Credit Utilization: What Is It and How Do You Calculate It?

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Your credit score reflects your financial status and impacts loan approvals, apartment rentals, and job opportunities. One crucial factor in calculating your credit score is the ‘credit utilization ratio’. Let’s explore what this means and why it matters.

The credit utilization ratio compares the credit you’ve used to the total credit limit available, represented as a percentage. For example, if you have three credit cards with a $10,000 limit each and balances of $6,000, $4,500, and $3,000 respectively, your credit utilization is 60%. High utilization can harm your credit score, as it suggests reliance on available credit. This ratio carries significant weight, accounting for almost 30% of your score.

Credit utilization is relevant to revolving credit, such as credit cards and open credit lines. It does not apply to installment loans. Calculating your utilization rate is simple: compile a list of your cards and credit lines, sum up your total card debt, determine your total credit limit, divide the debt by the limit, and multiply by 100.

Most experts recommend maintaining a utilization rate below 30% to show responsible credit usage. Consumers with top-tier credit scores had utilization below 10%. Note that while overall utilization matters, high utilization on any one card can be a red flag.

To ensure a healthy credit score, keep your per-card utilization within recommended limits.

Your credit score, indicating your financial health, is calculated based on important factors. Let’s examine these factors according to the widely used FICO scoring model:

  1. Payment History (35%): Demonstrates your reliability as a borrower. Late or missed payments raise concerns for lenders, indicating potential repayment difficulties.
  2. Credit Utilization or Amounts Owed (30%): Crucial in determining your credit score. High credit utilization suggests excessive debt, making lenders cautious.
  3. Length of Credit History (15%): Considers the age and activity of your credit accounts, including the time since last use.
  4. Variety in Credit (10%): Reflects diversity in your credit and lending accounts.
  5. New Credit (10%): Opening multiple accounts within a short period raises red flags for lenders, suggesting financial challenges.

To lower your credit utilization rate, consider the following strategies:

  1. Pay off more debt: Make extra credit card payments each billing cycle to gradually reduce your credit utilization ratio. Credit reporting agencies like Equifax, TransUnion, and Experian report credit card activity monthly.
  2. Distribute charges across multiple cards: If you mainly use one credit card, its high utilization ratio may not reflect your overall utilization. Distribute spending across several cards to ensure none exceeds a 30% utilization rate.
  3. Request a credit limit increase: If you have a good credit score, ask your credit card issuer for a higher limit. While you may not use the increased limit, it can help reduce your credit utilization ratio. Keep in mind that requesting new credit or balance transfer cards results in a hard credit inquiry, temporarily lowering your credit score.

Strategies for Financial Stability

To ensure financial stability, there are several strategies you can employ. One important aspect is understanding how to effectively use credit. By managing your credit wisely, you can avoid overspending and secure loans with lower interest rates in the future.

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What Is Annual Percentage Rate (APR)?

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The term Annual Percentage Rate (APR) is frequently used by financial institutions and plays a crucial role in real estate mortgage loans, although it may initially seem complex. Simply put, APR is the yearly cost of credit expressed as an interest rate. It helps compare the costs of different loans, such as mortgages. The mortgage APR combines interest and other fees, including closing costs and broker fees. While the interest rate focuses solely on the cost of interest, APR offers a more comprehensive understanding of the total interest cost by incorporating additional charges. When comparing loans, it’s important to consider APR instead of just interest rates to find the best lender. To understand APR, let’s consider a scenario where a bank offers a 30-year fixed-rate mortgage at 6.0% with closing costs and origination fees. The APR in this case would be 6.2%, slightly higher due to the additional fees. Variable APR can fluctuate over time, while adjustable-rate mortgages (ARMs) can change the interest rate and APR over time. Points and lender credits are promotional programs that can affect the APR. Understanding APR helps borrowers make informed decisions and budget effectively for real estate loans.

APR vs APY: A Detailed Comparison

When it comes to loans, Annual Percentage Yield (APY) is a common term. It represents the total cost of a loan, including compound interest over time. APY is typically higher than Annual Percentage Rate (APR) due to more frequent compounding. However, APR and APY are the same for simple interest loans.

For example, depositing $500 in a savings account with a 5% APY would earn you $25 in interest after one year. This compounding effect makes APY attractive for long-term savings.

APR helps borrowers understand the actual cost of a loan or mortgage over its lifetime, considering market conditions. By looking at the APR, you can determine which mortgage is more expensive, even if the interest rates are the same. APR provides a comprehensive view of all costs, aiding informed decisions about real estate acquisitions.

However, APR doesn’t account for every aspect of a mortgage loan. It doesn’t include costs from refinancing or prepayment penalties, which are crucial considerations. Additionally, factors like customer service and lender platforms’ usability should also be considered.

Understanding how APR is calculated is fundamental when making loan decisions. Comparing similar aspects when analyzing offers from different lenders is essential.

Fortunately, the Truth in Lending Act requires lenders to provide a disclosure statement to customers, detailing specifics such as APR, charges, upcoming payments, and the total cost of the mortgage.

To secure a lower APR, factors like credit scores, loan amount, down payment, loan type, location, and interest rate type come into play.

Understanding APR for Informed Mortgage Decisions

Understanding Annual Percentage Rate (APR) is crucial when considering mortgage loan options. It helps buyers make informed decisions on the best lender to choose. Evaluating APRs, not just interest rates, provides a comprehensive understanding of all loan charges from potential lenders. Knowing every aspect of your mortgage is essential for securing a beneficial deal. 

At Foothold, we simplify property management, allowing you to enjoy potential benefits. Explore available properties and envision your investment’s growth. Please note that the views expressed in this article are for informational purposes only and do not offer specific advice or recommendations. The views may change without prior notice. Refer to Foothold’s disclaimers for more information.

What is an FHA Loan?

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Don’t let high-interest rates hinder your dream of homeownership. Different loan programs are available to meet the diverse needs of potential and current homeowners. One such program is the FHA loan, guaranteed by the Federal Housing Administration. Learn more about this mortgage option to see if it’s right for you.

An FHA loan is a mortgage program backed by the Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development (HUD). Established in 1934, this mortgage offers flexibility, making homeownership accessible for individuals with high debt or lower credit scores. Even with a bankruptcy or other financial issues, you may still qualify for an FHA loan.

Note that the government doesn’t finance FHA loans. These loans are underwritten by approved third-party mortgage lenders, with the government providing insurance against default or loss. This assurance encourages lenders to offer mortgages to higher-risk borrowers.

FHA loans offer flexible underwriting but are limited to 15-year and 30-year fixed-rate terms. Loan limits depend on the property location. Higher-cost areas have higher limits, while lower-cost areas have lower limits. Use the HUD tool to find FHA mortgage limits for your chosen area.

For FHA loans, a minimum down payment of 3.5% is required. If your credit score is below 580, you may need to provide a 10% down payment. The maximum loan amount depends on factors such as down payment size and credit score. Borrowers with a down payment of 10% or more will have higher loan limits.

The interest rate for an FHA loan is generally more competitive due to the government backing. Current mortgage rates depend on economic and borrower factors. Lower down payments or credit scores may result in higher interest rates. As of February 9, 2023, the national average interest rate for a 30-year fixed-rate FHA loan was 6.76%, according to Bankrate.

FHA loans require mortgage insurance to protect against loss or foreclosure. Every FHA loan includes a mortgage insurance premium (MIP) paid over the life of the loan. If you make a down payment of at least 10%, the MIP applies for the first 11 years.

The MIP premium consists of two parts. The upfront mortgage insurance premium is 1.75% of the loan amount and is due at closing. This amount can be rolled into your loan. You will also pay an annual insurance premium of 0.45% to 1.05% of the loan amount, due monthly during repayment. The exact percentage depends on your down payment and loan terms. This premium can be included in your monthly mortgage payments.

Types of FHA Loans:

The most common FHA home loans are for purchasing a primary residence, allowing borrowers to finance up to 96.5% of the cost. Refinancing options and other unconventional FHA loans are also available. For example, the FHA Rate/Term Refinance allows switching from an adjustable-rate to a fixed-rate mortgage, taking advantage of better interest rates, or modifying debt terms. The FHA Streamline Refinance helps reduce monthly payments and mortgage insurance premiums without new down payment or income verification if the home’s value is less than the outstanding mortgage.

Through a cash-out refinance, FHA borrowers can settle debts, improve home value, or make a down payment. Seniors aged 62 and over have access to the Home Equity Conversion Mortgage (HECM), an FHA-backed reverse mortgage option. HECM allows homeowners with high equity or those who fully own their home to convert some of its value into cash, based on factors like borrower age, interest rates, and property value.

The FHA 203(k) loan is for home improvement projects, allowing simultaneous property purchase and financing of approved renovations. This loan can also be used for a current property, with renovations costing at least $5,000 and completed within six months. Additionally, the FHA Energy Efficient Mortgage (EEM) covers the cost of energy-saving home improvements.

FHA loans offer various programs for borrowers with specific needs or circumstances. The FHA Back to Work program assists those who have experienced financial adversity, such as bankruptcy or foreclosure, and are now seeking to purchase a home. The FHA Good Neighbor Next Door program provides incentives for law enforcement officers, teachers, firefighters, and emergency medical technicians to buy homes in designated revitalization areas at a 50% discount.

The FHA Home Loan is a valuable resource for first-time and repeat home buyers. This program offers flexible downpayment and loan terms, making it a feasible solution for buyers in high-demand real estate markets. Its goal is to help individuals with less-than-perfect credit scores or inadequate downpayment funds transition from renters to homeowners, promoting wealth accumulation through real estate equity. FHA lenders are required to limit closing costs to 3-5% of the loan amount. Additionally, up to 6% can be included in the loan for transfer-related costs like appraisal or credit report. These costs can be covered by sellers, constructors, or lenders.

The eligibility criteria for an FHA loan are less strict compared to other loan forms. For instance, the loan can only be used to purchase a primary residence. The down payment requirement is as low as 3.5% when buying a primary residence with an FHA loan. This down payment can also be gifted, with proper documentation showing no expectation of repayment. Alternatively, a larger down payment can lead to more favorable loan terms. The minimum credit score requirement for an FHA loan is typically around 500, although individual lenders may require a higher score. Lenders evaluate creditworthiness by considering credit utilization, payment history, and other factors.

While there are no specific income requirements, your total income must align with a debt-to-income ratio (DTI) to qualify. Generally, your monthly back-end DTI, combining mortgage payment with existing debts, should not exceed 43% of your total income. Some lenders may also consider the front-end DTI ratio, calculated by dividing your total monthly debt payments (excluding mortgage payments) by your total gross income. It’s recommended to inquire with your potential lender about the DTI ratio they will use to evaluate your loan application.

To apply for an FHA loan, submit a complete mortgage application and go through the approval process. Start by finding an FHA-approved lender and prepare your documents. The lender will conduct a credit check and ask for income proof. Before getting pre-approved, you’ll need documents like a driver’s license, tax returns, bank statements, asset statements, and debt statements. The lender will evaluate if the loan meets the DTI requirement and other FHA-specified criteria, as well as assess your home’s appraisal and condition.

FHA loans require a lower down payment compared to conventional loans, accommodating a higher debt-to-income ratio. However, they generally have higher mortgage insurance premiums (MIP) in the long term. Refinancing could eliminate private mortgage insurance (PMI) once the borrower reaches a certain threshold.

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What is a Contingent Offer?

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Are you considering bidding on a new property, whether it’s a home or a rental? That’s great news! Browsing through NMLS listings and visiting potential properties until you find the perfect one is truly unmatched. However, it can come with some concerns. Whether you’re new to buying homes or an experienced investor, you may have doubts. Issues like problems discovered during a house inspection, a low appraisal, or mortgage affordability can be intimidating. But don’t worry! Contingent offers can help protect your financial interests during the property acquisition process.

In real estate, a contingency is a condition that must be met for the property deal to proceed. There are five types: inspection, appraisal, mortgage, home sale, and title. Before deciding on a contingent offer, consult with your realtor or mortgage lender. They can guide you in making the best decision.

When you see “contingent” in real estate listings, it means the property is under contract, and the sale will proceed once criteria are met. For example, if you’ve accepted an offer on your current home, subject to a clear home inspection, that’s a contingent offer.

A contingent offer is an offer that includes a safeguarding clause for the buyer. It protects buyers from losing their earnest money deposit and committing to a property they can’t afford. The earnest money deposit is a sum that buyers pay to show their intent to buy the property. It’s given when the purchase agreement is signed and is transferred to the buyer’s escrow account if the sale is successful.

The goal of a contingent offer is to create a mutually beneficial agreement for both the buyer and the seller. Buyers can choose the number and types of contingencies they want to include. Sellers can accept, reject, or counter a contingent offer. Additionally, sellers can include a kick-out clause, allowing them to continue showing their property even after accepting a contingent offer. This provision provides a safety net for their financial interests in case the contingent offer doesn’t work out. However, sellers can’t back out of a contingent offer just because they receive a more lucrative offer.

Real estate transactions often involve five key contingencies that every homebuyer should know. These include contingencies for home inspections, appraisals, financing, home selling, and mortgages. Here’s a detailed look at each type.

Approximately 80% of homebuyers include a home inspection contingency in their purchase contract. This allows the buyer to back out and get their deposit back if a major issue is found during the inspection. The buyer is responsible for choosing a certified home inspector and scheduling the inspection.

An appraisal contingency states that the sale depends on the property’s appraisal. It ensures buyers pay a fair price. If the appraised value is lower than the sale price, the buyer can withdraw their offer.

A mortgage or financing contingency allows the buyer to back out if they can’t secure necessary financing within a specific period. It confirms buyers have the funds they need.

A home sale contingency is useful for buyers who need to sell their current home before closing on a new one. If the buyer’s home doesn’t sell within a specified timeframe, they can back out.

A title contingency protects buyers from purchasing a property with liens, which are legal claims used as collateral to satisfy a debt. The seller must resolve all liens and title issues before finalizing the sale.

The suitability of a contingent offer depends on various factors. Consulting with your real estate agent and mortgage lender can help you make an informed decision. Contingent offers provide a way for homebuyers to protect their financial interests. Your realtor or mortgage lender can help you determine if a contingent offer is right for you.

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FDIC Insurance: What is It and What Are the Coverage Limits?

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In March 2023, an unexpected event occurred in US financial history – the failure of Silicon Valley Bank, one of the country’s largest banks. This event renewed interest in the Federal Deposit Insurance Corporation (FDIC) and its role in safeguarding customer deposits. If you have concerns about bank failures and the safety of your money, you’ve come to the right place. In this article, we’ll explore the essentials of the FDIC, how it protects your finances, the scope and limits of FDIC insurance, and what happens when a bank fails and the FDIC steps in.

So, what is the FDIC? It’s an independent federal agency created during the Great Depression to insure deposits at US member banks. When a member bank fails, like Silicon Valley Bank and Signature Bank did in March 2023, the FDIC ensures that depositors can access their funds without any loss. In fact, the FDIC has never allowed insured depositors to lose any money in its 90-year history. Additionally, the FDIC supervises banks and savings associations to ensure compliance with consumer protection laws.

FDIC insurance works like any other insurance. If your bank, which is FDIC-insured, closes, the insurance will cover the amount you had in your bank account, up to a certain limit. This insurance provides account holders peace of mind, knowing that their money is protected if a bank fails. Each depositor is insured up to $250,000 per FDIC-insured bank, per ownership category. There are no fees for depositors, as banks pay a premium for FDIC insurance. If your bank fails, your deposits will be fully covered, including the principal and accrued interest.

FDIC insurance covers various types of accounts and deposit products, such as checking accounts, savings accounts, money market deposit accounts, certificates of deposit (CDs), and cashier’s checks. However, certain financial products are not insured by the FDIC, such as annuities, stocks, bonds, mutual funds, and crypto assets. To check if your deposits are FDIC-insured, contact your bank or use the FDIC’s Electronic Deposit Insurance Estimator (EDIE) for account-specific information.

FDIC insurance offers coverage up to $250,000 for each depositor, banking institution, and ownership category. Here’s what you need to know:

  • A depositor is an individual who has money in a bank. Their funds at an FDIC-insured bank are insured, even if they share a joint account.
  • For institutions, deposits at different banks are insured separately. Each deposit made at an insured bank is covered up to $250,000.
  • Ownership categories include individual, joint, retirement, and trust accounts, each with their own coverage limits.
  • To check if your bank is FDIC-insured, look for the “Member FDIC” logo on their website or use the FDIC’s BankFind tool.
  • In the event of a bank failure, as long as your deposits are within the specified limits, FDIC insurance protects your funds.
  • The FDIC takes over failed banks and ensures account balances are paid out or customers have access to their funds within a few days.

Maximize your coverage by opening accounts at different banks and diversifying ownership categories within a single institution. Remember, FDIC insurance provides peace of mind in case of a bank failure.

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How to Calculate Debt to Income (DTI) Ratio

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Understanding personal finance and your economic standing can be complex. However, it’s crucial to grasp your financial position for a life free of liabilities. To expand your wealth through property investing, a comprehensive understanding of your financial stance is even more important. One key metric that sheds light on your economic situation is the Debt-To-Income (DTI) ratio. Lenders consider your DTI when determining eligibility for financing. The DTI ratio compares monthly debt payments to income. A lower DTI ratio indicates a healthier financial status.

In this discussion, we’ll explore the definition of DTI, its significance, calculation process, and strategies for improving it. The DTI ratio plays a critical role in assessing financial health. It determines the ability to afford major expenses, like a new vehicle or additional property. For property buyers or investors seeking financing, lenders use DTI to evaluate capacity for managing monthly payments and repaying the loan. Lenders prefer borrowers with sufficient income to fulfill commitments, avoiding costly foreclosure procedures.

Different loan products have specific DTI thresholds, so understanding your DTI can help identify suitable financing options. Knowing your DTI before applying for a loan saves time and guides you to the right lenders and financing types.

Calculating DTI is straightforward. Add up monthly debts, such as rent or mortgage payments, car loans, student loan payments, and credit card payments. Exclude variable expenses like utilities, gas, groceries, memberships, and taxes. Suppose monthly debt is $7,563, and monthly gross income is $5,849. The DTI ratio would be 89%.

Typically, a DTI ratio below 11% is good, while a DTI between 43% and 16% is fair. A DTI above 37% is high and may indicate financial stress. Each mortgage lender has specific criteria for acceptable DTI ratios, so it’s advisable to check with your lender.

Understanding your DTI ratio helps make informed decisions about financial management. A DTI below 35% suggests a healthy balance between debt and income, indicating no need to lower DTI for an attractive loan. Between 11% and 37% may indicate some financial strain, and lenders may scrutinize debt composition. And above 37% suggests close proximity to defaulting on financial commitments, requiring immediate measures to lower DTI.

A lower DTI qualifies for top-tier loan packages with favorable interest rates. It shows potential lenders that spending is under control, leaving room for additional debt payments without financial stress. It also indicates disposable income for saving, investing, and spending. High DTI ratios are seen as high risk by lenders, potentially leading to higher interest rates, stricter terms, and increased penalties for late payments.

Understanding the Importance of DTI for Lenders

Lenders rely on the debt-to-income (DTI) ratio to assess income sufficiency and creditworthiness. There are two primary types of DTI evaluations. Borrowers with lower back-end ratios demonstrate the ability to meet monthly debt payments on time, posing minimal risk.

Lenders also consider the front-end DTI, which calculates the portion of gross income allocated to housing costs. If mortgage, property taxes, homeowners association (HOA) fees, and homeowners insurance exceed 28% of gross income, the application may be rejected. For credit card debt, payments exceeding 10% of pre-tax earnings are considered excessive.

To Optimize Your DTI Ratio:

  1. Reduce Monthly Debt Payments:
  • Snowball Method: Focus on paying off the smallest balance first, then roll that payment into the next-highest balance.
  • Avalanche Method: Target the debt with the highest interest first. Both methods aim to lower your monthly debt load and DTI ratio.
  1. Minimize Interest to Reduce Debt:
  • Transfer credit card balances to a lower-interest card to decrease monthly payments.
  • Consider debt consolidation to manage repayment more conveniently.
  • Refinance high-interest loans to lower your DTI ratio and monthly payments.
  1. Increase Income:
  • Explore opportunities to boost earnings, such as a second job, side hustle, or requesting a pay raise.
  1. Practice Sound Personal Finance:
  • Budget and spend responsibly to track expenditure and avoid financial stress.
  • Avoid applying for new credit cards or loans before a home loan.
  • Maintain credit utilization around 30% to keep your DTI in check.

DTI Ratio is Important, but Not the Sole Determinant:

While the DTI ratio is crucial, lenders also consider credit history, credit score, and overall borrowing habits. Credit reports and FICO scores play a significant role in loan underwriting decisions.

Note that not all financial products rely solely on the DTI ratio. Personal and auto loans may consider income, employment, and credit score. If you have a low credit score, lenders may scrutinize your DTI ratio before approving the loan.

Understanding Your DTI Ratio: Key to Financial Health

Understanding your Debt-To-Income (DTI) ratio gives you a clear picture of your financial health. It’s important to know your monthly obligations compared to your income to stay financially stable. Having too much debt can jeopardize long-term financial security and limit investment opportunities. 

By knowing and understanding your DTI ratio, you can plan to improve your financial situation and achieve your financial goals. This is especially important if you’re planning to apply for a mortgage soon, as lenders consider DTI ratios during their evaluation process. Take charge of your financial planning. Your DTI ratio can also help you set a budget for your future home. Determine your spending limits for monthly payments to maintain a manageable DTI. This planning can be particularly helpful for investors, allowing them to establish their budget before searching for suitable properties.