for lower monthly payments, you could get them by paying the loan off over a longer period of time. However, you would have to pay more in total costs. A loan from Lender B-also at a 14 percent APR, but for four years-will add about $488 to your finance charge.

If that four-year loan were available only from Lender C, the APR of 15 percent would add another $145 or so to your finance charges as compared with Lender B.

Other terms, such as the size of the down payment, will also make a difference. Be sure to look at all the terms before you make your choice.

Special Considerations

A home equity line of credit is open-end credit, similar to bank and department store credit cards, gasoline company cards, and certain check overdraft accounts. Open-end credit can be used again and again, generally until you reach a certain prearranged borrowing limit. The Truth in Lending Act requires that open-end creditors tell you the terms of the credit plan so that you can shop and compare the costs involved.

When you are shopping for an open-end plan, the APR represents only the periodic rate that you will be charged, which is figured on a yearly basis. For instance, a creditor that charges 1-1/2 percent interest each month would quote you an APR of 18 percent. Annual membership fees, transaction charges, and points, for example, are listed separately and are not included in the APR. Be sure to keep all of these in mind when comparing all of the costs involved in the plans.

Creditors must tell you when finance charges begin on your account, so you know how much time you have to pay your bill before a finance charge is added. Creditors may give you a 25-day grace period, for example, to pay your balance in full before making you pay a finance charge.

Creditors also must tell you the method they use to figure the balance on which you pay a finance charge; the interest rate they charge is applied to this balance to come up with the finance charge. Creditors use a number of different methods to arrive at the balance. Study them carefully as they can significantly affect your finance charge.

  • Adjusted balance method. Some creditors, for instance, take the amount you owed at the beginning of the billing cycle and subtract any payments you made during that cycle. Purchases are not counted. This practice is called the adjusted balance method.
  • Previous balance method. With this method, creditors simply use the amount owed at the beginning of the billing cycle to come up with the finance charge.
  • Average daily balance method. Under one of the most common methods, the average daily balance method, creditors add your balances for each day in the billing cycle and then divide that total by the number of days in the cycle. Payments made during the cycle are subtracted in arriving at the daily amounts, and, depending on the plan, new purchases may or may not be included. Under another method, the two-cycle average daily balance method, creditors use the average daily balances for two billing cycles to compute your finance charge. Again, payments will be taken into account in figuring the balances, but new purchases may or may not be included.

One final note: Be aware that the amount of the finance charge may vary considerably depending on the method used–even for the same pattern of purchases and payments.

When you are ready to settle on your mortgage loan, you want to get the best rate and loan terms that you can. To increase that likelihood, it is important to learn as much as you can about what the lender is promising you before you apply for a loan–including locking in your loan at a great rate. This guide provides information on how to do that.

Lock-ins and Fees

When you are ready to settle on your loan, you will want to get the loan terms that you’ve locked in. To increase that likelihood, it is important to learn as much as you can about what the lender is promising you before you apply for a loan. Ask for the following information when you shop for a loan:

  • Does the lender offer a lock-in of the interest rate and points?
  • When will the lender let you lock in the interest rate and points? When you apply? When the loan is approved?
  • Will the lock-in be in writing? If the lock-in is not in writing, you will have no record of the lender’s agreement with you in case of a dispute.
  • Does the lender charge a fee to lock in your interest rate? Does the fee increase for longer lock-in periods? If so, then by how much?
  • If you have locked in a rate and the lender’s rate drops, can you lock in at the lower rate? Does the lender charge you an additional fee to lock in the lower rate?
  • Can you float your interest rate and points for now and lock them in later?

Loan Processing Time

While the lender has the greatest role in how fast your loan application is processed, there are certain things you can do to speed up its approval. Try to find out what documentation the lender will require from you. Much of this documentation can be brought with you when you apply for the loan. When you first meet with your lender, be sure to bring the following documents:

  • The purchase contract for the house (if you don’t have the contract, check with your real estate agent or the seller).
  • Your bank account numbers, the address of your bank branch and your latest bank statement, plus pay stubs, W-2 forms, or other proof of employment and salary, to help the lender check your finances.
  • If you are self-employed, balance sheets, tax returns for 2-3 previous years, and other information about your business.
  • Information about debts, including loan and credit card account numbers and the names and addresses of your creditors.
  • Evidence of your mortgage or rental payments, such as cancelled checks.
  • Certificate of Eligibility from the Veterans Administration if you want a VA-guaranteed loan.

Tip: Be sure to respond promptly to your lender’s requests for information while your loan is being processed. It is also a good idea to call the lender and real estate agent from time to time. By calling occasionally, you can check on the status of your application, and offer to help contact others such as employers who may need to provide documents and other information for your loan. It is also helpful to keep notes on your contacts with the lender so that you will have a record of your conversations.

Expiration of Lock-ins

Because mortgage lock-in rates do expire, you’ll want to ask potential lenders about the following:

  • How long does the lender expect to take to process your loan?
  • What has been the lender’s average time for processing loans recently?
  • Has the lender’s loan volume increased? Heavy volume might increase the lender’s average processing time.
  • What rate is charged if the lock-in expires before settlement? The rate in effect when the lock-in expires?
  • If you fail to settle within the lock-in period, will the lender refund some or all of your application or lock-in fees if you decide to cancel the loan application?
  • If your lock-in expires and you want to get another lock-in at the rate in effect at the time of the expiration, will the lender charge an additional fee for the second lock-in?

Locking in the Mortgage

When looking for a mortgage, you should shop among lenders for (1) the most favorable interest rate and (2) the lowest points and other up-front charges.

In most cases, the terms you are quoted when you shop among lenders only represent the terms available to borrowers settling their loan agreement at the time of the quote. The quoted terms may not be the terms available to you at settlement weeks or even months later. Therefore, you should not rely on the terms quoted to you when shopping for a loan unless a lender is willing to offer a lock-in.

Lock-ins on rates and points might offer you a way to ensure that what you shop for is what you get. This next section explains what these arrangements mean.

What Is a Lock-In?

A lock-in, also called a rate-lock or rate commitment, is a lender’s promise to hold a certain interest rate and a certain number of points for you, usually for a specified period of time, while your loan application is processed.

Points are additional charges imposed by the lender that are usually prepaid by the consumer at settlement, but can sometimes be financed by adding them to the mortgage amount. One point equals one percent of the loan amount.

Depending on the lender, you may be able to lock in the interest rate and number of points that you will be charged when you file your application, during processing of the loan, when the loan is approved, or later.

A lock-in that is given when you apply for a loan may be useful because it is likely to take your lender several weeks or longer to prepare, document, and evaluate your loan application. During that time, the cost of mortgages may change. But if your interest rate and points are locked in, you should be protected against increases while your application is processed. This protection could affect whether you can afford the mortgage.

Remember that a locked-in rate could also prevent you from taking advantage of price decreases, unless your lender is willing to lock in a lower rate that becomes available during this period.

It is important to recognize that a lock-in is not the same as a loan commitment, although some loan commitments may contain a lock-in. A loan commitment is the lender’s promise to make you a loan in a specific amount at some future time. Generally, you will receive the lender’s commitment only after your loan application has been approved. This commitment usually will state the loan terms that have been approved (including loan amount), how long the commitment is valid, and the lender’s conditions for making the loan, such as receipt of a satisfactory title insurance policy protecting the lender.

Will Your Lock-In Be In Writing?

Some lenders have preprinted forms that set out the exact terms of the lock-in agreement. Others may only make an oral lock-in promise on the telephone or at the time of application. Oral agreements can be very difficult to prove in the event of a dispute.

Some lenders’ lock-in forms may contain crucial information that is difficult to understand or that is in fine print. For example, some lock-in agreements may become void through some unrelated action such as a change in the maximum rate for Veterans Administration guaranteed loans. Thus, it is wise to obtain a blank copy of a lender’s lock-in form to read carefully before you apply for a loan. If possible, show the lock-in form to a lawyer or real estate professional.

Tip: Obtain written, rather than verbal, lock-in agreements to make sure that you fully understand how your lender’s lock-ins and loan commitments work and to have a tangible record of your arrangements with the lender. This record may be useful in the event of a dispute.

Will You Be Charged for a Lock-In?

Lenders may charge you a fee for locking in the rate of interest and number of points for your mortgage. Some lenders may charge you a fee up-front, and may not refund it if you withdraw your application, if your credit is denied, or if you do not close the loan. Others might charge the fee at settlement. The fee might be a flat fee, a percentage of the mortgage amount, or a fraction of a percentage point added to the rate you lock in.

The amount of the fee and how it is charged will vary among lenders and may depend on the length of the lock-in period.

How to Handle the Options Available for Mortgage Settlement Terms

Lenders may offer different options in establishing the interest rate and points that you will be charged, such as:

Locked-In Interest Rate-Locked-In Points. Under this option, the lender lets you lock in both the interest rate and points quoted to you. This option is considered to be a true lock-in because your mortgage terms should not increase above the interest rate and points that you have agreed upon even if market conditions change.

Locked-In Interest Rate-Floating Points. Under this option, the lender lets you lock in the interest rate, while permitting or requiring the points to rise and fall (float) with changes in market conditions. If market interest rates drop during the lock-in period, the points may also fall. If they rise, the points may increase.

Even if you float your points, your lender may allow you to lock-in the points at some time before settlement at whatever level is then current. For instance, say that you’ve locked in a 5-l/2 percent interest rate, but not the 3 points that went with that rate. A month later, the market interest rate remains the same, but the points the lender charges for that rate have dropped to 2-1/2. With your lender’s agreement, you could then lock in the lower 2-1/2 points.

If you float your points and market interest rates increase by the time of settlement, the lender may charge a greater number of points for a loan at the rate you’ve locked in. In this case, the benefit you might have had by locking in your rate may be lost because you will have to pay more in up-front costs.

Floating Interest Rate-Floating Points. Under this option, the lender lets you lock in the interest rate and the points at some time after application but before settlement. If you think that rates will remain level or even go down, you may want to wait on locking in a particular rate and points. If rates go up, you should expect to be charged the higher rate.

Because practices vary, you may want to ask your lender whether any other options are available to you.

How Long Are Lock-ins Valid?

Usually the lender will promise to hold a certain interest rate and number of points for a given number of days, but to get these terms you must settle on the loan within that time period. Lock-ins of 30 to 60 days are common, but some lenders may offer a lock-in for a shorter period of time, for example, 7 days after your loan is approved, while some others might offer longer lock-ins (up to 120 days). Lenders that charge a lock-in fee may charge a higher fee for the longer lock-in period. Usually, the longer the period is, the greater the fee will be.

The lock-in period should be long enough to allow for settlement, and any other contingencies imposed by the lender, before the lock-in expires.

Tip: Before deciding on the length of the lock-in to ask for, you should find out the average time for processing loans in your area and ask your lender to estimate (in writing, if possible) the time needed to process your loan. You will also want to take into account any factors that might delay your settlement. These may include delays that you can anticipate in providing materials about your financial condition and, in case you are purchasing a new house, unanticipated construction delays.

Finally, ask for a lock-in with as few contingencies as possible.

What Happens If the Lock-In Period Expires?

If you do not settle within the lock-in period, you might lose the interest rate and the number of points you had locked in. This could happen if there are delays in processing, whether they are caused by you, others involved in the settlement process, or the lender. For example, your loan approval could be delayed if the lender has to wait for any documents from you or from others such as employers, appraisers, termite inspectors, builders, and individuals selling the home. On occasion, lenders are themselves the cause of processing delays, particularly when loan demand is heavy, which sometimes happens when interest rates fall suddenly.

If your lock-in expires, most lenders will offer the loan based on the prevailing interest rate and points. If market conditions have caused interest rates to rise, most lenders will charge you more for your loan. One reason why some lenders may be unable to offer the lock-in rate after the period expires is that they can no longer sell the loan to investors at the lock-in rate. When lenders lock in loan terms for borrowers, they often have an agreement with investors to buy these loans based on the lock-in terms. That agreement may expire around the same time that the lock-in expires and the lender may be unable to afford to offer the same terms if market rates have increased. Lenders who intend to keep the loans they make may have more flexibility in those cases where settlement is not reached before the lock-in expires.

Complaints about Lock-ins

Knowing what to look for puts you in a better position to decide whether, when, and how long to lock in mortgage terms. Also, by helping to keep the loan process moving, you can lessen the chance that your lock-in will run out before settlement.

But what if your lock-in does lapse? If you believe that the lapse was due to delays caused by the lender or someone else involved in the loan process, you should first try to reach a mutually satisfactory agreement with the lender. If that effort fails, consider writing to the appropriate state or federal regulatory agency.

Some lender actions, such as offering lock-in terms which are impossible to fulfill, failing to process your loan diligently, or causing your lock-in to expire are improper–and may even be illegal. In addition, because you may have contractual rights under your lock-in or loan commitment, you may want to consult with an attorney. Be aware, though, that complaints may not be resolved as quickly as may be necessary for a home purchase.

Depending upon their authority under applicable state or federal law, regulatory agencies may either attempt to help you resolve your complaint directly or record your complaint and recommend other action.

State consumer protection offices, banking authorities, and offices of the attorney general can be contacted regarding complaints against many lenders doing business in the state.

Escrow Accounts

Your monthly mortgage payments will cover principal and interest and, most likely, something called an escrow account. The following information will help you to understand how these accounts work.

What Is An Escrow Account?

An escrow account is a fund that your lender establishes in order to pay property taxes and hazard insurance as they become due on your home during the year. In this way, the lender uses the escrow account to guard its investment in your home. For example, if you did not pay your property taxes, your municipality could sell your home at a foreclosure sale. Similarly, if you neglected to pay the hazard insurance premium, a fire or flood that destroyed your home also would destroy the lender’s security for the loan.

Most mortgage loans require escrow accounts, but not all do.

Tip: If your mortgage contract does not specifically require an escrow account, try to negotiate with the lender for the right to pay your own taxes and insurance. In this way, you can avoid having your money tied up until it is needed.

However, if you have a mortgage insured by the Federal Housing Administration or the Veterans Administration you must pay the lender each month for taxes and insurance, and these payments must be held in an escrow account until the lender disburses them on your behalf.

How Are The Payments Calculated?

The goal of the escrow account is to have enough money to pay taxes and insurance when they become due. To achieve this goal, the lender adds one-twelfth of the tax and insurance amount to your mortgage payment each month. For example, if your taxes and insurance are $1,200 per year, the lender would collect $2,400 in twelve installments of $200 per month.

To cover possible tax or insurance increases, the federal Real Estate Settlement Procedures Act (RESPA) permits the lender to add to the yearly amount two months of extra payments prorated monthly. So, the lender would collect an additional $400 divided by 12, or $33.33 per month, for a total escrow payment of $233.33 per month.

Tip: To determine if you are being charged correctly, compare your escrow payments with what you owe annually on your hazard insurance and property taxes. You can get this information from your local tax authority and your insurance company. If the lender charges you substantially less than the required amount, you will need to pay an additional lump sum at the end of the year. If the lender charges you substantially more, it may tie up your money unfairly, as well as violate the RESPA regulations.

Why Mortgage Payments Change

Most lenders will analyze your escrow account yearly to make sure they are collecting enough money to pay your taxes and insurance. If your taxes or insurance premiums change during the year, your lender will need to adjust your payments accordingly.

Interest on Escrowed Funds

Does the lender have to pay me interest on money being held in escrow? In most cases, no. But this is determined by the law of the state where your property is located. Check with the state banking commission or consumer protection office concerning such state requirements.

Escrow Account Balance

Most lenders provide an annual statement at the end of the year. Read this carefully. If you have any questions, ask the lender. If the statement shows that the lender has collected more in escrow payments than it has paid out, ask to have the money refunded to you, unless you prefer to have it applied toward next year’s payments.

If You Have a Complaint

First try to resolve any dispute or problem with your lender. If you cannot resolve your problem with the person handling your account, talk to a supervisor or an officer of the company. Be sure to keep a copy of any correspondence you may have. Often, your state banking agency will be able to help you, or at least direct you to the state agency that can help.

Tip: If you are a consumer with a question or complaint related to your mortgage or mortgage servicer, please contact the Consumer Financial Protection Bureau’s (CFPB) Consumer Response team at 855-411-2372 (855-729-2372 TTY/TDD), or by fax number 855-237-2392.

If, like thousands of others, you are having trouble paying your debts, it is important to take action. Doing nothing can lead to much larger problems in the future-even bigger debts, such as the loss of assets such as your house, and a bad credit record. This Financial Guide suggests how you can help improve your relationships with creditors, reduce your debts, better manage your money and get a fresh start.

How can you tell when you have too much debt? What if bill collectors are not calling yet, but you are having difficulty paying monthly bills? If these problems seem familiar, you should take action.

  • Have you run several credit cards up to the limit?
  • Do you frequently make only the minimum monthly payments on your credit cards?
  • Do you apply for almost any credit card you are offered-without checking out the terms?
  • Have you used the cash advance feature from one card to pay the minimum payment on another?
  • Do you use cash advances (or use a credit card) for living expenses such as food, rent, or utilities?
  • Are you unaware of what your total debt is?
  • Are you unaware of how long it would take you to pay off all your current debts (excluding mortgages and cars) at the rate you are paying?

If you find any of these statements apply to you, you may need to learn more about managing debt before you try to reestablish credit.

Getting Started

Here are some specific steps you can take if you are in financial trouble:

1. Review each debt. Make sure that the debt creditors claim you owe is really what you owe and that the amount is correct. If you dispute a debt, first contact the creditor directly to resolve your questions. If you still have questions about the debt, contact your state or local consumer protection office or, in cases of serious creditor abuse, your state Attorney General.

2. Contact your creditors. Let your creditors know that you are having difficulty making your payments. Tell them why you are having trouble–perhaps it is because you recently lost your job or have unexpected medical bills. Try to work out an acceptable payment schedule with your creditors. Most are willing to work with you and will appreciate your honesty and forthrightness.

Tip: Most automobile financing agreements permit your creditor to repossess your car any time you are in default, with no advance notice. If your car is repossessed you may have to pay the full balance due on the loan, as well as towing and storage costs, to get it back. Do not wait until you are in default. Try to solve the problem with your creditor when you realize you will not be able to meet your payments. It may be better to sell the car yourself and pay off your debt than to incur the added costs of repossession.

3. Budget your expenses. Create a spending plan that allows you to reduce your debts. Itemize your necessary expenses (such as housing and health care) and optional expenses (such as entertainment and vacation travel). Stick to the plan.

Tip: Try self-budgeting before taking more extreme measures.

4. Try to reduce your expenses. Cut out any unnecessary spending such as eating out and purchasing expensive entertainment. Consider taking public transportation or using a car sharing service rather than owning a car. Clip coupons, purchase generic products at the supermarket and avoid impulse purchases. Above all, stop incurring new debt. Leave your credit cards at home. Pay for all purchases in cash or use a debit card instead of a credit card.

5. Pay down debts using savings. Withdrawing savings from low-interest accounts to settle high-rate loans or credit card debt usually makes sense.

Tip: Selling off a second car not only provides cash but also reduces insurance and other maintenance expenses.

6. Find out if you are eligible for social services. Government assistance includes unemployment compensation, Temporary Assistance for Needy Families (TANF) formerly Aid to Families with Dependent Children (AFDC), food stamps, now known as Supplemental Nutrition Assistance Program (SNAP), low-income energy assistance, Medicaid, and Social Security (including disability). Other resources may be available from churches and community groups.

7. Try to consolidate your debts. There are a number of ways to pay off high-interest loans, such as credit cards, by getting a refinancing or consolidation loan, such as a second mortgage.

Caution: Be wary of any loan consolidations or other refinancing that actually increase interest owed, or require payments of points or large fees.

Caution: Second mortgages greatly increase the risk that you may lose your home.

8. Prepare a financial plan. A financial plan can alleviate financial worries about the future and ensure that you will meet your financial goals whether they relate to retirement, asset acquisition, education, or just vacations.

Credit Counseling Agencies

If you are unable to make satisfactory arrangements with your creditors, there are organizations to help you accomplish this. For instance, National Foundation for Consumer Credit (NFCC) member agencies provide education and counseling to families and individuals. For consumers who want individual help, counselors with professional backgrounds in money management and counseling are available to provide support.

To promote high standards, the NFCC has developed a certification program for these counselors known as Certified Consumer Credit Counselors (CCCS). A counselor will work with you to develop a budget to maintain your basic living expenses and outline options for addressing your total financial situation.

If creditors are pressing you, a CCCS counselor can also negotiate with these creditors to repay your debts through a financial management plan. Under this plan, creditors often agree to reduce payments or drop interest and finance charges and waive late fees and over-the-limit fees. After starting the plan, you will deposit money with CCCS each month to cover these new negotiated payment amounts. Then CCCS will distribute this money to your creditors to repay your debts.

With more than 1,100 locations nationwide, CCCS agencies are available to nearly all consumers. Supported mainly by contributions from community organizations, financial institutions, and merchants, CCCS provides services free or at a low cost to individuals seeking help. To contact a CCCS office for confidential help call 1 (800) 388-2227, 24 hours a day, for an office near you or visit their website: NFCC

Personal Bankruptcy

Bankruptcy is a legal proceeding that is intended to give people who cannot pay their bills a fresh start.

Tip: A decision to file for bankruptcy is a serious step, which should be taken only if it is the best way to deal with financial problems.

There are two types of bankruptcy available to most individuals:

  • Chapter 13 bankruptcy allows debtors to keep property which they might otherwise lose, such as a mortgaged house or car. Reorganizations may allow debtors to pay off or cure a default over a period of three to five years, rather than surrender property.
  • Chapter 7 or “straight bankruptcy” involves liquidation of all assets that are not exempt in your state. The exempt property may include items such as work-related tools and basic household furnishings, among others. Some of your property may be sold by a court-appointed official or turned over to your creditors. You can file for Chapter 7 only once every eight years.

Both types of bankruptcy may get rid of unsecured debts (those where creditors have no rights to specific property), and stop foreclosures, repossessions, garnishments, utility shut-offs and debt collection activities. Both types also provide exemptions that permit most individual debtors to keep most of their assets, though these “exemption” amounts vary greatly from state to state.

Bankruptcy cannot clean up a bad credit record and will be part of this record for up to ten years. Thus, filing bankruptcy will make it more difficult to get a mortgage to buy a house. It usually does not wipe out child support, alimony, fines, taxes, and some student loan obligations. Also, under Chapter 13, unless you have an acceptable plan to catch up on your debt, bankruptcy usually does not permit you to keep property when the creditor has an unpaid mortgage or lien on it. Bankruptcy cases must be filed in federal court.

Tip: Be cautious when choosing a bankruptcy lawyer. Some of the less reputable lawyers make easy money by handling hundreds of bankruptcy cases without adequately considering individual needs and alternative solutions. Get recommendations from people you know and trust, and from employee assistance programs.

Some public-funded legal services programs handle bankruptcy cases without charging attorney fees. Or these programs may provide referrals to private bankruptcy lawyers. Keep in mind that the fees of these attorneys may vary widely.

Scams And Pitfalls

Consumers with credit problems have paid millions of dollars to firms that claim they can remove negative information, clean up credit reports, and allow consumers to get credit no matter how bad the credit history.

These credit repair clinics charge consumers anywhere from $50 to $2,000 and often use questionable methods. Most clinics make misleading promises to consumers, and charge high fees for doing what you could do yourself–or simply take your money and do nothing at all.

Tip: Do not confuse the for-profit credit repair clinics discussed here with the non-profit Consumer Credit Counseling Services (CCCS) we discussed before.

Here are some common promises made by credit clinics and the reasons consumers should beware of such claims:

“Based on little-known loopholes in Federal credit laws, we can show you how to clean up your credit report!”

These “loopholes” are merely the provisions of the Fair Credit Reporting Act (FCRA), under which you have the right to challenge information in your credit report you believe incorrect. We discussed these provisions earlier in the section on “What To Do If You Have A Bad Credit Report.” Credit repair clinics often flood credit bureaus with requests to check whether or not all negative data is correct. Credit clinics hope creditors will not be able to verify the information in a reasonable time period, causing the negative information to have to be dropped under the FCRA. Some credit clinics even tell consumers to challenge neutral information (e.g., name and address), hoping to distort file data so that the old, negative file will no longer be identifiable when a creditor asks for a consumer’s file. Creditors and credit bureaus have become familiar with such tactics, and they have sought to use the provision of the FCRA that allows them to dismiss “frivolous” disputes of file information and to refuse to respond to repeated disputes of the same data.

“We can show you how to remove negative information from your file-including judgments.”

Some clinics tell consumers to pay off any bills outstanding with the creditor in exchange for removal of negative information. Or, they may tell a consumer who has an account in collections to pay part of the balance with a check. The check is to carry a disclaimer saying that, by cashing the check, the creditor agrees to remove the account from collections and remove any negative information about the account from its files. Creditors are under no obligation to agree to such measures, and the fees paid to clinics for such advice is wasted.

“We can get you a major credit card-even if you’ve been through bankruptcy!”

What you are not told is that you will have to “secure” the card first. Most credit cards are unsecured; that is, you are not pledging any of your assets as collateral for any credit you may use. A card is secured when a consumer puts a deposit in the bank and gets a bankcard with a credit limit based on a percentage of that deposit. While a secured card can be an excellent tool for rebuilding credit, why should you pay the credit clinic just to provide an application and deposit slip?

Often for-profit or non-credential counseling organizations make promises that they cannot or do not keep. Be especially careful when asked for a large sum of money in advance.

Tip: Several states have enacted laws to protect consumers against the deceptive practices of many credit clinics. These state laws generally require credit clinics to inform consumers of their rights under the FCRA; be bonded (hold a type of insurance to protect consumers who may sue) if they accept payment in advance of services; accurately represent what they can and cannot do; and offer a cancellation period before any contract for services the consumer may sign takes effect. Check with your state attorney general’s office to determine if there are any regulations for credit clinics in your state.

Tip: To check an organization’s reputation, contact your state Attorney General, consumer protection agency, or Better Business Bureau.

*   *   *   *

A Final Word: Don’t lose hope, even if you despair of ever recovering financially. You can regain financial health if you act responsibly. The options presented here can put you on the road to financial recovery. Professional financial guidance can get you off to the right start.

Government and Non-Profit Agencies

The following agencies are responsible for enforcing federal laws that govern credit card transactions. Questions concerning a particular card issuer should be directed to the enforcement agency responsible for that issuer.

  • State Member Banks of the Reserve System:

Consumer & Community Affairs
Board of Governors of the Federal Reserve System
20th & Constitution Avenue, N.W.
Washington, D.C. 20551

  • National Banks:

Comptroller of the Currency
Customer Assistance Group
1301 McKinney Street
Suite 3450
Houston, TX 77010
Tel. (800) 613-6743

  • Federal Credit Unions:

National Credit Union Administration
1775 Duke St # 4206
Alexandria, VA 22314-6115

  • Non-Member Federally Insured Banks:

Federal Deposit Insurance Corporation
Consumer Response Center
1100 Walnut St, Box #11
Kansas City, MO 64106

  • Federally Insured Savings and Loans, and Federally Chartered State Banks:

Comptroller of the Currency
Customer Assistance Group
1301 McKinney Street
Suite 3450
Houston, TX 77010
Tel. (800) 613-6743

  • Other Credit Card Issuers (includes retail gasoline companies):

Bureau of Consumer Protection
Federal Trade Commission
600 Pennsylvania Avenue, NW
Washington, D.C. 20580

  • The U.S. Postal Inspection Service:

This office covers mail fraud, sexually offensive materials, solicitations that look like government materials but are not. If you suspect such violations, contact your local Postmaster or Postal Inspector or:

Criminal Investigations Service Center
Attn: Mail Fraud
222 S. Riverside Plaza Ste 1250
Chicago Il 60606-6100
Tel. 877-876-2455

  • The Federal Trade Commission:

Does not handle individual complaints, but reporting failure to deliver, late delivery, unordered merchandise, misrepresentation or fraud helps uncover widespread abuses that the FTC might take action to stop.

Division of Enforcement
Federal Trade Commission
600 Pennsylvania Avenue, NW
Washington, DC 20580
Tel. (202) 326-2222

  • National Do Not Call Registry:

If you wish to have your name removed from telephone lists of marketing companies.

National Do Not Call Registry
Federal Trade Commission
600 Pennsylvania Avenue, NW
Washington, DC 20580
website: www.donotcall.gov

  • Direct Marketing Mail Opt-Out:

Consumers who do not wish to receive promotional mail at home

Direct Marketing Association
1120 Avenue of the Americas
NY, NY New York, NY 10036-6700
Tel. 212.768.7277
website: www.DMAChoice.org

  • Low or No-Cost Credit Cards:

Bankrate.com lists banks charging no fees and low interest rates for credit cards. Visit the website: www.bankrate.com

Frequently Asked Questions

Should I prepay my mortgage?

As a general rule, if you are able to prepay your mortgage (and if there is no penalty for doing so) you should prepay as much as you can every month. There are, however, two exceptions to the general rule:

  1. You do not have an emergency fund of three to six months’ worth of expenses stashed away. Any extra money you have should be put towards the emergency fund. Once you’ve achieved this essential financial goal, then you can begin paying down your mortgage.
  2. You have a large amount of credit card debt. In such case, all of your extra funds should be used to pay down those debts.

In addition, there are a few individuals for whom paying down a mortgage earlier might not be as beneficial financially, particularly if they achieve a better return by investing that money elsewhere. Whether an investor fits into this category depends on his or her marginal tax rate, mortgage interest rate, the return they can get on an investment, and any long-term investment goals they might have.

When should I refinance my home?

Refinancing becomes worth your while if the current interest rate on your mortgage is at least 2 percentage points higher than the prevailing market rate. Talk to some lenders to determine what rates are available and the costs associated with refinancing. These costs include appraisals, attorney’s fees, and points.

Once you know what the costs will be, figure out what your new payment would be if you refinanced. You can then estimate how long it will take to recover the costs of refinancing by dividing your closing costs by the difference between your new and old payments (your monthly savings).

Be aware that the amount you ultimately save depends on many factors, including your total refinancing costs, whether you sell your home in the near future, and the effects of refinancing on your taxes.

Should I borrow against my securities?

Borrowing against your securities can be a low-cost way to borrow money. No deduction is allowed for the interest unless the loan is used for investment or business purposes.

Tip: If your margin debt exceeds 50 percent of the value of your securities, you will be subject to a margin call, which means that you will have to come up with cash or sell securities. If the market is falling at the time, a margin call can cause a financial disaster. Therefore, we recommend against the use of margin debt, unless the amount is kept way below 50 percent. Twenty-five percent is a much safer percentage.

What is a home equity line of credit?

A home equity line of credit is a form of revolving credit in which your home serves as collateral. Because a home is likely to be a consumer’s largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills and not for day-to-day expenses.

With a home equity line, you will be approved for a specific amount of credit, in other words, the maximum amount you can borrow at any one time while you have the plan.

Many lenders set the credit limit on a home equity line by taking a percentage (say, 75 percent) of the appraised value of the home and subtracting the balance owed on the existing mortgage. For example:

Appraisal of home $100,000
Percentage x 75%
Percentage of appraised value $75,000
Less mortgage debt -40,000
Potential credit line $35,000

In determining your actual credit line, the lender will also consider your ability to repay by looking at your income, debts, and other financial obligations, as well as your credit history.

Once you’re approved for a home equity loan, you will usually be able to borrow up to your credit limit whenever you want. Typically, you draw on your line of credit by using special checks, but under some plans, borrowers can use a credit card or other means to borrow money and make purchases. There may be limitations on how you use the line, however. Some plans may require you to borrow a minimum amount each time you draw on the line–for example, $300–and to keep a minimum amount outstanding.

What are the costs of obtaining a home equity line of credit?

Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home. For example these fees may be charged:

  • A fee for a property appraisal, which estimates the value of your home
  • An application fee, which may not be refundable if you are turned down for credit
  • Up-front charges, such as one or more points (one point equals one percent of the credit limit)
  • Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes
  • Yearly membership or maintenance fees

You also may be charged a transaction fee every time you draw on the credit line.

What is an interest rate “lock-in”?

If you decide to apply for financing with a particular lender, and if you do not want to let the interest rate “float” until closing, then get a written statement guaranteeing the interest rate and the number of discount points that you will pay at closing. This binding commitment or “lock-in” ensures that the lender will not raise these costs even if rates increase before you settle on the new loan. You also may consider requesting an agreement where the interest rate can decrease (but not increase) before closing. If you cannot get the lender to put this information in writing, you may want to choose one that will.

Most lenders place a limit on the length of time (say, 60 days) that they will guarantee the interest rate. You must sign the loan during that time or lose the benefit of that particular rate. Because many people are refinancing their mortgages, there may be a delay in processing the papers. Therefore, it may be wise to contact your loan officer periodically to check on the progress of your loan approval and to see if information is needed.

What disclosures must a lender give you?

For a financing loan, the lender must give you a written statement of the costs and terms of the financing before you become legally obligated for the loan. This is required by the Truth in Lending Act and you usually receive the information around the time of settlement–although some lenders provide it earlier.

Tip: Review this statement carefully before you sign the loan. The disclosure tells you what the APR, finance charge, amount financed, payment schedule, and other important credit terms are.

If you refinance with a different lender, or if you borrow beyond your unpaid balance with your current lender, you also must be given the right to rescind the loan. In these loans, you have the right to rescind or cancel the transaction within three business days following settlement, receipt of your Truth in Lending disclosures, or receipt of your cancellation notice, whichever occurs last.

What is a reverse mortgage?

A reverse mortgage is a type of home equity loan that allows you to convert some of the equity in your home into cash while you continue to own the home. Reverse mortgages operate like traditional mortgages, only in reverse. Rather than paying your lender each month, the lender pays you. Reverse mortgages differ from home equity loans in that most reverse mortgages do not require any repayment of principal, interest, or servicing fees as long as you live in the home.

The reverse mortgage’s benefit is that it allows homeowners who are age 62 and over to keep living in their homes and to use their equity for whatever purpose they choose. A reverse mortgage might be used to cover the cost of home health care, or to pay off an existing mortgage to stop a foreclosure, or to support children or grandchildren.

When the homeowner dies or moves out, the loan is paid off by a sale of the property. Any leftover equity belongs to the homeowner or the heirs.

What loan interest is tax-deductible?

The deductibility of interest has been limited in recent years. The following types of interest are at least partially deductible:

  • Mortgage interest
  • Business interest
  • Investment interest
  • Education related interest

What are the limitations on deductibility of mortgage interest?

Generally, interest expense on the taxpayer’s primary residence and second (but not a third) home, is deductible. Interest is only deductible on the first $1,000,000 of the acquisition loan ($500,000 if married filing jointly). As the loan is paid off the limit is reduced. In other words, you cannot refinance a loan for a higher amount than the current principal balance and increase the deduction. In addition interest on a home equity loan of up to $100,000 can be deducted.

Is interest expense incurred for business purposes deductible?

Yes. Interest expense incurred for a trade or business is deductible against the income of that business. For example, if you are self-employed the business interest would be deducted on Schedule C.

Is investment related interest expense deductible?

Yes. Investment interest is deductible up to the amount of investment income.

Is interest on educational loans tax deductible?

For FAQs on deducting education loans, see Tax Benefits of Higher Education: Frequently Asked Questions.

When can you stop paying private mortgage insurance?

Generally, if you make a down payment of less than 20 percent when buying a home, the lender will require you to buy private mortgage insurance (PMI). You can generally drop the PMI when you have attained 20 percent equity in the home, or when the value of your home goes up (due to a good real estate market) so that your equity constitutes 20 percent.

Under the Homeowner’s Protection Act (HPA) of 1998 you have the right to request cancellation of PMI when you pay down your mortgage to the point that it equals 80 percent of the original purchase price or appraised value of your home at the time the loan was obtained, whichever is less. You also need a good payment history, meaning that you have not been 30 days late with your mortgage payment within a year of your request, or 60 days late within two years. Your lender may require evidence that the value of the property has not declined below its original value and that the property does not have a second mortgage, such as a home equity loan.

Under HPA, mortgage lenders or servicers must automatically cancel PMI coverage on most loans, once you pay down your mortgage to 78 percent of the value if you are current on your loan. If the loan is delinquent on the date of automatic termination, the lender must terminate the coverage as soon thereafter as the loan becomes current. Lenders must terminate the coverage within 30 days of cancellation or the automatic termination date, and are not permitted to require PMI premiums after this date. Any unearned premiums must be returned to you within 45 days of the cancellation or termination date.

For high-risk loans, mortgage lenders or servicers are required to automatically cancel PMI coverage once the mortgage is paid down to 77 percent of the original value of the property, provided you are current on your loan.

If PMI has not been canceled or otherwise terminated, coverage must be removed when the loan reaches the midpoint of the amortization period. On a 30-year loan with 360 monthly payments, for example, the chronological midpoint would occur after 180 payments. This provision also requires that the borrower must be current on the payments required by the terms of the mortgage. Final termination must occur within 30 days of this date.

HPA applies to residential mortgage transactions obtained on or after July 29, 1999, but it also has requirements for loans obtained before that date.

What should I do if a friend or family member asks me to co-sign a loan?

Many people agree to co-sign loans for friends or relatives, as a favor, as a vote of confidence, or because they just can’t say no. Unfortunately, their act of kindness often backfires because according to many finance companies most cosigners end up paying off the loans they’ve cosigned–along with late charges, legal fees and all. Not only is this an unwanted out-of-pocket expense, but it can also affect the cosigner’s credit record.

While a lender will generally seek repayment from the debtor first, it can go after the cosigner at any time. When you agree to cosign a loan for a friend or family member, you are also responsible for its repayment along with the borrower.

Guaranteeing a loan is a better option than to cosign one in that where a loan is guaranteed, the lender can usually go after the guarantor only after the principal debtor has actually defaulted.

However, if you’ve decided you’re willing to cosign a loan, at the very least you should seek the lender’s agreement to refrain collecting from you until the borrower actually defaults, and try to limit your liability to the unpaid principal at the time of default. You should also plan on staying apprised of the borrower’s financial situation to prevent him or her from defaulting on the loan. An example of this might be having the lender notify you whenever a payment is late.

Cosigning an Account. You may be asked to cosign an account to allow someone else to obtain a loan. With cosigning, your payment history and assets are used to qualify the cosigner for the loan.

Tip: Cosigning a loan, whether for a family member, friend, or employee, is not recommended. Many have found out the hard way that cosigning a loan only leads to trouble.

It bears repeating that cosigning a loan is no different than taking out the loan yourself. When you cosign, you are signing a contract that makes you legally and financially responsible for the entire debt. If the other cosigner does not pay, or makes late payments, it will probably show up on your credit record. If the person for whom you cosigned does not pay the loan, the collection company will be entitled to try to collect from you.

If the cosigned loan is reported on your credit report, another lender will view the cosigned account as if it were your own debt. Further, if the information is correct, it will remain on your credit report for up to seven years.

Tip: If someone asks you to cosign a loan, suggest other alternatives such as a secured credit card by which they can build a credit history. If you are asked to cosign for someone whose income is not high enough to qualify for a loan, you are actually doing them a favor by refusing because they will be less likely to be overwhelmed by too much debt. If you’re still considering cosigning a loan, then you might want to consult an attorney before taking any action to find out what your liability is, if in fact the other person does default.

Tip: If you have already cosigned for someone, and he or she is not making payments on time, consider making the payments yourself and asking the cosigner to pay you directly, in order to protect your credit rating.

How can I get the best deal on a home equity loan or an equity line of credit?

If you decide to apply for a home equity loan, look for the plan that best meets your particular needs. Look carefully at the credit agreement and examine the terms and conditions of various plans, including the annual percentage rate (APR) and the costs you’ll pay to establish the plan.

Tip: The disclosed APR will not reflect the closing costs and other fees and charges, so compare these costs, as well as the APRs, among lenders.

Interest Rates. Home equity plans typically involve variable interest rates rather than fixed rates. A variable rate must be based on a publicly available index (such as the prime rate published in some major daily newspapers or a U.S. Treasury bill rate). The interest rate will change, mirroring fluctuations in the index.

To figure the interest rate that you will pay, most lenders add a margin, such as 2 percentage points, to the index value.

Tip: Because the cost of borrowing is tied directly to the index rate, find out what index and margin each lender uses, how often the index changes, and how high it has risen in the past.

Sometimes lenders advertise a temporarily discounted rate for home equity loans-a rate that is unusually low and often lasts only for an introductory period, such as six months.

Variable rate plans secured by a dwelling must have a ceiling (or cap) on how high your interest rate can climb over the life of the plan. Some variable-rate plans limit how much your payment may increase, and also how low your interest rate may fall.

Some lenders permit you to convert a variable rate to a fixed interest rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

Agreements generally permit the lender to freeze or reduce your credit line under certain circumstances, such as during any period the interest rate reaches the cap.

What are the costs of obtaining a home equity line of credit?

Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home.

For example, these fees may be charged:

  • A fee for a property appraisal, which estimates the value of your home
  • An application fee, which may not be refundable if you are turned down for credit
  • Up-front charges, such as one or more points (one point equals one percent of the credit limit)
  • Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes
  • Yearly membership or maintenance fees

You also may be charged a transaction fee every time you draw on the credit line.

You could find yourself paying hundreds of dollars to establish the plan. If you were to draw only a small amount against your credit line, those charges and closing costs would substantially increase the cost of the funds borrowed.

On the other hand, the lender’s risk is lower than for other forms of credit because your home serves as collateral. Thus, annual percentage rates for home equity lines are generally lower than rates for other types of credit.

The interest you save could offset the initial costs of obtaining the line. In addition, some lenders may waive a portion or all of the closing costs.

Should I obtain a home equity line of credit or a traditional second mortgage loan?

If you are thinking about a home equity line of credit you might also want to consider a traditional second mortgage loan. This type of loan provides you with a fixed amount of money repayable over a fixed period. Usually the payment schedule calls for equal payments that will pay off the entire loan within that time.

Tip: Consider a traditional second mortgage loan instead of a home equity line if, for example, you need a set amount for a specific purpose, such as an addition to your home.

In deciding which type of loan best suits your needs, consider the costs under the two alternatives. Look at the APR and other charges.

Tip: Do not simply compare the APR for a traditional mortgage loan with the APR for a home equity line because the APRs are figured differently. The APR for a traditional mortgage takes into account the interest rate charged plus points and other finance charges. The APR for a home equity line is based on the periodic interest rate alone. It does not include points or other charges.

How should I determine which of several loan alternatives is best?

Use the legally-required disclosures of loan terms to compare the costs of home equity loans.

The Truth in Lending Act requires lenders to disclose the important terms and costs of their home equity plans, including the APR, miscellaneous charges, the payment terms, and information about any variable-rate feature. In general, neither the lender nor anyone else may charge a fee until after you have this information.

You usually get these disclosures when you receive an application form, and you will get additional disclosures before the plan is opened. If any term has changed before the plan is opened (other than a variable-rate feature), the lender must return all fees if you decide not enter into the plan because of the changed term.

Credit costs vary. By remembering two terms, you can compare credit prices from different sources. Under Truth in Lending, the creditor must tell you-in writing and before you sign any agreement-the finance charge and the annual percentage rate.

The finance charge is the total dollar amount you pay to use credit. It includes interest costs, and other costs, such as service charges and some credit-related insurance premiums.

For example, borrowing $100 for a year might cost you $10 in interest. If there were also a service charge of $1, the finance charge would be $11.

The annual percentage rate (APR) is the percentage cost (or relative cost) of credit on a yearly basis. This is your key to comparing costs, regardless of the amount of credit or how long you have to repay it:

Example: You borrow $100 for one year and pay a finance charge of $10. If you can keep the entire $100 for the whole year and then pay back $110 at the end of the year, you are paying an APR of 10 percent. But, if you repay the $100 and finance charge (a total of $110) in twelve equal monthly installments, you don’t really get to use $100 for the whole year. In fact, you get to use less and less of that $100 each month. In this case, the $10 charge for credit amounts to an APR of 18 percent.

All creditors-banks, stores, car dealers, credit card companies, finance companies- must state the cost of their credit in terms of the finance charge and the APR. Federal law does not set interest rates or other credit charges. But it does require their disclosure–before you sign a credit contract or use a credit card–so you can compare costs.

How can I raise money for my small business?

Even though, raising capital is the most basic of all business activities, it can be a complex and frustrating process. There are several sources to consider when looking for financing. The primary source of capital for most new businesses comes from savings and other forms of personal resources. While credit cards are often used to finance business needs, there may be better options available, even for very small loans.

Many entrepreneurs also look to private sources such as friends and family when starting out in a business venture. Often, money is loaned interest-free or at a low-interest rate, which can be beneficial when getting started.

Outside of personal resources, the most common source of funding is a bank or credit union. Venture capital firms also help companies grow in exchange for equity or partial ownership.

What types of loans exist for business financing?

To successfully obtain a loan, you must know exactly how much money you need, why you need it, and how you will pay it back. Your written proposal must convince the lender that you are a good credit risk.

Terms of loans vary from lender to lender, but there are two basic types of loans: Short-term and long-term.

Generally, a short-term loan has a maturity of up one year. These include working capital loans, accounts receivable loans, and lines of credit

Long-term loans have maturities greater than one year but usually less than seven years. Real estate and equipment loans may have maturities of up to 25 years. Long-term loans are used for major business expenses such as purchasing real estate and facilities, construction, durable equipment, furniture and fixtures, vehicles, etc.

What do banks look for when considering a loan request?

When reviewing a loan request, the bank official is primarily concerned about repayment. To help determine this ability, many loan officers will order a copy of your business credit report from a credit-reporting agency.

Using the credit report and the information you have provided, the lending officer will consider the following issues:

  • Have you invested savings or personal equity in your business totaling at least 25 to 50 percent of the loan you are requesting? Remember, a lender or investor will not finance 100 percent of your business.
  • Do you have a sound record of credit-worthiness as indicated by your credit report, work history and letters of recommendation? This is very important.
  • Do you have sufficient experience and training to operate a successful business?
  • Have you prepared a loan proposal and business plan that demonstrate your understanding of and commitment to the success of the business?
  • Does the business have sufficient cash flow to make the monthly payments on the amount of the loan request?

How do I write a good loan proposal?

A good loan proposal contains the following key elements:

General Information

  • Business name and address, names of principals and their social security numbers.
  • Purpose of the loan: exactly what the loan will be used for and why it is needed.
  • Amount of money required: the exact amount you need to achieve your purpose.

Business Description

  • Details of what kind of business it is, how long it has existed, number of employees, and current business assets.
  • Ownership structure: details on your company’s legal structure.

Management Profile

Develop a short statement on each principal in your business, including background information such as education, experience, skills, and accomplishments.

Market Information

Clearly define your company’s products as well as your markets, identify your competition, and explain how your business competes in the marketplace. Profile your customers and explain how your business can satisfy their needs.

Financial Information

  • Financial statements: balance sheets and income statements for the past three years. If you are just starting out, provide a projected balance sheet and income statement.
  • Personal financial statements on yourself and other principal owners of the business.
  • Collateral you would be willing to pledge as security for the loan.

How can I check my credit report?

Mistakes on credit reports occur more frequently than you might think. And whether those mistakes are there because they’re caused by stolen or unauthorized use of credit cards, other individuals with the same name, or a creditor reporting something in the wrong way, it’s important to check your credit report on a regular basis.

By law, and at your request, you are entitled to one free credit report from each of the three major credit bureaus listed below once every 12 months. To check your report or obtain a copy do not contact the three nationwide consumer reporting companies individually. Instead, visit www.annualcreditreport.com, call 1-877-322-8228, or complete the Annual Credit Report Request Form and mail it to: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281. The form is available at www.ftc.gov/credit.

AnnualCreditReport.com is a centralized service for consumers to request free annual credit reports. You may order your reports from each of the three nationwide consumer reporting companies at the same time, or you can order one report at a time from each of the three companies.

In addition, federal law states that you’re entitled to a free report if a company takes adverse action against you, such as denying your application for credit, insurance, or employment, but you must submit a request for your report within 60 days of receiving notice of the action. The notice will give you the name, address, and phone number of the consumer reporting company.

You’re also entitled to one free report a year if you’re unemployed and plan to look for a job within 60 days; if you’re on welfare; or if your report is inaccurate because of fraud, including identity theft. Otherwise, a consumer reporting company may charge you up to $11.00 for another copy of your report within a 12-month period. Residents of California, Colorado, Connecticut, Georgia, Maine, Maryland, Massachusetts, Minnesota, Montana, New Jersey, Puerto Rico, Vermont, or the US Virgin Islands, may be entitled to a free or reduced price personal credit report from each of the three major credit bureaus, which are listed below:

What if there is an error on my credit report?

By law (under the Fair Credit Reporting Act) you have the right to correct inaccurate information in your credit file. You must dispute your report directly to the credit reporting agency.

Notify the credit reporting company, in writing, what information you think is inaccurate. Include copies (do not send originals) of documents that support your position. Provide your complete name and address and clearly identify each item in your report you dispute and state the facts and explain why you dispute the information. You must also request that the item is removed or corrected.

Credit reporting companies must investigate the items in question — usually within 30 days — unless they consider your dispute frivolous. They also must forward all the relevant data you provide about the inaccuracy to the organization that provided the information. After the information provider receives notice of a dispute from the credit reporting company, it must investigate, review the relevant information, and report the results back to the credit reporting company. If the information provider finds the disputed information is inaccurate, it must notify all three nationwide credit reporting companies so they can correct the information in your file.

Tip: Send your dispute by certified mail, return receipt requested, and keep copies of your dispute letter and enclosures. By doing so, you can document what the credit reporting agency received.

When the investigation is complete, the credit reporting company must give you the results in writing and a free copy of your report if the dispute results in a change. This free report does not count as your annual free report. If an item is changed or deleted, the credit reporting company cannot put the disputed information back in your file unless the information provider verifies that it is accurate and complete. The credit reporting company also must send you written notice that includes the name, address, and phone number of the information provider.

If you request it, the credit reporting company must send notices of any corrections to anyone who received your report in the past six months. You can have a corrected copy of your report sent to anyone who received a copy during the past two years for employment purposes.

If an investigation doesn’t resolve your dispute with the credit reporting company, you can ask that a statement of the dispute be included in your file and in future reports. You also can ask the credit reporting company to provide your statement to anyone who received a copy of your report in the recent past. You can expect to pay a fee for this service.

While the investigation is going on, be sure to tell the creditor or another information provider, in writing, that you dispute an item. Be sure to include copies (NOT originals) of documents that support your position. Many providers specify an address for disputes. If the provider reports the item to a credit reporting company, it must include a notice of your dispute. And if you are correct — that is, if the information is found to be inaccurate — the information provider may not report it again.

Tip: If you are divorced and suffering the consequences of a credit rating damaged during the marriage, you may be able to obtain relief if the bad credit rating was your spouse’s fault and you can prove it. According to the Equal Credit Opportunity Act, a lender must consider any evidence you have that shows your spouse—not you—was the irresponsible one.

How can I build a credit history so that I can establish credit?

It may take some time to establish your first credit account if you have no reported credit history. This problem affects mainly (1) young people, (2) older people who have never used credit, and (3) divorced or widowed women who shared credit accounts reported only in the husband’s name.

Here are some steps you can take:

    • Check with a credit bureau to find out what is in your credit report.

Tip: If you have had credit before under a different name or in a different location and it is not reported in your file, ask the credit bureau to include it. Although credit bureaus are not required to add new accounts to your file, many will do so for a fee.

Tip: If you currently share a credit account with your spouse, ask the creditor to report it under both names

    • When contacting your creditor or credit bureau, do so in writing and include relevant information, such as account numbers, to speed the process. As with all important business communications, keep a copy of what you send.
    • Build a credit history by applying for credit with a local business, such as a department store, or borrow a small amount from your credit union or the bank where you have checking and savings accounts. A local bank or department store may approve your credit application even if you do not meet the standards of larger creditors.
    • If you are rejected for credit, find out why. There may be reasons other than lack of credit history. Your income may not meet the creditor’s minimum requirement or you may not have worked at your current job long enough.

Tip: Wait at least six months before making each new application. Credit bureaus record each inquiry about you. Some creditors may deny your application based on your having too many credit inquiries.

Tip: If you still cannot get credit, ask someone with an established credit history to act as your co-signer. Then, once you have repaid the debt, try again to get credit on your own. Alternatively, you may wish to consider a secured credit card.

Who can see my credit file?

The Fair Credit Reporting Act allows access to your credit file only by the following: those authorized in writing by you, creditors to whom you are applying for credit, insurers, potential employers, and those who have a “legitimate business purpose related to a business transaction involving you” including, landlords, a state or local child support enforcement agency, insurance companies, employers and potential employers (but only with your consent), companies with which you have a credit account for account monitoring purposes, those considering your application for a government license or benefit if the agency is required to consider your financial status.

In addition, government agencies can obtain identifying information about you. This is limited to your name, current and former addresses, and current and former places of employment.

Every time someone requests a copy of your credit report, it is noted as an “inquiry” on your credit file. You are entitled to know who has requested your credit file within the past six months (or two years if for employment purposes). This information is provided when you order a copy of your credit report.

Tip: In addition to checking on the information in your report, review who has seen your file. Credit bureaus must establish procedures to keep anyone without a legitimate business purpose from obtaining your report, but unauthorized access to credit files does sometimes occur.

How can I decipher my credit report?

Your credit report is divided into four sections: identifying information, credit history, public records, and inquiries.

Identifying information is information used to identify you such as your maiden and married name(s), social security number, current and previous addresses, date of birth, telephone numbers, driver’s license numbers, employer, and spouse’s name.

Credit history is made up of your accounts, which are sometimes called tradelines. There are two types of credit accounts, revolving, which includes items such as credit cards, and installment, which includes car loans and mortgages. Each account listed includes the name of the creditor and the account number, when you opened your account, what kind of account it is, the payment amount, the status of the account (open, closed, paid, active), the balance if it’s a loan, and how well you have paid the account (never late, 30 days late, etc.).

Public records lists financially related data such as bankruptcies, judgments and tax liens that would adversely affect your credit.

The last section, inquiries, is a list of everyone who has asked to see your credit report–everyone from credit card companies you applied to for a new card or banks for a new car loan and creditors interested in pre-qualifying you for a credit card.

It is vital that you understand every piece of information on your credit report in order that you be able to identify possible errors or omissions.

Read your report carefully, making a note of anything you do not understand. The credit bureau is required by law to provide trained personnel to explain it to you. If accounts are identified by code number, or if there is a creditor listed on the report that you do not recognize, ask the credit bureau to supply you with the name and location of the creditor so you can ascertain if you do indeed hold an account with that creditor.

In addition to the account information, credit reports often contain symbols and codes that look like “Greek” to the average consumer. Fortunately, every credit bureau report also includes a key explaining each code.

Equal Credit Opportunity Act (ECOA) Codes

The Equal Credit Opportunity Act (ECOA) requires creditors who report information about accounts to report it in the names of all people with a relationship to the account, including co-signers or authorized users. To help lenders identify your legal liability on all your credit accounts, credit bureaus add a code to each account, termed the ECOA code. Credit bureaus may list the ECOA codes differently, but the basic categories are as follows:

Individual. You alone are legally responsible. This designation gives you a strong credit reference, assuming a good history. You alone are legally responsible. This designation gives you a strong credit reference, assuming a good history. You alone are legally responsible. This designation gives you a strong credit reference, assuming a good history.

Joint. You and someone else — often a spouse – are both legally liable. A joint account is equal to an individual account for building your credit history. You and someone else — often a spouse – are both legally liable. A joint account is equal to an individual account for building your credit history. You and someone else — often a spouse – are both legally liable. A joint account is equal to an individual account for building your credit history.

Co-signer. You signed loan documents for someone else, to help them qualify for a loan. Also referred to as “On Behalf of” (secured credit for another individual other than spouse).

Co-signer, primarily liable: You took out an account for yourself, but someone else co-signed for the loan to ensure payment. Also known as “Maker” (account for which subject is liable but a co-maker is liable if maker defaults.)

Authorized user. You can use the account, and may have a card in your name, but you did not sign the application and are not legally responsible. Because you have no legal obligation, this designation does not help you get your own credit history. You can use the account, and may have a card in your name, but you did not sign the application and are not legally responsible. Because you have no legal obligation, this designation does not help you get your own credit history. You can use the account, and may have a card in your name, but you did not sign the application and are not legally responsible. Because you have no legal obligation, this designation does not help you get your own credit history. Officially referred to as “Business/Commercial” and identifies that the company reported in the name fields is contractually liable for the account.

Undesignated. No status was reported by the creditor reporting the account information and is not used on accounts opened after 06/1977.

 

How will a divorce or separation affect my credit?

Here are some tips for handling the credit aspects of divorce, both in the planning stages and afterward.

Cancel All Joint Accounts. First, it is important to cancel all joint accounts immediately once you know you are going to obtain a divorce.

Creditors have the right to seek payment from either party on a joint credit card or other credit account, no matter which party actually incurred the bill. If you allow your name to remain on joint accounts with your ex-spouse, you are also responsible for the bills.

Some credit contracts require that you immediately pay the outstanding balance in full if you close an account. If so, try to get the creditor to have the balance transferred to separate accounts.

If Your Spouse’s Poor Credit Affects You. If your spouse’s poor credit hurts your credit record, you may be able to separate yourself from the spouse’s information on your credit report. The Equal Credit Opportunity Act requires a creditor to take into account any information showing that the credit history being considered does not reflect your own. If for instance, you can show that accounts you shared with your spouse were opened by him or her before your marriage and that he or she paid the bills, you may be able to convince the creditor that the harmful information relates to your spouse’s credit record, not yours.

In practice, it is difficult to prove that the credit history under consideration doesn’t reflect your own, and you may have to be persistent.

Women: Maintain Your Own Credit-Before You Need It. If a woman divorces, and changes her name on an account, lenders may review her application or credit file to see whether her qualifications alone meet their credit standards. They may ask her to reapply, although the account remains open.

Maintaining credit in your own name avoids this inconvenience. It can also make it easier to preserve your own, separate, credit history. Further, should you need credit in an emergency, it will be available.

Do not use only your spouse’s name, for example, “Mrs. John Wilson” for credit purposes.

Tip: Check your credit report if you haven’t done so recently. Make sure the accounts you share are being reported in your name as well as your spouse’s. If not, and you want to use your spouse’s credit history to build your own, write to the creditor and request the account be reported in both names.

Find out if there is any inaccurate or incomplete information in your file. If so, write to the credit bureau and ask them to correct it. The credit bureau must confirm the data within a reasonable time period, and let you know when they have corrected the mistake.

If you used your spouse’s accounts, but never co-signed for them, ask to be added on as jointly liable for some of the major credit cards. Once you have several accounts listed as references on your credit record, apply for a department store card, or even a Visa or MasterCard, in your own name.

If you held accounts jointly and they were opened before 1977 (in which case they may have been reported only in your husband’s name), point them out and tell the creditor to consider them as your credit history also. The creditor cannot require your spouse’s or former spouse’s signature to access his credit file if you are using his information to qualify for credit.

Tip: A secured credit card is a fairly quick, easy way to get a major credit card if you do not have a credit history.

What factors affect my credit rating?

Your credit rating is affected by a number of different factors, some obvious and others few consumers are aware of. The following factors are discussed below:

  • Whether you have a credit card or use another person’s credit card
  • Whether you have a bank checking or savings account
  • Where you live
  • Your age
  • Your debt-income ratio
  • Whether you have declared bankruptcy or have had “charge-offs” to your account
  • Whether you are delinquent in any child support payments
  • Whether you have “too much” credit available

Does having a credit card or using another person’s credit card improve my credit rating?

One of the best things you can have on a credit report is a bank credit card– such as a Visa, MasterCard or Discover card -that has been paid on time over a specified period in the past. In a credit scoring system, a good bank card reference usually carries more weight than an American Express card or a department store card.

If you are an authorized user (someone who has permission to use a credit card, but is not legally liable for the bills) on someone else’s account, the payment history will likely be reported in your credit file, but you won’t be able to rely on it to help you build your own credit rating. Usually, it will neither help you nor hurt you when you apply for a loan.

Does having a checking or savings account improve my credit rating?

A checking or savings account will usually enhance your credit rating. Some banks give you extra points in applying for their credit card if you have a checking or savings account with them. In fact, some banks also give discounts on loan rates when you hold other accounts with them.

Is my credit rating affected by where I live?

Many creditors give a higher score to those who have lived at the same address for at least two years. Others give extra points just for living in the same area for two years or more.

Creditors may take into account your geographic location in scoring your length of time at one address. If you live in a city, where people move more often, the length of time at your address will probably count less than if you live in the country.

If your address is a post office box, you may find yourself turned down for credit. To fight fraud, some creditors screen out applicants whose addresses indicate commercial offices, mail drops or prisons.

Since post office boxes or rural delivery boxes are commonplace in rural areas, a lender may issue a card to that address while rejecting applicants with a P.O. Box in a large city.

People who own their homes usually earn a higher score than renters.

Does my age affect my credit rating?

If a lender’s credit experience shows that people in a certain age group have a better record of paying their bills than people of other ages, that lender may, legally, give a higher score to the better-paying age group.

However, the Equal Credit Opportunity Act (ECOA), a federal law intended to prevent discrimination in lending, does not allow lenders to discriminate against people age 62 or over. The ECOA requires creditors using a scoring system to give those aged 62 and older an age-factor score at least as high as the best score given to anyone under age 62.

How important is my debt-income ratio in determining my credit-worthiness?

Some creditors look at your “debt/income ratio” to determine whether you qualify for credit and how much credit you qualify for.

To find your debt/income ratio, total up your monthly payments on all bills. Then, divide these payments by your monthly gross income (before tax). This is your debt/income ratio.

If it’s less than 28 percent, you should have no trouble getting a loan (and can consider yourself successful at managing your debt and maintaining a good credit rating). If it falls between 28 percent and 35 percent, you have what’s considered high debt, and you may find it difficult to obtain some loans. If your debt/income ratio is 35 percent or more, you will probably not be able to get additional credit. More importantly, you are potentially in financial jeopardy.

Keep in mind that these are general guidelines. Some large card issuers will accept debt ratios as high as 40-45 percent. Others compare your net (after-tax) income to your debts to determine your debt ratio.

Tip: In determining your debt/income ratio, do not include payments for your mortgage, utility bills, doctor bills or other items that do not appear on your credit report: The creditor will not look at these.

If you should incur unexpected expenses, get ill, lose your job, or get divorced, you could find yourself unable to meet your obligations. Consider seeking credit counseling through a local non-profit consumer credit counseling service.

Will bankruptcies or “charge-offs” affect my credit rating?

Most lenders (but not all) will automatically reject you if your application or credit file indicates a bankruptcy. Both types of bankruptcy — Chapter 13 (the wage-earner’s plan under which all debts are eventually repaid) and Chapter 7 (straight bankruptcy) — remain in your credit files for ten years. Few creditors draw any distinction between the two types, so you don’t get any “credit” for having repaid your bills using Chapter 13.

In addition to the bankruptcy itself remaining on your report for ten years, each separate account that was discharged through bankruptcy can be reported in your file for up to seven years.

“Charge-offs” (accounts written off as “un collectible”) and “collection accounts” (accounts sent either to the creditor’s own collection department or to an outside collection agency) are extremely negative.

Note: If an account that has been charged-off (other than for bankruptcy), the creditor will usually turn it over to a collection agency, which will then attempt to collect. It then becomes a “collection account” for reporting purposes.

Tip: If you pay the charged-off amount, make sure the creditor updates the account as a “paid charge-off.”

Tip: In exchange for paying off a collection account, you may be able to negotiate with the creditor or collection agency the permanent removal of the negative information from your credit bureau files. However, lenders are under no obligation to make such an agreement.

Will delinquent child support payments affect my credit?

Delinquent child support frequently appear on credit reports. In 1984, Congress amended the federal Child Support Enforcement (CSE) legislation to require more routine reporting of delinquent payments.

State child support enforcement agencies must report overdue child support to a credit bureau that requests such information, as long as the amount exceeds $1,000. CSE agencies may also report delinquencies of any amount on a voluntary basis.

Before a CSE agency reports your delinquent child support debts to a credit bureau, it must tell you that it is going to do so and provide you with information on how to dispute the delinquency.

Can my credit rating be negatively affected by having too much available credit?

You may be turned down for a loan because you have too much available credit. When creditors evaluate your application for credit, they ascertain whether, if you were to use all your available credit, you would be over your head.

Accounts you no longer use, or have paid off, can count against you if they are listed as “open” on a credit report. The act of paying off a revolving account does not, in itself, result in its being “closed” in the eyes of creditors. Further, some creditors do not report to credit bureaus the fact that accounts are closed.

Tip: Every time you close an account, ask the creditor to report it as “closed by consumer” to all credit bureaus to which the account has previously been reported. If a closed account appears on your credit report as open, dispute the entry with the credit bureau.

In determining whether you have too much available credit, creditors usually consider:

    • The number of accounts you hold. As noted above, having too many credit card accounts can count against you.
    • The total credit you have available. Having too much available credit can count against you.

Conversely, being at or near the limit on your credit cards (i.e., with little available credit) can also count against you if it suggests that you have incurred too heavy a debt load.

How can I tell whether I have too much debt?

If you answer yes to any one of the following questions, you should take action:

  • Have you run several credit cards up to the limit?
  • Do you frequently make only the minimum monthly payments?
  • Do you apply for almost any credit card you are offered–without checking out the terms?
  • Have you used the cash advance feature from one card to pay the minimum payment on another?
  • Do you use cash advances (or a credit card) for living expenses such as food, rent, or utilities?
  • Are you unable to say what your total debt is?
  • Are you unable to say how long it would take you to pay off all your current debts (excluding mortgages and cars) at the rate you have been paying?

If you find several of these statements describe your credit habits, it may be that you need to take steps to manage your debt before bill collectors start calling and your credit history is endangered.

What steps should I take if I get into financial trouble?

Here are some specific steps you can take if you are in financial trouble.

    1. Review each debt that creditors claim you owe to make certain you really owe it, and that the amount is correct.
    2. Contact your creditors to let them know you’re having difficulty making your payments. Tell them why you’re having trouble. Try to work out an acceptable payment schedule with your creditors.

Tip: Do not wait until your account is turned over to a debt collector. At that point, the creditor has given up on you. As soon as you find that you cannot make your payments, contact your creditors to try to work out a reduced payment plan.

    1. Budget your expenses. Create a spending plan that allows you to reduce your debts. Itemize your necessary expenses (such as housing and healthcare) and optional expenses (such as entertainment and vacation travel). Stick to the plan.
    2. Try to reduce your expenses. Cut out any unnecessary spending such as eating out and expensive entertainment. Consider taking public transportation rather than owning a car. Clip coupons, purchase generic products at the supermarket and avoid impulse purchases. Above all, stop incurring new debt. Consider substituting a debit card for your credit cards.
    3. Use your savings and other assets to pay down debts. Withdrawing savings from low-interest accounts to settle high-rate loans usually makes sense.

Tip: Selling off a second car not only provides cash but also reduces insurance and other maintenance expenses.

Tip: If you are unable to make satisfactory arrangements with your creditors, there are organizations to help you with your financial situation. For instance, Consumer Credit Counseling Service (CCCS) agencies, which are local, nonprofit organizations affiliated with the National Foundation for Consumer Credit (NFCC), provide education and counseling to families and individuals.

To contact a CCCS office for confidential help, look in your telephone directory white pages, or call 1-800-431-8157 for an office near you. To contact the National Foundation for Consumer Credit Counseling and connect with an NFCC Certified Consumer Credit Counselor call 800-388-2227.

Tip: Some people with debt problems have found that Debtors Anonymous, General Service Office, PO Box 920888, Needham, MA 02492-0009, 1-800-421-2383 has provided helpful service.

Personal bankruptcy, a serious step, should be considered only if other means have been exhausted, and only if it is the best way to deal with financial problems. A skilled and trusted bankruptcy lawyer should be consulted.

What can I do if I am being hounded by a debt collector?

If you fall behind in paying your creditors, or an error is made on your accounts, you may be contacted by a “debt collector.” The Fair Debt Collection Practices Act prohibits certain practices by debt collectors.

What to do: To stop a debt collector from calling you, write a letter to the collection agency telling them to stop. Once the agency receives your letter, it may not contact you again except to say there will be no further contact. Another exception is that the agency may notify you if the debt collector or the creditor intends to take some specific action.

If you believe a debt collector has violated the law by harassing you, you have the right to sue a collector in a state or federal court within one year from the date you believe the law was violated. The following practices are specifically prohibited.

Harassment, Oppression, or Abuse. For example, debt collectors may not:

  • Use threats of violence or harm against the person, property, or reputation
  • Publish a list of consumers who refuse to pay their debts (except to a credit bureau)
  • Use obscene or profane language
  • Repeatedly use the telephone to annoy someone
  • Telephone people without identifying themselves
  • Advertise your debt

False Statements. For example, debt collectors may not:

  • Give false credit information about you to anyone
  • Send you anything that looks like an official document from a court or government agency when it is not
  • Use a false name
  • Falsely imply that they are attorneys or government representatives
  • Falsely imply that you have committed a crime
  • Falsely represent that they operate or work for a credit bureau
  • Lie about the amount of your debt
  • Lie about the involvement of an attorney in collecting a debt
  • Indicate that papers being sent to you are legal forms when they are not
  • Indicate that papers being sent to you are not legal forms when they are
  • Tell you that you will be arrested if you do not pay your debt
  • Tell you they will seize, garnish, attach, or sell your property or wages, unless the collection agency or creditor intends to do so, and it is legal to do so
  • Tell you that actions, such as a lawsuit, will be taken against you, which legally may not be taken, or which they do not intend to take

Unfair Practices. For example, collectors may not:

  • Collect any amount greater than your debt, unless allowed by law
  • Deposit a post-dated check prematurely
  • Make you accept collect calls or pay for telegrams
  • Take or threaten to take your property unless this can be done legally
  • Contact you by postcard

What are my rights against banks, creditors and debt collectors?

You have the following rights:

  • Banks. If you have a complaint about a bank in connection with any of the Federal credit laws or if you think any part of your business with a bank has been handled in an unfair or deceptive way write the nearest office of the Federal Trade Commission or Consumer & Community Affairs, Board of Governors of the Federal Reserve System, 20th & Constitution Avenue, N.W. Washington, D.C. 20551.
  • Credit Clinics. File a complaint with the Better Business Bureau, your state attorney general’s office, and the Federal Trade Commission (FTC).
  • Debt Collectors. Report any problems you have with a debt collector to your state Attorney General’s office and the Federal Trade Commission.
  • Other Institutions. The Federal Trade Commission enforces a number of federal laws involving consumer credit, including the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Fair Credit Billing Act, and the Fair Debt Collection Practices Act.

You may also take legal action against a creditor. If you decide to bring a lawsuit, here are the penalties a creditor must pay if you win:

  • Truth in Lending and Consumer Leasing Acts. If any creditor fails to disclose information required under these Acts, or gives inaccurate information, or does not comply with the rules about credit cards or the right to cancel certain home-secured loans, you as an individual may sue for actual damages-any money loss you suffer. In addition, you can sue for twice the finance charge in the case of certain credit disclosures, or, if a lease is concerned, 25 percent of total monthly payments. You may also be entitled to reimbursement for court costs and attorney’s fees.
  • Equal Credit Opportunity Act. If you think you can prove that a creditor has discriminated against you for any reason prohibited by the Act, you as an individual may sue for actual damages plus punitive damages of up to $10,000.
  • Violations by Debt Collectors. You have the right to sue a collector for violations under the Fair Debt Collection Practices Act in a state or federal court within one year from the date you believe the law was violated. If you win, you may recover money for the damages you suffered. A group of people also may sue a debt collector and recover money for damages up to $500,000, or one percent of the collector’s net worth, whichever is less.
  • Fair Credit Billing Act. A creditor who breaks the rules for the correction of billing errors automatically loses the amount owed on the item in question and any finance charges on it, up to a combined total of $50- even if the bill was correct.
  • Fair Credit Reporting Act. You may sue any credit reporting agency or creditor for breaking the rules about who may see your credit records or for not correcting errors in your file. A person who obtains a credit report without proper authorization or an employee of a credit reporting agency who gives a credit report to unauthorized persons may be fined up to $5,000 or imprisoned for one year, or both.

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