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Debt Avalanche vs. Snowball Method
When you’re getting ready to shop for a house, you need to be clear on your current financial situation and where you need to be, ideally before you start trying to work with lenders.
The amount of existing debt in your name will play a big role in whether you’re approved for a mortgage and how much house you can buy.
Paying off as much debt as you can before you start shopping for a home loan is critical, but it’s not an easy undertaking.
When you get ready to pay off debt, you might want to follow a method like the debt avalanche or the debt snowball. These are two popular methods to tackle debt, and they have a lot of similarities but a few differences, which we compare below.
The general idea of both the avalanche and snowball method is that you’re paying minimum payments on all your debt except the one your primarily focusing on at the time.
The Debt Avalanche
The debt avalanche method begins by figuring out the minimums you have to pay on all your debt, with the exclusion of your current mortgage if you have one. You’ll order your debts from the highest interest rates down to the lowest. Then, you’ll create a budget.
Your budget will show you how much more you can put toward debt every month to speed up your payoff.
Whatever the highest-interest rate debt is, it becomes your priority. If you have an extra $200 you can put toward debt, which you see after creating a budget, that money goes toward your highest interest debt each month until it’s paid off.
You keep moving down the list based on the highest interest rates, rolling your minimums into your extra payment amount until everything is repaid.
You have to be mindful of things like a promotional interest rate ending.
The avalanche method is a cheap, logical, and easy-to-follow path to getting rid of debt, but it can take a while.
The Snowball Method
With the snowball method, the underlying concept is the same, except you start paying off your debts with the one that has the smallest balance. You work your way up to the biggest balance, and you don’t consider interest rates in the order of repayment.
The snowball method works well for someone with a lot of little dispersed debt. You might be managing many minimum payments, and you can feel like you’re always paying bills, which gets discouraging.
When you start paying the smallest first, you can feel like you’re making some success as you chip away at them.
People find that, mentally, the snowball method works for them because it builds their confidence as they tackle increasingly large challenges throughout the process.
The Biggest Takeaway
Some people feel strongly about both methods and favor one over the other.
The avalanche method tends to be the most logical approach, while the snowball method is more emotional because it’s about little wins.
Regardless, the biggest takeaway is the same—you should choose one debt and put as much towards it as you can until it’s paid off. Pick whichever you want, but you’re creating a more manageable situation for yourself by choosing one.
FHA vs. Conventional Loan: Which is Right for You?
When you feel ready to buy a house, different types of loans may be available to you. Two primary mortgage options are an FHA loan and a conventional loan. Below, we briefly compare each to help you understand which might be right for your situation.
What is an FHA Loan?
The Federal Housing Administration insures FHA loans. The government-backed loans have less stringent borrowing qualifications. Some people go with this type of loan if they don’t have a big down payment or they have a lower credit score.
What is a Conventional Loan?
Conventional loans aren’t issued, nor are they guaranteed by a government agency. Private lenders insure these loans. You’ll need a better credit score and lower debt-to-income ratio to qualify for a conventional loan, as well as a down payment of usually at least 20%.
A conventional loan is also known as a conforming loan because they conform to standards set by Fannie Mae and Freddie Mac. These groups buy mortgages from lenders, holding them or turning them into mortgage-backed securities.
You can opt for a conventional loan with a fixed rate interest rate or an adjustable rate. The terms of a conventional loan usually range from 10 to 30 years, with 15 and 30-year mortgages being the most common.
Below, we look more comprehensively at some of the differences between these two primary home loan types.
Your credit score is three digits, and it can be anything from poor to excellent. According to most lenders, a poor score is anywhere from 350 to 570, with an excellent score being anything 800 and above.
The bulk of lenders will look at the FICO Score. The FICO Score is a credit scoring model created by the Fair Isaac Corporation. There’s also the VantageScore model.
Three credit bureaus report credit scores: Experian, Equifax, and TransUnion. Your scores can vary between the three.
Credit score depends on your history of making on-time payments, your mix of types of credit, how long your credit history is, and how you use your credit.
Most lenders require that you have at least a 620 to qualify for a conventional loan but generally like to see scores higher than this. For an FHA loan, you can qualify with a score as low as 500 because there’s less risk for the lender since the government backs the loan.
The lower your score, the more of a down payment you have to put down.
A 20% down payment is usually the standard for a conventional loan. Not everyone has 20% down for a house, though. You don’t have to put this much of a down payment on a house, but with a conventional loan, if you don’t, you’ll have to pay for private mortgage insurance or PMI.
To get an FHA loan, if you have a credit score that is at least 580, your down payment can be as small as 3.5%. If your score ranges from 500 to 579, you have to put 10% down.
Several key factors influence mortgage interest rates, including demand, the condition of the economy, and the Federal Reserve. Lenders also look at your financial history, how much you’re borrowing, and your down payment when deciding on your interest rate.
If you want lower interest rates, you pay lender discount points. Then you can have a lower monthly payment.
The FHA interest rates are often comparable with conventional mortgages and based on similar factors.
This year, the conventional loan limit in the lower 48 states is $647,200. In Alaska and Hawaii, it’s $970,800. In high-cost areas, it’s also $970,880. Someone who wants to get a loan that’s more than these limits would have to get a jumbo loan.
Jumbo loans are non-conforming because Fannie Me and Freddie Mac don’t back them. The underwriting guidelines are stricter, and they’re harder to get.
For an FHA loan, the limit depends on where you’re buying. The upper limit in counties considered low-cost is $420,680. In the high-cost county, the highest limit is $970,800.
A conventional loan tends to make the most sense for people who have a credit score of a minimum of 620, a down payment of at least 20% to avoid PMI, and a low debt-to-income ratio. An FHA loan might be good for a borrower who doesn’t have a high credit score, has a higher DTI, or has less money available for a down payment.
What is a Hard Money Loan?
An alternative type of loan, hard money loans, can provide financing in particular situations. If you need money fast or don’t qualify for a more traditional type of loan, you might consider hard money loans.
Below, we explore what a hard money loan is and its implications.
These loans are secured by real property rather than being secured by your creditworthiness as a borrower.
An individual or a private company provides hard money loans rather than traditional lenders. These are usually short-term and non-conforming. The loan is secured like a traditional mortgage because there’s a guarantee by the property that the funding is being used to buy.
The loan’s name comes from the fact that the tangible asset, aka the property, is used to back the loan’s value. If you default on a secured loan, the lender can take the asset over to regain their losses.
Hard money loans usually have an easier and faster approval process—much more so than traditional mortgages and other types of secured loans.
With a mortgage, it can take more than a month from the time you apply to when you close to buy a property. If you get a hard money loan, you might be able to close in a few days.
Working with Hard Money Lenders
A private investor or company specifically working in this type of lending is who you would go to for a hard money loan. You’re not going to find this option by going to a local bank. These lenders don’t have to follow the same stringent regulations that conforming lenders do, so they can decide who they want to lend.
Hard money lenders set their own debt-to-income ratios and credit scores. Even if a traditional lender denies you, a hard money lender might give you a loan.
The biggest consideration for hard money lenders is the value of the property you’re using the funding to buy instead of your creditworthiness as a borrower.
How Does the Process Work?
A hard money lender might still go through a quick credit check, but it’s not as stringent as getting a traditional loan.
While it can sound great, especially for borrowers who wouldn’t otherwise be approved, there are downsides. The lender is taking on a lot more risk with this approach to lending, meaning the loan is likely to be more expensive for you.
The interest rates are high, and some lenders will require much larger than normal down payments.
These loans are also short-term in many cases. That means you could have just a few years to pay them back instead of a term of 15 or 30 years.
Who Uses These Loans?
Real estate investors are the primary market for hard money loans.
Investors who flip houses, for example, may use hard money funding. Flipping a house and reselling it usually can happen pretty quickly. When a flipper finds a good deal on a property, they want to act fast, so the quick funding of hard money is appealing. Flippers also usually sell the house fast, so they don’t need a long loan term anyway.
If someone wants to buy a rental property as an investment, the idea is similar.
If you’re a business owner who wants to buy commercial property, hard money funding can help you when you’re not able to get traditional financing.
Interest Rates on Hard Money Loans
The interest rates are going up on conventional 30-year fixed-rate mortgages. The average right now is nearly 6%.
Back in the fall of 2021, when interest rates were averaging 3%, hard money loans had interest rates of anywhere from 8-15%. Now, they’re significantly higher.
Hard money loans are expensive and risky. They’re best left to professional real estate investors as a result. They’re not an ideal option if a traditional lender can’t approve you. Instead, work to deal with the root causes of why you aren’t able to get a mortgage and try to fix those issues.
What Should You Know If You Inherit a House?
Inheriting a house can bring about a range of emotions. You might feel sad because it likely means you’ve lost a loved one. It can also be overwhelming to know what steps you should take next and what the financial implications are. It can also be exciting because a house can be a huge asset.
So what should your first steps be if you inherit a house?
You essentially have three options if you find yourself in this situation. You can sell it, move into it or rent it to someone.
First, when you inherit a house, you’ll have to think about the legal and financial responsibilities that come with it. There may be debt obligations, for example. You also have to think about the tax liabilities that come with inheriting property, which may include capital gains and federal estate taxes.
If you inherit a home, there’s no federal inheritance tax, but some states have an inheritance tax. In most cases, you don’t automatically face a tax liability if you inherit property.
Capital gains are taxes linked to the profit you generate from an asset, including a house. If you sell the home, you may be subject to capital gains taxes. You could pay taxes on the difference between the fair market value when you inherited a home and the selling price.
If you keep the home, you might be eligible for an exclusion.
Is There Currently a Mortgage?
If you inherit a home that’s paid for, you have fewer financial considerations to weigh.
If the property has an open mortgage, you might assume it, which would mean you take over the payments as an heir and you pay off the debt based on the original terms of the mortgage.
Some loans, including reverse mortgages, require that the unpaid balance is due either when the loan holder passes away or upon sale. That would mean as an heir, if there is an open reverse mortgage, you would be required to sell the home and then settle the remaining debt.
Did You Inherit a House with Your Siblings?
A common and also complicating scenario occurs if multiple siblings or other family members all inherit a house. This means multiple opinions might be part of the decision as to what to do with the property.
If there are multiple stakeholders, then options include a buyout. In this case, if one sibling wants to keep the home for whatever reason, they can buy the other sibling out.
One of the simplest things to do is to sell the home and split the profits. You might also rent it out and split those profits.
If you can’t agree on what to do, then you may need to file a lawsuit for partition. This asks a judge to order the sale of the home. You’ll have to pay legal fees, and this is time-consuming, so you’re going to receive less than you would have without having to resort to this step.
Can You Move into the House?
If there aren’t complicating factors or if the people who share ownership of the property agree to it, you might want to move into a home you inherit. If there’s an outstanding mortgage, again, you’ll have to think about whether or not you’re in a position to take on that debt and whether it makes good financial sense to do so.
You have to think not just about the mortgage payment, but property taxes as well and any other associated costs of keeping the home.
If there aren’t debt obligations, you may be able to sell your current home and move in without worrying about taking on debt.
If you decide to sell the home you inherited, you have to cover any repairs that are needed and real estate agent fees and closing costs.
Again, if you fall in a particular tax bracket, you’ll also have to pay capital gains on the difference between the fair market value of the property when you inherited it and what you sell it for.
Many things factor into what you should do when you inherit a home, from whether or not the home is debt-free currently to how many people you now share it with. Do your research, so you understand all financial implications before making any decisions.
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|Mortgage Rates |
Averages as of June 2022:
30 yr. fixed: 5.1%|
15 yr. fixed: 4.31%
5/1 yr. adj: 4.2%