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10 Reverse Mortgage Myths and Misconceptions

A few common myths and misconceptions often confuse homeowners about Reverse mortgages. An experienced lender like New American Funding (NAF) can help you navigate these misconceptions. Read on to learn what a Reverse mortgage is and the truths around common beliefs about this loan.

What is a Reverse Mortgage?

A Reverse mortgage is a loan available to qualifying homeowners aged 62 or older, allowing them to convert a portion of their home equity into cash. It’s a valuable financial tool for seniors looking to access their home equity during retirement without selling their property or taking on additional monthly payments. Then upon death, moving, or the sale of the home, the proceeds from the sale pay off the reverse mortgage balance, and the remaining equity distributes to the borrower or their heirs.

Now that you know what a Reverse mortgage is, let’s look at what it is not by diving into common myths and misconceptions. You’ll also discover how a Reverse mortgage works in this article.

Myth 1: You Can Lose Your Home

One of the most persistent myths about Reverse mortgages is that borrowers can lose their homes. This misconception stems from a lack of understanding of the Reverse mortgage process and the safeguards to protect borrowers. If the borrower continues to live in the home, maintains the property, and pays property taxes and insurance, they will not lose their home.

Reverse mortgages have several built-in protections to ensure borrowers can continue living in their homes without fear of losing them. There are four Reverse mortgage safeguards:

  1. Non-Recourse Feature: Reverse mortgages are non-recourse loans, meaning that the borrower or their estate is not responsible for any amount of the loan that exceeds the home’s value when sold or otherwise disposed of. This feature means the lender cannot go after the borrower’s other assets to cover the loan balance.
  2. Mandatory Counseling: Borrowers must attend a counseling session with a HUD-approved counselor before obtaining a Reverse mortgage. This session helps borrowers understand the ins and outs of Reverse mortgages, their obligations as borrowers, and the potential risks and benefits associated with the loan. A Loan Officer with NAF can help guide you through the process.
  3. Loan Maturity Triggers: Reverse mortgages are due and payable when certain maturity events occur. These events include the borrower passing away, selling the home, or permanently moving out. The loan will not become due and payable as long as the borrower continues to live in the house and meets their other obligations.
  4. Federal Insurance: The most common type of Reverse mortgage, the Home Equity Conversion Mortgage (HECM), is insured by the Federal Housing Administration (FHA). This insurance protects both borrowers and lenders by ensuring that borrowers will continue to receive their loan payments even if the lender becomes insolvent, and it guarantees that the loan balance will not exceed the home’s value when it is sold or otherwise disposed of.

The myth that borrowers can lose their homes through a Reverse mortgage is a misunderstanding and misinformation. As long as borrowers meet their obligations, live in the house, maintain the property, and pay property taxes and insurance, they can continue enjoying the benefits of a reverse mortgage without fear of losing their homes.

Myth 2: Your Heirs Will Be Liable for Repaying the Loan

This misconception has led many potential borrowers to shy away from Reverse mortgages, fearing that they may leave their loved ones with a hefty financial burden. Here are two features of this loan that prevent that from happening:

  1. Non-Recourse Feature – Reverse mortgages come with a non-recourse feature, which means that the borrower’s heirs will never owe more than the home’s value at the time of repayment. This essential safeguard protects the borrower’s family from inheriting any debt beyond the home’s value. Even if the loan balance exceeds the home’s value, the heirs will not be responsible for the difference. 
  2. Repayment Options for Heirs – When a borrower passes away or leaves the home permanently, the Reverse mortgage becomes due. At this point, the heirs have several options for repaying the loan:
  • Sell the home: The most common repayment method is to sell the house. The proceeds from the sale pay off the loan balance, and any remaining funds distribute to the heirs. In this scenario, the heirs are not responsible for any additional repayment.
  • Refinance the Reverse mortgage: If the heirs want to keep the home, they can refinance it into a traditional mortgage or another financial product. Refinancing allows them to repay the Reverse mortgage loan balance and assume home ownership.
  • Pay off the loan with other funds: Sometimes, heirs may pay off the Reverse mortgage loan balance using additional funds, such as savings or proceeds from life insurance policies. Using other funds enables them to retain ownership of the home without having to sell it or refinance the loan.

Discussing the Reverse mortgage with heirs so they understand the features and the myths is also a great way to ensure you are on the same page. As well as working with a lender like NAF, who can also help you understand the safeguards of this mortgage.

Myth 3: You Have A New Monthly Payment

One of the most significant misconceptions about Reverse mortgages is that they create an additional financial burden by adding a new monthly payment. Reverse mortgages provide financial relief and flexibility for homeowners, particularly seniors who need extra income during retirement.

Here’s how this mortgage provides financial relief:

  • Extra Money On Hand. This type of mortgage provides older homeowners additional income during their retirement years by allowing qualified borrowers to convert their home equity into cash. The loan amount is determined based on several factors, including the borrower’s age, the home’s appraised value, and current interest rates. The homeowner can receive the loan proceeds as a lump sum, monthly payments, a line of credit, or a combination of these options.
  • No Monthly Payments. Unlike traditional mortgages, borrowers don’t need to make monthly mortgage payments. However, they must maintain their property, pay property taxes, and keep up with homeowner’s insurance.

Here’s how the mortgage works over time:

  • Loan Amount Increases Over Time. Interest and fees associated with the loan are added to the outstanding balance each month and aren’t due until the borrower’s death, permanent move, or home sale.
  • Equity Gets Distributed. Upon death, move, or sale of the home, the proceeds from the sale pay off the Reverse mortgage balance, and the remaining equity goes to the borrower or their heirs.

Not only is the myth of a new monthly payment with Reverse mortgages unfounded, but they provide financial flexibility for homeowners, particularly seniors, without adding the burden of a monthly mortgage payment.

Myth 4: You Don't Qualify Because Your Home Isn't Paid Off

Another common misconception about Reverse mortgages is that homeowners must own their homes outright to qualify for a Reverse mortgage. This myth discourages many potential borrowers from considering this financial tool. In reality, a Reverse mortgage can pay off an existing mortgage, and the home doesn’t need to be entirely debt-free.

Here’s how to use a Reverse mortgage to pay off an existing mortgage.

If you have a mortgage on your home, you can use the proceeds from a Reverse mortgage to pay it off. First, you must qualify for a Reverse mortgage by meeting these criteria:

  • Meet age requirements: Be at least 62 years old.
  • Primary Residence: The property must be the borrower’s primary residence.
  • Home Equity: The homeowner must have a significant amount of equity built up in their home, typically at least 50%.
  • Financial Capability: Borrowers should demonstrate the ability to cover property taxes, homeowner’s insurance, and home maintenance costs.

By using a Reverse mortgage to pay off an existing mortgage, homeowners can enjoy several benefits:

  • No Monthly Mortgage Payments: Homeowners eliminate their monthly mortgage payments by paying off the existing mortgage, providing financial relief and flexibility.
  • Increased Cash Flow: The remaining funds from the Reverse mortgage can supplement retirement income, pay off other debts, or cover unexpected expenses.
  • Financial Security: A Reverse mortgage can provide financial security for homeowners in retirement, ensuring a steady income stream and reducing dependence on other sources of funds.

The belief that a home must be paid off to qualify for a Reverse mortgage is a myth. A Reverse mortgage can pay off an existing mortgage, eliminating the need for monthly mortgage payments and increasing a homeowner’s financial flexibility

Another common misconception about Reverse mortgages is that homeowners must own their homes outright to qualify for a Reverse mortgage. This myth discourages many potential borrowers from considering this financial tool. In reality, a Reverse mortgage can pay off an existing mortgage, and the home doesn’t need to be entirely debt-free.

Here’s how to use a Reverse mortgage to pay off an existing mortgage.

If you have a mortgage on your home, you can use the proceeds from a Reverse mortgage to pay it off. First, you must qualify for a Reverse mortgage by meeting these criteria:

  • Meet age requirements: Be at least 62 years old.
  • Primary Residence: The property must be the borrower’s primary residence.
  • Home Equity: The homeowner must have a significant amount of equity built up in their home, typically at least 50%.
  • Financial Capability: Borrowers should demonstrate the ability to cover property taxes, homeowner’s insurance, and home maintenance costs.

By using a Reverse mortgage to pay off an existing mortgage, homeowners can enjoy several benefits:

  • No Monthly Mortgage Payments: Homeowners eliminate their monthly mortgage payments by paying off the existing mortgage, providing financial relief and flexibility.
  • Increased Cash Flow: The remaining funds from the Reverse mortgage can supplement retirement income, pay off other debts, or cover unexpected expenses.
  • Financial Security: A Reverse mortgage can provide financial security for homeowners in retirement, ensuring a steady income stream and reducing dependence on other sources of funds.

The belief that a home must be paid off to qualify for a Reverse mortgage is a myth. A Reverse mortgage can pay off an existing mortgage, eliminating the need for monthly mortgage payments and increasing a homeowner’s financial flexibility.

Myth 5: You Can't Sell Your Home

Many people believe that having a Reverse mortgage means they cannot sell their home. A Reverse mortgage does not prevent homeowners from selling their property; it might even be a strategic financial decision in some cases.

When you decide to sell your home with a Reverse mortgage, repay the loan using the proceeds from the sale. The remaining equity will belong to you or your heirs after paying off the loan balance, interest, and fees. This process gives homeowners the flexibility to sell their home when they see fit, especially if the house has appreciated, and can help them make the most of their investment.

An experienced Loan Officer, like at NAF, can help you understand if a Reverse mortgage is right for you.

Myth 6: Your House Must Be Debt-Free to Qualify for a Reverse Mortgage

Contrary to popular belief, having an existing mortgage on your home does not disqualify you from obtaining a Reverse mortgage. One of the primary uses of a Reverse mortgage is to help borrowers pay off their existing mortgage and free up their monthly cash flow.

When you apply for a Home Equity Conversion Mortgage (HECM), the most common type of Reverse mortgage, any existing liens or mortgages on your property must be paid in full when closing. This rule ensures that the Reverse mortgage will be the only loan remaining on the property.

Consulting with a HUD-approved counselor and a financial advisor or attorney can help you determine if a Reverse mortgage is right in your financial circumstance.

Myth 7: A Reverse Mortgage Is a Government Benefit

One common misconception about Reverse mortgages is that they are government benefits. This myth likely arises from the fact that the most popular Reverse mortgage program, the Home Equity Conversion Mortgage (HECM), is insured by the Federal Housing Administration (FHA). Reverse mortgages are not government benefits, but loans provided by private lenders like NAF.

The FHA’s role in Reverse mortgages is to provide insurance for the HECM loans. This insurance helps protect both the borrower and the lender in case of default or other issues arising during the loan term. The FHA insurance guarantees that the borrower will receive their loan proceeds as agreed, and it also ensures reimbursement to the lender for any losses incurred due to the borrower’s default.

FHA insurance adds an extra layer of security for all parties involved, making the Reverse mortgage process more reliable and attractive to potential borrowers and lenders. The FHA’s involvement does not turn Reverse mortgages into government benefits making this another myth.

Myth 8: To Qualify For a Reverse Mortgage, Both Spouses Need To Be 62+

To qualify for a Reverse mortgage, only one spouse needs to be 62 years of age or older. If one spouse is under 62, they are the non-borrowing spouse. However, there are specific implications regarding the loan repayment terms for the non-borrowing spouse that couples should be aware of:

  • If the borrowing spouse passes away, the non-borrowing spouse has 90 days to put the property in their name and can stay home for the rest of their life.
  • If the non-borrowing spouse reaches the age of 62, they can apply for their reverse mortgage, and the funds available would then be accessible to them.

Myth 9: You Have Limited Options For Receiving And Utilizing The Loan Proceeds From a Reverse Mortgage

One common myth surrounding Reverse mortgages is that borrowers have limited choices regarding receiving and utilizing the loan proceeds. In reality, borrowers have various options when determining how to receive their funds and how to spend them.

Options for receiving loan proceeds include:

  • Lump sum: Borrowers can receive the entire loan amount upfront as a single payment. This option is helpful for those who need a large amount of money for a specific purpose, like paying off an existing mortgage or making a large purchase.
  • Monthly payments: Borrowers can opt for fixed monthly payments for a specified period or as long as they live in the home. This option provides a steady income stream to help supplement retirement income, cover living expenses, or pay for healthcare costs.
  • Line of credit: Borrowers can establish a line of credit that allows them to access the funds as needed. This option offers flexibility, as borrowers can draw on the line of credit whenever they require additional funds, and the available credit can grow over time.
  • Combination of Options: Borrowers can also choose various options, such as receiving a portion of the loan proceeds as a lump sum and the remaining amount as a line of credit or monthly payments.

You can utilize the loan proceeds in various ways, including:

  • Supplementing Retirement Income: Many borrowers use the proceeds to supplement their retirement income, ensuring they have enough money to cover their living expenses and maintain their desired lifestyle.
  • Paying off Debt: Borrowers can use the loan proceeds to pay off existing debts, such as credit card balances, car loans, or even their original mortgage. By eliminating these debts, borrowers can reduce their monthly expenses and improve their financial situation.
  • Funding Home Improvements: The loan proceeds can help make necessary repairs or improvements to the borrower’s home, such as installing a new roof, updating the kitchen, or making the house more accessible for aging in place.
  • Covering Healthcare Costs: Reverse mortgage funds can help cover the costs of healthcare expenses, including prescription medications, in-home care, or long-term care facilities.
  • Supporting Family Members: Some borrowers choose to use the loan proceeds to provide financial assistance to their children, grandchildren, or other family members, such as helping with college tuition or providing a down payment for a first home.

The myth that Reverse mortgage borrowers have limited options for receiving and utilizing the loan proceeds is untrue. Borrowers can choose from various payout options and use the funds for any purpose, allowing them to tailor the Reverse mortgage to their needs and financial goals.

Myth 10: Reverse Mortgages Are Designed To Take Advantage of Retirees

People misunderstand Reverse mortgages giving rise to the myth that they take advantage of retirees. In reality, retirement and Reverse mortgages go well together. These mortgages are legitimate financial tools designed to help seniors access their home equity during retirement.

There are essential financial obligations and considerations associated with Reverse mortgages that a borrower should consider. Expenses and fees include:

  • Origination fees
  • Property taxes
  • Mortgage insurance premiums
  • Interest rates
  • Closing costs
  • Decrease in home’s equity which could affect inheritance to heirs
  • Other loan requirements

Despite these considerations, many borrowers find that the benefits of a Reverse mortgage outweigh the potential drawbacks allowing them to enjoy their golden years without worrying about dwindling finances.

FAQs

Is it Hard to Sell a House That has a Reverse Mortgage?

Selling a house with a Reverse mortgage is similar to selling a traditional one. You can pay off the Reverse mortgage loan with the proceeds from the sale, and any remaining equity will belong to the homeowner or their heirs.

How Does a Reverse Mortgage Work?

A Reverse mortgage allows qualifying homeowners aged 62 and older to convert a portion of their home equity into cash. The loan does not require monthly mortgage payments; payment happens when the borrower sells the home, moves out, or passes away.

Do People Lose Their Homes With a Reverse Mortgage?

If the borrower continues to live in the home, maintains the property, and pays property taxes and insurance, they will not lose their home due to a Reverse mortgage.

Who Benefits Most From a Reverse Mortgage?

Qualified homeowners aged 62 and older, with significant home equity, and looking for additional income during retirement may benefit most from a Reverse mortgage. It’s essential to consider your financial situation and consult with a trusted lender like New American Funding to determine if a Reverse mortgage is the right option.

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How To Get Rid Of Private Mortgage Insurance

As you begin the process of searching for your dream home and figuring out how mortgages work, you’ll run into a lot of terminology around mortgage insurance. There are several different types of mortgage insurance that are each tied to various loan products. For instance, borrowers who use FHA loans (backed by the Federal Housing Administration) are required to pay a mortgage insurance premium (MIP). There are also ways to eliminate MIP as well.

Conventional loans, the most common home loan, require something called private mortgage insurance (PMI).

What Is PMI?

PMI is private mortgage insurance that is required by your lender on Conventional loans – most often, it’s required when a borrower puts down less than 20% as a down payment on their new home. PMI was created after the Great Depression as an alternative to Federal Government insurance, which was the only type that was available.

An example of a federally insured loan is an FHA loan. FHA loans are backed by the Federal Housing Administration. This means that should a borrower default on their loan, the FHA will pay the lender the remaining unpaid principal balance.

Conventional loans do not have that government backing. They follow guidelines that are set by Fannie Mae and Freddie Mac, or another private source. These two corporations are publicly traded and were created by the federal government to expand the mortgage industry. Since they are not insured by the government, they require their own insurance, which is PMI.

Things That Affect PMI

How much you will pay in PMI is directly related to how much money you are able to put down, what your credit score is, and your loan-to-value ratio (LTV).

Down payment amount: Your down payment is the initial amount of money that you put down on house. Each loan type has a different down payment requirement with various conditions. For Conventional loans, the down payment requirement is anywhere between 3%-20% depending on your credit score and other factors. If you are able to pay 20% up front, you will usually not have to pay PMI on the loan.

Credit score: Your creditworthiness is a significant factor in which loans you can qualify for, as well as the terms and conditions of that loan. Conventional loans often require a minimum credit score of 620 to qualify. Improving your credit score can affect the terms of your loan, including how much PMI you will pay. With a higher credit score, you might pay less PMI.

LTV: LTV is a “lending risk assessment ratio” that is used by a lender to determine how much risk they believe will be involved in lending to a particular borrower. It describes the monetary amount of the home loan you are borrowing as a percentage of the home’s value. The more money you can put down on the home you want to purchase, the lower your LTV will be. This, in turn, will lower your PMI.

When Does PMI Go Away?

Once you have PMI on your loan, getting rid of it will depend on your equity. Your equity is the difference between the value of your home and the amount of money you still owe. As you pay down your loan, your equity increases.

Once your equity reaches 22% of the original value of the home, your PMI will automatically end. This automatic cancellation is the result of the Homeowners Protection Act of 1998. The act was created to address the difficulties homeowners were experiencing when trying to cancel their PMI. It sets the standard based on the general acceptance of 80% LTV as sufficient evidence that the homeowner is committed to continuing to make timely and consistent mortgage payments. Once you have reached 22% equity in your home, your LTV will be 78%.

9 Ways to Remove Private Mortgage Insurance

1. Refinance your mortgage: Refinancing a mortgage is a common practice and a Loan Officer can help you make the transition. When you refinance a mortgage, you replace your current loan with a new one. This lets you choose new loan terms, like the type of interest rate, the amount, and the term length for repayment.

One of the main advantages of refinancing a mortgage is that, in some cases, it can allow you to get rid of your PMI. If you owe less than 80% of what your home is worth, or if it has increased in value since you took out your initial loan, you might be able to use refinancing to eliminate your PMI payments.

2. Automatic termination of PMI: As required by federal law, PMI will be automatically terminated on 1-unit primary and secondary homes when your loan is scheduled to be repaid down to 78% of the original value of the home. If you have an investment property or a 2-4 unit home, you can contact us at [email protected] or +1 (800) 893-5304 to find out when your PMI will be automatically terminated. Because an escrow account may be required for your type of loan, you may not be able to cancel it!

3. Request PMI cancellation: To cancel before the termination date, you must meet the requirements under federal law and submit payment to New American Funding Servicing department for an appraisal or other valuation that will be required by the investor of your loan to ensure that the value of the home has not decreased. Valuations ordered for a refinance or by a 3rd party will not be accepted.

4. Pay down your mortgage: The faster you can pay down your mortgage, the faster you will reach 20% equity in your home and be able to request PMI cancellation. Putting any extra money into your monthly payments can reduce the balance and decrease the amount of interest you pay over the life of the loan.

Anytime you get extra finances like tax returns or money from a side hustle, consider putting it towards your mortgage.

5. Order a new appraisal: Another way you may be able to get rid of PMI is if your home’s value has increased over the time you’ve been repaying the loan. In order to determine if your home value has changed, you’ll need to order a new appraisal.

An appraisal is an “unbiased professional opinion” of a home’s market value. Appraisals are a necessary part of the lending process because homes serve as collateral for the mortgage, so a lender needs an accurate estimate of what that collateral is worth in order to decide the loan amount.

Appraisals can cost anywhere from $300-700 depending on factors like size and the condition of the property.

6. Prepay your mortgage: Prepaying your mortgage is the process of adding extra money to pay down the principal of your loan. This could reduce the interest you pay and allow you to increase the equity you have in your home more quickly. The faster you can build equity in your home, the faster you can cancel PMI.

You can prepay your mortgage several ways. You can make extra monthly payments, biweekly payments, or if you get a surprise lump sum of money you can put that down as a one-time payment. You can also plan to make an additional annual payment. Prepaying your mortgage allows you to gain equity in your home more quickly, which will let you cancel PMI when you reach 20%-22%.

7. Home improvements: Since PMI is directly related to how much equity you have in your home, doing things that may increase the value of your home could help you build equity faster, which will allow you to cancel PMI faster.

Adding improvements to your home can be as simple as upgrading your appliances or as detailed as renovating your entire kitchen. Examples of common home improvements include:

  • Repainting
  • Energy efficient upgrades
  • Renovating for accessibility
  • Adding or replacing insulation, weather stripping, or other upgrades to increase durability
  • Upgrading appliances like your washer, dryer, or stove
  • New garage door
  • New windows
  • Landscaping
  • Upgrading your bathrooms
  • Creating a home office space

8. Remodel to add square footage: Remodeling your home can be expensive, so it may not be a good idea to do it with the intention of cancelling your PMI. But it is certainly something to keep in mind if you are interested in remodeling.

Square footage is one of the main factors that is considered by appraisers to decide the value of your home. When you begin the process of remodeling your home, you’ll want to consider the cost of the remodel vs. the increase in value to the home. Some remodels and renovations will likely have a more beneficial cost to value ratio than others, so researching your options can be helpful.

Various remodels and additions may be more or less beneficial to you depending on where you live and the conditions of the market. Some examples of home remodels and/or additions include:

  • Adding a bedroom
  • Adding a wooden deck
  • Adding an in-ground pool
  • Extending a room

Remodeling your home may add value to the property, which could increase the equity you have in your home. If you remodel then get your property reappraised and discover that you’ve reached 20%-22% equity, you might be able to have your PMI cancelled.

It is important to note that there is such a thing as “over improving” your home, so be mindful of the factors involved.

9. Track your property value: Since PMI depends on equity and equity depends on the value of the property, when the value of your property is affected, your equity and PMI may be too. If your property value increases, the amount of equity you have built in your home could increase as well. If it has increased to 20%-22% then you might be able to cancel your PMI.

Factors that affect your property value include:

  • The housing market: The conditions of the housing market affect the value of your home. These conditions include supply and demand, shifts in local laws, real estate trends, and socioeconomic shifts.
  • Location: The location of your property has a significant impact on its value. Its proximity to things like schools or other businesses could offer sought-after options for jobs and education. What neighborhood the property is in will also affect its market value as well as its proximity to highway access and public transportation.
  • Size: The amount of livable space as well as the size of the lot will affect the value of your home. This includes how many bedrooms and bathrooms the home has, how many rooms, and spaces like a deck or basement.
  • Condition: A well-maintained home that is in good condition and requires few repairs will have a higher value on the market than one that will require more maintenance. Age factors into this as well. A new home with modern amenities that won’t require as much upkeep will have a higher value.

These are not the only factors that will influence your home’s value. Keeping track of environmental factors like new developments in your area and law and economic changes could allow you to take advantage of shifts in the market.

Clean & Replace Filters

Breathe easy, buyer. Changing the air filters when you move in is good for myriad reasons: First, you get to see what size filters are needed throughout the home. Second, you’ll be able to rest easy knowing the filters you put in are new and up to standard.

But don’t stop at air filters. Dishwashers, refrigerators, washing machines, and dryers all have filters or screens that can be cleaned or replaced. Replacing or cleaning these items can prevent blockages and keep equipment in good working condition for years to come.

PMI Rights Under Federal Law

The Homeowners Protection Act was created to set guidelines and standards for borrowers who were having trouble cancelling their PMI. It provides the benchmarks for the equity, LTV, and PMI relationship and protects borrowers against unnecessary and unrestricted charges. Under this law, lenders are required to give you a way to cancel PMI once you’ve reached a certain benchmark.

FAQs

How Much Does PMI Cost?

How much PMI will cost depends on factors like how much money you put down for your down payment, what your credit score is, and your LTV. As well as the value of the home itself.

When Does PMI Go Away?

PMI will automatically go away once your loan balance reaches 78% of the original amount. This is true as long as you are up to date on your loan payments.

How Can You Avoid PMI?

In most cases, you can avoid PMI by paying a 20% down payment on your home. You can always ask your lender what their PMI thresholds are.

Can PMI be Removed if my Home’s Value Increases?

The value of your home increasing does not automatically mean you’ll be able to cancel your PMI. However, your home value increasing does increase your equity. If your equity increases to 20%-22% you may be able to remove PMI.

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Do You Pay Taxes On Cash-Out Refinance?

Understanding the financial effects of a Cash-Out Refinance is essential. One question that often comes up with homeowners is whether they must pay taxes on the money they receive from it. The short answer is no; the money you receive from a Cash-Out Refinance is not taxable. However, there are certain circumstances under which you could be liable for taxes. Read on to learn more. An experienced Loan Officer, like at New American Funding (NAF), can also help guide you through the process.

Cash-Out Refinance Overview

A Cash-Out Refinance is a financing method that allows homeowners to tap into their home equity by refinancing their current mortgage for a more significant sum of money. The homeowners receive the difference between the new and original mortgage in cash and can use it as they wish.

Is Cash-Out Refinance Taxable?

Contrary to popular belief, the cash obtained from a Cash-Out Refinance is not considered income by the IRS and is not subject to income tax. It’s not income because the money is essentially a loan – you’re using your home equity. That means you’re borrowing against the equity in your home, and you don’t have to report it on your tax return. There are circumstances where you can even save in taxes, but there are also certain cases where you could be liable for taxes.

What Are The Tax Implications Of A Cash-Out Refinance?

The tax implications of a Cash-Out Refinance primarily hinge on how you use the funds. There are potential tax benefits to Cash-Out Refinancing and specific circumstances where you can earn tax deductions or owe.

Can You Get A Tax Deduction From A Cash-Out Refinance?

In these scenarios, you could potentially get a tax deduction when you use the money in the following ways:

  • Make substantial home improvements – Homeowners can claim tax deductions on mortgage interest if they use the cash to make substantial improvements to their homes that increase the property’s value. For instance, renovating a rental property or adding a home office could provide tax savings opportunities. It’s important to note that not all upgrades are considered capital improvement by the IRS.
  • Purchase mortgage points – Homeowners who purchase mortgage points during the Cash-Out Refinance could potentially have an additional tax-deductible expense. Mortgage points, or discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate.
  • Add a home office – Homeowners who use the funds to create a designated workspace in the home could potentially write off a portion of the mortgage interest, property taxes, and even utility bills as business expenses. However, there are specific rules to qualify for this deduction.

You Could Be Liable For Tax Deductions When:

There are certain circumstances under which you could be liable for taxes, including these potential scenarios:

  • Profits from home improvement exceed the tax-free limit – The money from the refinance is used to substantially improve your home, increasing the home’s value and the potential capital gain when you sell the house. If the profit exceeds the tax-free limit the IRS sets, you may have to pay capital gains tax.
  • Deducting interest on the money that you don’t use for home renovations – The Tax Cuts and Jobs Act of 2017 changed the rules, allowing homeowners to deduct the interest on mortgage debt up to $750,000, but only when they use the money buy, build, or substantially improve the taxpayer’s home that secures the loan.
  • The home sells for a profit – In this case, you may owe capital gains taxes. However, if you’ve lived in the home for at least two of the last five years before selling, up to $250,000 of the profit (or $500,000 if you’re married and filing jointly) is tax-free.

Tax laws are complicated and can change, so consult with a tax professional to make the right choice for your financial situation.

Making Your Cash-Out Refinance Tax Deductible

A potential benefit of a Cash-Out Refinance is the possibility of tax deductions when you use the funds for eligible purposes, like improving your home or adding a home office.

Making Capital Improvements

Making capital improvements is one way to increase your chances of tax deductions because it adds value in the case of resale. Improvements like:

  • Adding a swimming pool – provides enjoyment and a sense of luxury and potentially increases the home’s resale value.
  • Adding a fence – enhances the aesthetic appeal, increases privacy, and adds security.
  • HVAC Replacement – new systems reduce energy consumption making it more cost-efficient.
  • Adding a new room – adds usable square footage to the home.
  • Upgrading the kitchen – improves functionality and energy-efficient appliances, saves money, and increases market appeal.
  • Installing energy-efficient home appliances or equipment – reduces energy usage and cuts down costs on utility bills.

Setting Up A Home Office

Using Cash-Out Refinance funds to set up a home office could also make you eligible for tax deductions. That’s because it’s a capital improvement that increases the value of your property. There are strict regulations around what constitutes a home office, though.

IRS Guidelines To Claim A Home Office

  • You use the space exclusively and regularly for business. Using it exclusively means not using the area for any other purpose, such as a playroom or a bedroom.
  • The office must be the principal place of business. If you have another office outside your home where you conduct most of your business, the IRS will not consider your home workspace a home office.

Expenses and Deductions

If your home office setup meets the IRS criteria, you can deduct expenses related to the business use of your home. These deductions could include:

  • Mortgage interest
  • Insurance
  • Utilities
  • Repairs

When using funds from a Cash-Out Refinance to set up your home office, you can deduct the portion of the mortgage interest directly proportional to the office’s square footage in relation to the whole house. Similarly, you can deduct a percentage of your utility bills, such as electricity and internet, based on the office’s size.

Alternatives To Cash-Out Refinance

While a Cash-Out Refinance can be beneficial, other alternatives are also worth exploring. Here are three options to explore, all with potential advantages, disadvantages, and tax implications.

1. Home Equity Loans – A Home Equity loan is a type of second mortgage that allows homeowners to borrow against the equity they have built up in their homes. Borrowing this way can provide substantial money for capital improvements or other significant expenses.

The interest rates for Home Equity loans are typically lower than those for personal loans or credit cards, making them a financially attractive option. However, the downside is that your home serves as collateral, meaning if you default on the loan, you risk losing your property.

2. Personal Loans – Personal loans are another alternative. Unlike Home Equity loans, personal loans don’t require putting up your home as collateral. Not having to put your home up for collateral can be a safer option if you’re uncertain about your ability to repay the loan. However, the interest rates on personal loans are typically higher than those on Home Equity loans or Cash-Out Refinances so they might cost more in the long run.

3. Saving and Budgeting – The old-fashioned approach of saving and budgeting requires discipline and patience. It’s the least risky. By setting aside a certain amount of money each month for your project, you avoid needing loans and associated interest payments.

Each of these alternatives has potential tax implications; the best choice will depend on your personal circumstances and needs. A Loan Officer at NAF can help you understand the steps to refinance your home and help you decide which loan may be right for you.

FAQ's

Can You Avoid Capital Gains Tax By Refinancing?

Refinancing your home does not directly affect your capital gains tax. Capital gains tax applies when you sell an asset for more than you bought, like property or stocks. Refinancing is simply changing the terms of your loan, not selling the property. However, taking cash out during refinancing and using it to improve your home may reduce the potential capital gains when you sell your home.

When Is A Good Time To Do A Cash-Out Refinance?

The best time to consider a Cash-Out Refinance is when interest rates are low, your home’s value has increased significantly, or you need a large sum of money for major expenses like home renovations, debt consolidation, or large purchases. Considering your financial situation and plans is essential, as refinancing can extend your repayment period and increase your total interest cost.

How Often Can You Refinance Your Home?

Technically, there’s no limit to how often you can home refinance. However, you may have to pay closing costs each time you refinance, which can add up over time. Also, lenders may have restrictions, such as requiring a specific time to pass between refinances. Base your decision on whether the benefits, like a lower interest rate or cash-out, outweigh the costs.

Do Taxes Go Up When You Refinance?

Refinancing your home does not typically increase property taxes, as your home’s assessed value determines taxes, not your mortgage. However, if you use a Cash-Out Refinance to fund significant home improvements, the value of your home may increase, potentially leading to higher property taxes. The value varies by area, so consulting with a tax professional or your local tax assessor’s office is best.

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Second-Tier VA Loan: What It Is and Who Qualifies

For active-duty military and veterans, second-tier VA loans may be able to fund and finance the dream of homeownership. The U.S. Department of Veterans Affairs works with top mortgage lenders such as New American Funding (NAF) to allow veterans to access funds. For many, VA home loans may be able to offer a helping hand while mapping out the road to the American Dream.

How Do VA Loans Work?

VA loan programs include specific types of loans provided by the . The programs assist eligible veterans as they navigate various housing hurdles. The VA has government-backed programs that address different stages of the homeownership process such as buying, building, and refinancing current loans. You may be able to receive a VA-backed loan from an approved mortgage lender such as NAF. If you meet the requirements, you may be able to qualify for VA loan entitlement.

VA loan entitlement examines if a veteran meets the requirements to access home loan assistance. The entitlement notes the amount an individual veteran may be able to receive as a guarantee for a loan.

How Many VA Loans Can You Have at the Same Time?

Depending on the situation, you may be able to have multiple VA loans at the same time. It’s possible to use the last of your remaining entitlement from your first VA loan to take out a second VA loan. The VA does not limit the total number of loans that you may receive throughout your life. Lenders such as New American Funding provide a wide selection of VA-backed loans ranging from a VA Purchase loan to a .

Veterans with full entitlement typically do not have loan limits. However, remaining entitlement is often subject to county loan limits. The VA does not require insurance such as mortgage insurance. Review VA home loan limits and speak with us to understand the opportunities available to you.

What Is a VA Loan Entitlement?

Entitlement is the amount the VA guarantees on a veteran’s loan. Veterans with full entitlement do not have exact loan limits. Entitlement might ensure that the VA covers a veteran’s down payment and 25% of the loan if the veteran defaults. Keep in mind entitlement has two layers.

The first layer allows a veteran to take out a loan to help fund a primary residence. A second-tier or second-layer VA loan indicates that a veteran likely has two loans. Second-tier entitlement may occur after a veteran previously purchased a home. In certain situations, a portion of the entitlement may be linked  to a mortgage. It’s possible to restore entitlement by fully repaying a loan.

If you qualify for a VA loan, you’ll receive a Certificate of Eligibility (COE), proving to lenders such as New American Funding that you have achieved both entitlement and eligibility.

Eligibility Requirements for a Second-Tier VA Mortgage

Eligibility requirements for a second-tier VA mortgage typically include minimum service requirements. The requirements surrounding a second-tier VA mortgage come into play once a veteran has made a first purchase using a VA loan.

Minimum Active Service Duty

The minimum active service duty requirements depend on when you serve. For example, the minimum active-duty service criteria for service members differs between WWII and the present day. You may qualify if you have served for at least 90 days in a row. Stipulations may vary between wartime and peacetime service.

Obtain a Certificate of Eligibility (COE)

A COE proves that you are eligible to obtain a second-tier VA mortgage. It is a necessary step when attempting to work with qualified lenders. You may need additional documents to receive your COE.

Keep in mind that you may be able to get a COE for hardship or a medical condition.

Income

Your debt-to-income ratio will determine your loan eligibility. The VA recommends a ratio of 41%. A debt-to-income ratio explains how much of your monthly income goes to pay off your debt. The VA does not have a maximum income limit for receiving VA benefits.

Credit

The VA does not have a standard minimum credit score. The VA takes into account various components of your entire loan. Improved credit may offer you access to better terms and rates.

Meet Lender’s Requirements to Receive a VA-backed Home Loan

Lenders have their own eligibility requirements. Reach out to your Loan Officer, to learn more about credit score or income expectations. Lenders often provide specific

How to Calculate Second-Tier Entitlement Amounts

When calculating a second-tier entitlement, it’s important to know the total amount of your loan. Secondary entitlement may differ depending on your remaining entitlement and county loan limits. The VA typically guarantees a portion of your loan. As a result of the guarantee, second-tier entitlement amounts as 25% of your total loan amount. You may only borrow the amount that you are qualified to receive and you can get an estimate for how much different types cost using our calculators.

3 Possible Second-Tier VA Entitlement Situations

You may be able to use a second-tier VA entitlement during different situations. For example, it may be possible to access your entitlement when keeping your house and making a new purchase, buying again after a VA mortgage default or exploring VA loan assumptions. Speak with your Loan Officer at NAF to know the options available to you.

Keeping Your House and Making a New Purchase

In some situations, you may be able to keep your house while you make a new purchase. This benefit allows you to maintain your current property while gaining ownership of a second property. You may be able to use the second property as your primary residence and make the first property into a rental. Restoring your entitlement may be able to help you fund an investment property or second home.

Buying Again After VA Mortgage Default

It’s usually possible to buy again after a VA mortgage default. A veteran must likely wait around two years after a default or foreclosure to become eligible. Having defaulted may not stop you from qualification.

To avoid defaulting, speak to your Loan Officer or contact the VA for financial counseling. It’s best to reach out when a veteran experiences difficulty making payments.

VA Home Loan Assumptions

As a VA loan holder, you have certain built-in rights. It’s possible to sell your home to an approved buyer who agrees to assume your loan. The buyer must meet certain credit expectations and agree to take on your liability to the lender and the VA.

Using Second-Tier VA Loan Entitlement Following Foreclosure or Bankruptcy

A veteran may be able to use a second-tier VA loan entitlement after a foreclosure or bankruptcy. If a veteran previously used some of their eligibility, then the lender will likely need to calculate the amount of eligibility tied to the property. A veteran may get a second-tier VA loan if they rebuild their credit and meet the minimum waiting period requirement.

Achieve More with a Second-Tier VA Loan

A second-tier VA loan can offer you the resources necessary to obtain funding. The VA works with approved lenders and may be able to support you in your building or buying endeavors. With the right team, you may be able to harness your eligibility and make it work for you as you step into future homeownership.

Frequently Asked Questions

How do You Determine Your Remaining Entitlement?

Determining your remaining entitlement depends on the maximum amount of entitlement available and the amount currently used. Speak with your Loan Officer to better understand your situation.

How Long do You Have to Wait to Use Your VA Loan Again?

VA loan benefits are lifetime benefits. Once a loan is paid , full entitlement may be restored. 

Can a Second Person Be on a VA loan?

Yes, it’s possible to have a second person on a VA loan. For example, a joint VA loan may include non-veterans like non-veteran spouses.

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All About Home Inspections

There are many variables in the homebuying process. There are applications for a loan and any assistance a borrower might want, approvals, and negotiations with the seller once your dream home has been found. One variable that is generally recommended for a new homebuyer is a home inspection. Home inspections are not usually required by a lender the same way an appraisal is, but they can be very beneficial to a buyer by giving them insight into the property they want to purchase and potentially helping them negotiate the price of the house. 

What is a home inspection?

A home inspection is essentially an unbiased report made by a qualified third party on the physical condition of a house. They can cost anywhere from $200-$1,000 depending on the location and square footage. When you are buying a home, the cost of the home inspection is usually included in your closing costs.

What is included in a home inspection depends on several variables. These can include:

The scope of the inspection: Certain systems may require specialized inspections to determine their condition and usability. For instance, a home inspector may examine certain aspects of the electrical system in your home and report on the state of the conductors or whether the outlets are loose. They cannot examine the state of the wiring in the walls. You would need an electrician if you are curious about the condition of your full electrical system.

Accessibility: Home inspectors will not enter restricted or locked areas or inspect places that are dangerous to their safety or generally inaccessible. For example, they may not fully examine your roof if it is dangerously steep or enter the attic if it’s behind a locked door.

Visibility: Your home inspector will examine components of systems and structures that are visible to them. For instance, they may record water damage to an internal wall and recommend that it be examined further for the possibility of mold or rot, but they cannot determine the presence of mold or rot themselves unless it is clearly visible.

In general, home inspections will cover visually accessible structural, systematic, exterior, and interior aspects of a home. These can include:

  • The home’s foundation
  • The floor
  • The roof
  • The ceiling
  • Walls and wall coverings
  • Exterior and interior doors
  • Windows
  • Any steps or stairs
  • Cabinets and countertops
  • Appliances
  • Insulation and ventilation
  • Heating and cooling systems
  • Electrical and plumbing systems
  • Driveway, patio, and walkways

Your home inspector will examine these structures and systems and create a detailed report of their observations and recommendations. They will note parts of the home that need repairs, may be close to wearing out, or may be indicative of further damage. They will provide photos and recommendations for next steps. The inspection itself generally takes 2-4 hours, though it may take longer depending on the size and condition of the home and you can usually expect to have the report within 2 days.

What a home inspection is not

A home inspection is not an appraisal, a guarantee, or an in-depth examination. Your home inspector will not tell you how much your house is worth and is not a replacement for specialized evaluations of your systems like electrical or plumbing. There are plenty of things home inspectors are not required to determine. These can include:

  • Market value or marketability
  • Whether or not you should purchase the property
  • The presence of hazardous substances
  • The presence of environmental hazards
  • Operating costs of current systems
  • Soil conditions
  • Potential liability
  • Surveying services

Why a home inspection is beneficial

Buying a home is one of the largest financial investments a person can make. Getting a home inspection can help you protect that investment by making sure that you know exactly what you’re getting. A home inspector will report on the things that need to be repaired and point out indicators of potentially larger issues that may end up costing you more than you expect in the long run. This allows you to make a fully informed decision about your purchase.

A home inspection can also give you negotiating power. For instance, if a home inspector finds potentially costly repairs are needed in some part of the home, you may be able to negotiate for a lower home price. You can also ask a seller to fix certain things before you agree to move in.

A home inspection report does not guarantee seller cooperation though, so you may want to have a home inspection contingency in your purchase offer. This contingency allows you to back out of the purchase transaction if you are dissatisfied with the results of the home inspection report.

Home inspection vs. appraisal

Home inspections and appraisals are often mentioned in the same context. Inspections are recommended and appraisals are usually required by your lender. Both are included in the closing costs of buying a home. But they have very different goals and consequences.

A home inspection records issues and potential issues with a home’s structure, systems, and interior and exterior aspects. A home inspection informs the buyer of the condition of the home they are considering purchasing. It can give you an idea of how much work you may need to do on a property and can warn you if there are things that may be potentially dangerous or costly in the future. Home inspections are recommended to help a buyer make an informed decision about the major investment that is buying a home.

Where a home inspection focuses on the condition of the home, an appraisal focuses on the value. Lenders require an appraisal of the property to confirm that the value of the property aligns with the loan amount the buyer is borrowing. This tells the lender whether or not the property value is enough to act as collateral for the loan itself. An appraiser evaluates the fair market value of a home by considering the condition of the home, its location, the land it sits on, and the value and/or sales price of other homes in the area.

Home inspection FAQs

Can a home fail an inspection?

No. Home inspections are not pass/fail examinations. They are simply objective observations of the condition of the home. They do not determine the value of the house or whether it is up to code, they just record the current state of the house. The impact the report has depends on the buyer.

What is included in a home inspection report?

The scope of the report depends on the home inspector, the size and structure of the house, and the accessibility of various components. You can find sample reports on the International Association of Certified Home Inspectors website.

Are home inspectors licensed?

Whether or not a home inspector is licensed depends on the requirements of the state in which they are located. Many housing-related regulations such homeowners insurance and home inspections vary by state. The American Society of Home Inspectors lists state-by-state regulations on their website.