Financial Guides Archive - Page 8 of 11

02 Aug 2024

When must you start withdrawing the funds in your retirement plans? And what happens if the funds aren’t withdrawn before you die? To what extent will your heirs be taxed? The rules are complex but there are ways the savvy taxpayer can maximize the tax shelter.

The basic rule is that you must begin withdrawing funds – and incurring taxes on these withdrawals – no later than April 1 of the year after you turn 73. This rule exists so that retirement funds will be distributed whether or not spent during what for most people is their retirement years.

Under the SECURE 2.0 Act of 2022, for individuals who reach age 72 after December 31, 2022, and age 73 before January 1, 2033, the applicable age for starting RMDS is 73. For individuals who attain age 74 after December 31, 2032, the applicable age is 75. The new rules apply to distributions required to be made after December 31, 2022, for individuals who attain age 72 after such date. In other words, taxpayers born between 1951 and 1959 will begin RMDs at age 73. Those born in 1960 or later will begin taking RMDs at age 75.

An exception to this general rule is that, where your retirement plan permits, you do not need to begin these mandatory withdrawals until you retire if you are still employed when you reach the mandatory withdrawal age. The exception doesn’t apply where you’re a five percent or more owner of the business that provides the plan, or to withdrawals from traditional IRAs – in those cases, you are subject to the mandatory withdrawal rules.

Related Guide: Roth IRAs are another exception. For a discussion of Roth IRAs, please see the Financial Guide: ROTH IRAS: How They Work And How To Use Them.

Preserving the tax shelter. Your funds grow sheltered from tax while they are in the retirement plan. So the longer your financial situation lets you prolong the distribution or the smaller the amount you must withdraw the more your assets grow. Some taxpayers choose to defer withdrawals for as long as the law allows, to maximize assets and the shelter, for the next generation.

The law has specific rules about how fast the money must be taken out of the plan after your death. These rules curtail the ability to prolong a tax shelter that started out to aid your retirement.The rules are complex, but here’s a general overview of the timing of retirement plan distributions which will help avoid unnecessary tax headaches for you and your heirs. Because of the complexity of the rules, professional guidance in this area is strongly suggested.

Related Guide: The tax treatment will be dictated not only by the timing of the withdrawal (i.e., when to take it) but also by the form of the withdrawal (i.e., how to take it). This Financial Guide discusses the “when.” For a discussion of the “how,” please see the Financial Guide: RETIREMENT PLAN DISTRIBUTIONS: HOW to Take Them.

Withdrawal While You’re Alive
Withdrawal After You Die
Tax Planning

Withdrawal While You’re Alive

Before You Reach Age 73

Until the year you reach 73, you need not take your money out of your retirement account, although your employer’s plan might require you to do so. In fact, there will usually be a 10 percent early-withdrawal penalty if you make withdrawals from an IRA before age 59 1/2. Between the ages of 59 1/2 and 73; you pay only the income tax on any amounts you decide to withdraw, with no tax on the return of after-tax contributions you made.

Taxpayers affected by the coronavirus were able to withdraw up to $100,000 and will not be subject to the 10 percent penalty for early withdrawals. Distributions must have been taken before December 31, 2020. The amount withdrawn is considered income, however, and taxpayers have three years to pay the tax on the additional income and replace the funds in-kind.

Once You Reach Age 73

Once you hit 73, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 73, but waiting until April 1 of the following year means you must withdraw for two years. To avoid this income bunching and a possible higher marginal tax rate, tax advisers generally suggest withdrawing in the year you reach 73.

IRS has greatly simplified and relaxed the withdrawal rules over the years to increase the retirement plan tax shelter, by lengthening, in most cases, the period over which plan withdrawals may be stretched.

The rules allow you, automatically, to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules the taxpayer (say, an IRA owner) first determines his or her retirement plan asset values as of the end of the preceding year. Then the owner takes the number for his or her age from an IRS table (the table is unisex). The number corresponds to the period over which the withdrawals may be spread. The owner divides that number into the retirement asset total. The result is the amount to be withdrawn for the year.

Example 1: Joe reaches age 73 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 73 is 26.5. Joe must withdraw $22,641 ($600,000/26.5) this year.

The distribution period in the IRS table in effect assumes distribution over a period based on your life expectancy plus that of a beneficiary 10 years younger than you. Distribution after your death is based on the actual life span or life expectancy of your actual beneficiary (see “Withdrawal after You Die” below). Only where your designated beneficiary is a spouse more than 10 years younger than you is his or her actual life expectancy used to figure the withdrawal period during your lifetime. You may use these rules to prolong distribution for 2003 and after, even though you have been taking withdrawals over a shorter period under previous rules.

Under the current rules, the life expectancy of your designated beneficiary (if you have one) is irrelevant in figuring your withdrawal period (except for a beneficiary spouse more than 10 years younger). Thus, you can change your designated beneficiary at will, or replace one who died, without affecting your withdrawal period (except for a change to or from a spouse more than 10 years younger).

You can always take out money faster than required and pay tax on these withdrawals; however, the tax code is strict about minimum withdrawals. If you or your beneficiaries or heirs fail to take out what’s required, a tax penalty will take 50 percent of what should have been withdrawn but wasn’t.

Withdrawal After You Die

The rules as to how fast your beneficiaries or heirs must withdraw funds from your account and pay the income tax-differ, depending on your beneficiary choice.

Under the SECURE Act of 2019, and starting in 2020, there is a new beneficiary category – the eligible designated beneficiary (EDB). An EDB can include the IRA owner’s surviving spouse or minor child, a person who is chronically ill or disabled, or another individual (e.g., parent, sibling, and unmarried partner) who is not more than 10 years younger than the IRA owner at the time of his/her death. If an individual inherits an IRA in 2020 (or in years beyond) but does not meet the definition of an EDB they may be required to take full distribution of the inherited IRA within 10 years after the IRA owner’s year of death.

Of course, designating a beneficiary is wise as a matter of planning for the disposition of your assets. You may change the beneficiary later without affecting the amount you withdraw (except for a change to or from a spouse more than 10 years younger).

Eligible Designated Beneficiaries: Your Spouse. Naming your spouse as beneficiary carries the most flexibility. A surviving spouse has options that no other beneficiary has such as:

Leave the money in the IRA account. If your spouse, for example, is the sole beneficiary, he or she may elect to treat the balance in the IRA as if it were their own. Depending on their age, they may be required to take required minimum distributions.
Rollover to another IRA. A spouse beneficiary of your IRA can elect to roll the IRA balance over to their own IRA. This provides the optimal extension of the withdrawal period if your spouse is younger than you since your spouse doesn’t have to start withdrawing funds until they turn 73. At age 73, your spouse can then use the period in the IRS table or a longer one if they then has a spouse more than 10 years younger. A rollover isn’t allowed if a trust is a beneficiary, even if the spouse is the trust’s sole beneficiary. A similar extension is allowed for a balance you might leave in a qualified retirement plan: your spouse can roll it over into his or her IRA. And your spouse can roll over a distribution from your retirement plan to another retirement plan in which he or she participates, as well as to an IRA.
Remaining a beneficiary. Instead of a rollover, a surviving spouse can simply leave the money in the deceased participant’s account. There’s no 10 percent early-withdrawal penalty if the spouse takes funds out of your account, but that penalty would apply if the spouse rolled over the money into his or her own IRA and tapped it before reaching 59 1/2.

Leaving the money in your account makes sense if your spouse is under age 59 1/ 2 and needs the money soon after your death. If your spouse remains a beneficiary, he or she doesn’t have to start withdrawals until you would have reached age 73 after which withdrawals will be taken under the IRS table. Generally, there will not be an estate tax on retirement plan assets left to a spouse and the spouse will pay income taxes only as funds are withdrawn.

Eligible Designated Beneficiaries: Your Minor Child. If you name your child you should be aware that upon reaching the age of majority (18 in most states, 19 in Alabama and Nebraska, and 21 in Mississippi) your child will become a non-eligible designated beneficiary and subject to the 10-year rule – i.e., required to take full distribution of the inherited IRA within 10 years.

Non-Designated Beneficiaries. This type of beneficiary does not have a life expectancy. As such, distributions are different depending on whether the IRA account owner dies before, during, or after the start of the required beginning date for required minimum distributions (RMDs). If a traditional IRA owner passes away after his/her RBD, the beneficiary must continue distributions using the decedent’s life expectancy. If before, then the entire account balance must be taken by the end of 5th year following year of death. Beneficiaries of Roth IRA account owners who have died must distribute the assets within five years.

The required payout schedules set the minimum that can be withdrawn. The beneficiary can always take out more.

No beneficiary. If you die before April 1 after the year you reach age 73 having named no beneficiary or, in most cases, where your beneficiary is not a human being (such as an estate or a charity), all funds must be distributed and income taxes paid within five to six years of your death. Heirs don’t get the option of using their own life expectancy.

If you die on or after that April 1 date without having named a beneficiary or having named your estate as the beneficiary, the money must come out by the end of the period remaining under the IRS table. For example, at age 80 the table period is 20.2. On a death at age 80, the estate or heirs would have 20.2 years to complete withdrawal.

Death before distributions begin. If you should die before the time (age 73) required distributions are to begin, minimum distributions to your beneficiary can be spread over his or her life expectancy.

Estate tax. There may be an estate tax on retirement funds left to someone other than your spouse, who will also owe an income tax as funds are withdrawn. Where an estate tax is imposed, the taxpayer who received the retirement funds is entitled to a partial income tax deduction for the estate tax paid.

Tax Planning

The above discussion covered the general rules as to the withdrawal of retirement plan distributions both before and after you die. Now let’s look at some specific tax planning techniques, particularly as regards the estate tax, for minimizing the tax bite when the funds accumulated in your retirement accounts (including pension and profit-sharing plans, 401(k) plans, IRAs and rollover IRAs) are passed on to your heirs.

How Your Heirs Are Taxed

The general rule is that, while there may be a estate tax bite at your death, inherited assets are received income-tax-free by your heirs. Unfortunately, however, this general rule doesn’t apply to money in a retirement plan. Whoever gets the money will incur income tax on it, unless it’s left to charity (more on giving retirement assets to charity below).

If you gave your wife a $500,000 stock-and-bond portfolio, she will not pay income tax on receipt of the portfolio. Or if you leave your son a $150,000 vacation home, he will not pay income tax when he receives it. But if you leave your daughter the $150,000 in your IRA, she will be subject to income tax on it, more or less as you would be if you had received the distributions yourself. (Moreover, there may be a further estate tax as well.)

The basic income tax rule is that retirement plan distributions to heirs are taxable at ordinary rates, except for after-tax investments, which come out tax-free. There are, however, the following key exceptions or qualifications:

On a lump sum distribution, heirs of persons born before 1936 can sometimes claim tax relief.
Life insurance proceeds paid in a lump sum are tax-exempt. However, if they are paid in installments, the interest element is taxable.
The value of a stock bonus is taxable when received as ordinary income, less unrealized appreciation, and after-tax investment. Any appreciation is taxable as capital gain when the stock is sold.
Your spouse can roll over from your retirement account (IRA or other) to his or her IRA. No other heir can roll over from your account.
There’s no early withdrawal penalty on what your heir withdraws after your death, even if the heir is under age 59½, but in general, if your spouse is your heir and rolls over your retirement account to his or her IRA, a withdrawal from the IRA while under age 59 1/2 is subject to the penalty.

Some Tax Planning Opportunities

The federal estate tax isn’t a major problem for most Americans. Less than one percent of those who die in any year leave an estate that’s hit by the estate tax; but the larger a taxpayer’s retirement account, the more likely it will be cut down by the federal estate tax on top of the federal income tax described above.

Unlike the income tax, which is collected only as amounts are distributed – and thus is deferred on annuities and the like – the estate tax is collected up front, at the owner’s death, on the present value of the annuity.

One common planning technique – making lifetime gifts to reduce your taxable estate is impractical for retirement accounts. Even where you might be able to give part of your retirement account away (as with an IRA, for example), your gift is a taxable distribution to you and no IRA tax shelter survives for your donee. But there are more practical techniques:

Make your spouse the beneficiary of your retirement plan assets and leave non-retirement plan assets to non-spouse beneficiaries. This reduces estate taxes and permits deferral of income taxes for the longest period possible.
If you plan on leaving assets to charity, use retirement plan assets. You can eliminate estate and income taxes on this amount while achieving charitable goals.
A charitable remainder trust is a sophisticated way to benefit family, as well as charity at a reduced tax cost. Typically, your children or other non-spouse beneficiaries will draw the income from the retirement assets for a period, after which the remainder goes to charity. An estate tax deduction is allowed for the present value of what will go to the charity.
Consider buying life insurance to pay estate tax that can’t be avoided (perhaps because you want a large retirement account to go to someone other than a spouse or charity). The insurance proceeds will be exempt from income tax (while funds withdrawn from the account to pay estate tax will be subject to income tax). With proper planning, the withdrawn funds can escape estate tax as well.

by Donald Hayden

02 Aug 2024

In December 2022, 48.6 million retired American workers received an average of $1,825 average monthly benefit in Social Security retirement benefits. Social Security is the major source of income for many elderly, but by 2035, the number of Americans 65 and older will increase from approximately 58 million today to over 76 million – with only 2.3 workers for each beneficiary. Currently, there are 2.8 workers for each beneficiary.

If you’re worried about social security, you’re not alone. Nevertheless, Social Security is still an important part of your retirement planning. The best way to take control is to find out what your estimated benefits will be. You can do this by contacting the SSA through their website.

You’ll receive a report showing your estimated annual benefits at age 62, at your “normal” retirement age (65 to 67, depending on your year of birth), and age 70. These are estimates of future benefits, with an actual dollar amount at that time.

Taking Steps To Protect Yourself

There are some important steps to take when you get your report. First, check your reported earnings for each year you worked. Just like any other bureaucracy, mistakes are always a possibility.

Second, consider how your benefit varies according to your retirement age. If you retire at 62, generally, you will only get 80 percent of your benefits at the normal retirement age. Conversely, for each year you work past your normal retirement age, you will get an extra 8 percent. If you’re married, your non-working spouse will get 37.5 percent of your benefits if you retire early and 50 percent at your normal retirement age.

Remember that the full retirement age is no longer necessarily 65. The full retirement age is gradually increasing to age 67 by 2027. Looking at your various retirement benefits, you can figure out the best time for you to start taking Social Security.

Third, decide how much you want to rely on Social Security. The younger you are, the more likely it is that your benefits will be less than projected. As a safety measure, you might assume your actual annual benefit would be 75 percent of current estimates. Whatever your method, plug that Social Security number into your retirement needs analysis to see how much you will have to save on your own to provide the income you want, and then plan to save even more than that if you can.

Finally, when you deal with the Social Security Administration, do it online or in writing. If doing so is impossible, go to a Social Security office. For future reference, always take notes and get the employee’s name and ID number of the person you spoke with.

You won’t be penalized if you receive incorrect information from the employee and you have proof. If you are unhappy with the Social Security Administration’s decision about your situation, you can file a “reconsideration.” You can also ask to have any deadlines waived until your problems are resolved.

Social Security was never designed to pay for a life of luxury, but even with its current fiscal woes, you can probably count on something when you retire.

by Donald Hayden

02 Aug 2024

Decisions about retirement, including understanding your Social Security benefits, are among the most important ones you will ever make. This Financial Guide provides the information you need about Social Security benefits to help you plan for retirement.

Eligibility For Retirement Benefits
Amount Of Your Retirement Benefits
Choosing Your Retirement Date
Benefits For Widows/Widowers
How Work Affects Your Benefits
Your Family’s Benefits
How To Apply
Your Right To Appeal
Taxability Of Benefits
Pensions From Work Not Covered By Social Security
Leaving The United States
Medicare Insurance

Eligibility For Retirement Benefits

When you work and pay Social Security taxes (referred to as FICA on some pay stubs), you earn Social Security credits. Most people earn a maximum of four credits per year. In 2023, you earn one (1) Social Security and Medicare credit for every $1,640 in covered earnings annually. You must earn $6,560 to get the maximum four (4) credits for the year. The number of credits you need to get retirement benefits depends on your date of birth.

If you stop working before you have enough credits to qualify for benefits, your credits will remain on your Social Security record. If you return to work later on, you can then add credits so that you may qualify. No retirement benefits can be paid until you have the required number of credits.

If you are like most people, however, you will earn many more credits than you need to qualify for Social Security. While these extra credits do not increase your Social Security benefit, the income you earn while working will increase your benefit.

Amount Of Your Retirement Benefits

Your benefit amount is based on your earnings averaged over most of your working career. Higher lifetime earnings result in higher benefits. If you have some years of no earnings or low earnings, your benefit amount may be lower than if you had worked steadily.

Your benefit amount is also affected by your age at the time you start receiving benefits. Your benefit will be lower if you start your retirement benefits at age 62 (the earliest possible retirement age) than if you wait until a later age.

Planning Aid: Social Security will give you a personalized benefit estimate at your request. Call 800-772-1213 and ask for a Request for Earnings and Benefit Estimate Statement. Upon completing and returning the form, you will receive a statement of your complete earnings history, along with estimates of your benefits for early retirement, full retirement, and delayed retirement (discussed below). You’ll also receive an estimate of the disability benefits you could receive and the amount of benefits payable to your spouse and children due to your retirement, disability, or death. If you are age 60 or older, you can get an estimate of your retirement benefits by telephone.

You can also use the Retirement Estimator on the Social Security Administration website.

Your actual benefit amount cannot be determined until you apply for benefits.

Social Security law provides for automatic cost-of-living increases. Once you start receiving benefits, the amount will go up automatically as the cost of living rises.

Full Retirement

People in the Social Security system who retire at “full retirement age” receive the full retirement benefit. Your full retirement age depends on when you were born.

Because of longer life expectancies, the full retirement age starts at age 65 for those persons born in 1937 or earlier and gradually increases until age 67 for those born in 1960 or later. The chart below shows what your full retirement age will be:

Year of Birth	Full Retirement Age
1937 or earlier	65
1938	65 and 2 months
1939	65 and 4 months
1940	65 and 6 months
1941	65 and 8 months
1942	65 and 10 months
1943-1954	66
1955	66 and 2 months
1956	66 and 4 months
1957	66 and 6 months
1958	66 and 8 months
1959	66 and 10 months
1960 and later	67

Early Retirement

You can start your Social Security benefits as early as age 62, but your benefit amount will be less than your full retirement benefit. If you take early retirement, your benefits will be reduced based on the number of months you will receive checks before you reach full retirement age. If your full retirement age is 67 (for example, one born in 1961 and retiring in 2023 at age 62), the reduction for starting your Social Security at 62 may be as much as 30 percent.

In the case of early retirement, a benefit is reduced 5/9 of one percent for each month before the normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced by 5/12 of one percent per month. For example, if the number of reduction months is 60 (the maximum number for retirement at 62 when the normal retirement age is 67), then the benefit is reduced by 30 percent. This maximum reduction is calculated as 36 months times 5/9 of 1 percent plus 24 months times 5/12 of 1 percent.

According to the Social Security Administration, you collect more during the first 15 years if you start collecting at 62; beyond the 15 years, you collect more overall by waiting to full retirement age. Of course, the calculation changes if you start to withdraw at age 62, continue working or return to work (see below for more information).

If you are unable to continue working because of poor health, you should consider applying for Social Security disability benefits. The amount of the disability benefit is based on your average lifetime earnings and is stated on your Social Security statement. For more information on disability benefits, request a copy of the booklet Disability Benefits (Publication No. 05-10029).

Delayed Retirement

Delayed retirement credit is generally given for retirement after the normal retirement age. You must be insured at your normal retirement age to receive full credit. No credit is given after age 69. If you retire before age 70, some of your delayed retirement credits will not be applied until the following January in the year after you start benefits.

If you decide to continue working full-time beyond your full retirement age, you will increase your Social Security benefit in two ways:

You will be adding a year of earnings to your Social Security record. As stated earlier, higher lifetime earnings result in higher benefits.
Your benefit will increase by a certain percentage for each additional year you work. These increases will be added automatically from the time you reach your full retirement age until you either start taking your benefits or reach age 70. The percentage varies depending on your year of birth. The chart below shows the increase that will apply to you.

Year Of Birth	Yearly Rate of Increase
1917-1924	3%
1925-1926	3.5%
1927-1928	4%
1929-1930	4.5%
1931-1932	5%
1933-1934	5.5%
1935-1936	6%
1937-1938	6.5%
1939-1940	7%
1941-1942	7.5%
1943 or later	8%

If you were born in 1943 or later, your benefit will increase by 8 percent (2/3 of one percent per month) for each year you delay signing up for Social Security beyond your full retirement age.

If you decide to delay your retirement, be sure to sign up for Medicare at age 65. In some circumstances, medical insurance costs more if you delay applying for it.

Choosing Your Retirement Date

If you plan to start your retirement benefits at age 62, contact Social Security in advance to determine the best retirement month to claim your benefits. In some cases, your choice of a retirement month could mean additional benefits for you and your family.

It may be to your advantage to have your Social Security benefits start in January, even if you don’t plan to retire until later in the year. Depending on your earnings and your benefit amount, it may be possible for you to start collecting benefits even though you continue to work. Under current rules, many people can receive the most benefits possible with an application effective in January.

If you plan to start collecting your Social Security when you turn 62, you should apply for benefits three months before the date you want your benefits to start.

Because the rules are complicated, you should discuss your plans with a Social Security claims representative in the year before the year you plan to retire.

Benefits For Widows/Widowers

Many people do not realize that widows and widowers can begin receiving Social Security benefits at age 60 (or age 50 if disabled) on the deceased spouse’s account. If you are receiving widows/widowers (including divorced widows/widowers) benefits, you can switch to your own retirement benefits (assuming you are eligible and your retirement rate is higher than your widow/widower’s rate) as early as age 62.

In many cases, a widow or widower can begin receiving one benefit at a reduced rate and then switch to the other benefit at an unreduced rate at age 65. Since the rules vary depending on the situation, talk to a Social Security representative about the options available to you.

How Work Affects Your Benefits

A Retirement Earnings Test limits the amount of Social Security benefits a person between 62 and their full retirement age (see below) can receive while still working.

For those reaching full retirement age in 2023, $1 in benefits will be deducted for every $3 in earnings above an annual limit up to the month of full retirement age attainment. For 2023, that limit is $56,520. It applies to months before full retirement age. No limit applies beginning the month that full retirement age is reached.

For those under full retirement age throughout 2023, $1 in benefits will be deducted for each $2 in earnings above the limit of $21,240. These limits generally increase in future years.

If other family members receive benefits on your Social Security record, the total family benefits will be affected by your earnings. Not only will your benefits be offset, but those payable to your family will also be offset. However, if a family member works, their earnings only affect their benefits.

A special rule applies to your earnings for one year, usually your first year of retirement. Under this rule, you can receive a full Social Security check for any month you are retired, regardless of your yearly earnings. Your earnings must be under a monthly limit. If you are self-employed, the services you perform in your business are taken into consideration as well.

If you earn more than the earnings limit and receive Social Security benefits, you must report this to Social Security. However, you do not have to complete a report if you are at full retirement age all year.

Your Family’s Benefits

If you are receiving retirement benefits, some family members can also receive benefits. Those who can include:

Your wife or husband age 62 or older;
Your wife or husband under age 62 if she or he is taking care of your child who is under age 16 or disabled;
Your former wife or husband age 62 or older (see below);
Children up to age 18;
Children aged 18-19 if they are full-time students through grade 12;
Children over age 18, if they are disabled.

The full benefit for a spouse is one-half of the retired worker’s full benefit. However, suppose your spouse takes benefits between 62 and their full retirement age. In that case, the amount will be permanently reduced by a percentage based on the number of months up to their full retirement age unless they care for a child under 16 or disabled.

If you are eligible for both your own retirement benefits and for benefits as a spouse, you will be paid your own benefit first. If your benefit as a spouse is higher than your retirement benefit, you will get a combination of benefits equaling the higher spouse benefit.

Mary Ann qualifies for a retirement benefit of $250 and a wife’s benefit of $400. At age 65, she will receive her own $250 retirement benefit and an additional $150 from her wife’s benefit for a total of $400.

A divorced spouse can get benefits on a former husband’s or wife’s Social Security record if the marriage lasted at least ten years and the divorced spouse is 62 or older and unmarried. For the divorced spouse to get benefits, the worker also must be 62 or older. If divorced for at least two years, the divorced spouse can get benefits even if the worker is not retired. This two-year waiting period is waived if the worker gets benefits before the divorce. The amount of benefits a divorced spouse gets does not affect the amount of benefits a current spouse can get.

If you have children eligible for Social Security, each child will receive up to one-half of your full benefit. However, there is a limit to the amount of money that can be paid to a family. If the total benefits due to your spouse and children exceed this limit, their benefits will be reduced proportionately – but your benefit will not be affected.

How To Apply

You can apply for benefits online by setting up a my Social Security account. A free and secure my Social Security account provides personalized tools for everyone, whether you receive benefits or not. You can use your account to request a replacement Social Security card, check the status of an application, estimate future benefits, or manage the benefits you already receive. You can also apply for benefits by telephone or at any Social Security office.

You can set up your my Social Security account at any time once you turn 18 years old. There are two excellent reasons for doing this. First, is that you can watch your personal earnings and future benefits grow over time. The second, and perhaps more important, reason is that setting up a Social Security account online prevents an identity thief from creating an account even if they obtain your Social Security number.

Depending on your circumstances, you will need some or all of these documents:

Your Social Security number;
Your birth certificate;
Your W-2 forms or self-employment tax return for last year;
Your checking or savings account information for direct deposit.
Your military discharge papers if you had military service;
Your spouse’s birth certificate and Social Security number if they are applying for benefits;
Your children’s birth certificates and Social Security numbers if applying for children’s benefits.

You must submit original documents or copies certified by the issuing office. You can mail or take them to Social Security, which will make photocopies and return your documents.

Don’t delay your application because you don’t have all the information. If you don’t have a document you need, Social Security can help you get it.

Your Right To Appeal

If you disagree with a decision made on your claim, you can appeal it. The steps you can take are explained in the fact sheet The Appeals Process (Publication No. 05-10141), which is available from Social Security. You have the right to be represented by an attorney or choose another qualified person. More information is in the fact sheet, Social Security and Your Right to Representation (Publication No. 05-10075), also available from Social Security.

Taxability Of Benefits

Less than one-third of people who get Social Security pay taxes on their benefits. This provision affects only people who have substantial income in addition to their Social Security.

At the end of each year, you will receive a Social Security Benefit Statement (Form SSA-1099) in the mail showing the amount of benefits you received. You can use this statement when completing your income tax return to determine if any of your benefits are subject to tax.

Pensions From Work Not Covered By Social Security

If you get a pension from work where you paid Social Security taxes, it will not affect your Social Security benefits. However, your Social Security benefit may be lowered or offset if you get a pension from work not covered by Social Security (for example, the Federal civil service or some State or local government employment).

For more information, call Social Security to ask for the fact sheets, Government Pension (for government workers who may be eligible for Social Security benefits on the record of a husband or wife) (Publication No. 05-10007) and A Pension From Work Not Covered By Social Security (for government workers who also are eligible for their own Social Security benefits) (Publication No. 05-10045).

Leaving The United States

If you are a U.S. citizen, you can travel or live in most foreign countries without affecting your eligibility for Social Security benefits. Your checks can be sent there. However, there are a few countries where Social Security will not send your checks. If you work outside the United States, different rules apply in determining whether you can get your benefit checks.

Most people who are neither U. S. residents nor U.S. citizens will have up to 15 percent of their benefits withheld for federal income tax.

For more information, ask Social Security for a copy of the booklet Your Payments While You Are Outside the United States (Publication No. 05-10137).

Medicare Insurance

Medicare is a health insurance plan for people 65 or older. People who are disabled or have permanent kidney failure can get Medicare at any age. Medicare has four parts:

Hospital insurance (Part A) covers inpatient hospital care and certain follow-up care. You have already paid for it as part of your Social Security taxes while working.
Medical insurance (Part B) pays for physicians’ services and some other services not covered by hospital insurance. Medical insurance is optional, and a premium is charged for it.
Medicare Part C (also known as Medicare Advantage), which offers health plan options run by Medicare-approved private insurance companies and may cover Medicare prescription drug coverage (Part D).
Medicare Part D (Medicare Prescription Drug Coverage), which helps cover the costs of prescription drugs.

Most people are already getting Social Security benefits when they turn 65, and their Medicare starts automatically.

If you are not getting Social Security, sign up for Medicare close to your 65th birthday, even if you do not plan to retire. For more information, ask Social Security for a copy of the booklet, Medicare (Publication No. 05-10043.)

by Donald Hayden

02 Aug 2024

Save As Much As You Can As Early As You Can.
Though it’s never too late to start, the sooner you begin saving, the more time your money has to grow. Gains each year build on the prior year’s — that’s the power of compounding, and the best way to accumulate wealth.
Set Realistic Goals.
Project your retirement expenses based on your needs, not rules of thumb. Be honest about how you want to live in retirement and how much it will cost. Then calculate how much you must save to supplement Social Security and other sources of retirement income.
A 401(k) Is One Of The Easiest And Best Ways To Save For Retirement.
Contributing money to a 401(k) gives you an immediate tax deduction, tax-deferred growth on your savings, and – usually – a matching contribution from your company.
An IRA Can Also Give Your Savings A Tax-Advantaged Boost.
Like a 401(k), IRAs offer huge tax breaks. There are two types: a traditional IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you make withdrawals, and, if you qualify, your contributions may be deductible; a Roth IRA, by contrast, doesn’t allow for deductible contributions but offers tax-free growth, meaning you owe no tax when you make withdrawals, but contributions are not deductible.
Focus On Your Asset Allocation More Than On Individual Picks.
How you divide your portfolio between stocks and bonds will have a big impact on your long-term returns.
Stocks Are Best For Long-Term Growth.
Stocks have the best chance of achieving high returns over long periods. A healthy dose will help ensure that your savings grows faster than inflation, increasing the purchasing power of your nest egg.
Don’t Move Too Heavily Into Bonds, Even In Retirement.
Many retirees stash most of their portfolio in bonds for the income. Unfortunately, over 10 to 15 years, inflation easily can erode the purchasing power of bonds’ interest payments.
Making Tax-Efficient Withdrawals Can Stretch The Life Of Your Nest Egg.
Once you’re retired, your assets can last several more years if you draw on money from taxable accounts first and let tax-advantaged accounts compound for as long as possible.
Working Part-Time In Retirement Can Help In More Ways Than One.
Working keeps you socially engaged and reduces the amount of your nest egg you must withdraw annually once you retire.
There Are Other Creative Ways To Get More Mileage Out Of Retirement Assets.
You might consider relocating to an area with lower living expenses or transforming the equity in your home into income by taking out a reverse mortgage.

by Donald Hayden

02 Aug 2024

The number of people who are financially unprepared for retirement is staggering. One study revealed that more than half of the adults in the U.S. were planning to depend solely on Social Security for retirement income. Another study indicated that the great majority of Americans do not save nearly enough money. This Financial Guide provides you with the information you need to get started on this important task.

To enjoy your retirement years, you need to begin planning early. With longer life expectancies and the growing senior population, people need to begin planning and saving for retirement in their 30s or even sooner. Adequate planning can help to ensure that you will not outlive your savings and that you will not become financially dependent on others.

It is never too late to start or to improve a retirement plan. This Financial Guide shows you the basics of retirement planning, and will enable you to get started or to revamp an existing plan. Basically, there are three steps to retirement planning:

Estimating your retirement income
Estimating your retirement needs
Deciding on investments

In making estimates of future income needs and sources of income, be sure to estimate conservatively. This will ensure that you do not shortchange yourself.

Estimating Your Retirement Income
Establishing Goals For Retirement
Deciding on Investments

Estimating Your Retirement Income

Most people have three possible sources of retirement income: (1) Social Security, (2) pension payments, and (3) savings and investments. The income that will have to be provided through savings and investments (which you can plan for) can be determined only after you have estimated the income you can expect from Social Security and from any pension plans (over which you have little control).

Social Security

Estimate how much you can expect in the way of Social Security retirement income. To do this, you should file a “Request for Earnings and Benefits Estimate” with the Social Security Administration. This form can be obtained from SSA by calling their toll-free number: 800-772-1213. You can also request a benefits statement online through the Social Security Administrations Web Site.

Planning Aid: You can also request a benefits statement online through the Social Security Administration’s Web site.

Many people are being sent estimates of their future Social Security benefits without having to make a request. You may have received such an estimate in the mail.

The amount of Social Security benefits you will receive depends on how long you worked, the age at which you begin receiving benefits, and your total earnings.

If you wait until your full retirement age (65 to 67, depending on your year of birth) to begin receiving benefits, your monthly retirement benefit will be larger than if you elect to receive benefits beginning at age 62. The full retirement age will increase gradually to age 67 by the year 2027.

Be aware that Social Security benefits may be subject to income tax. The basic rule is that if your adjusted gross income plus tax-exempt interest plus half of your Social Security benefits are more than $25,000 for an individual or more than $32,000 for a couple, then some portion of your Social Security benefit will be subject to income tax. The amount that is subject to tax increases as the level of adjusted gross income goes up.

Related Guide: Also, if you earn income while you are receiving Social Security, your benefit may be decreased. For the specific rule, see the Related Financial Guide: SOCIAL SECURITY BENEFITS: How To Get The Maximum.

Pension Plans

Estimate how much you can expect to receive from a traditional pension plan or other retirement plan. If you are covered by a traditional pension plan and you are vested, ask your employer for a projection of what you can expect to receive if you continue working until retirement age or under other circumstances, for example, if you terminate before retirement age. You may already have received such an estimate.

If you are covered by a 401(k) plan, a profit-sharing plan, a Keogh plan, or a Simplified Employee Pension, make an estimate of the lump sum that will be available to you at retirement age. You may be able to get help with this estimate from your employer.

If you are in the military or formerly served in the military, contact the relevant branch of service to find out about retirement benefits.

Establishing Goals For Retirement

Determine how much income you will need (or want) after retirement. Once you have determined this amount, you can figure out how much you will need to put away to have a big enough nest egg to fund your desired income level.

Many people don’t realize that their retirement could last as long as their careers: 35 years or longer. Your nest egg may have to last much longer than you might think. Remember that the earlier you retire, the more you will have to save. If you want to retire at age 55, you’ll have to save a lot more than if you retire at age 65.

A general guideline is that you will want to have at least 70 percent of whatever income stream you have before retirement. If you have any special needs or desires, for example, a desire to travel extensively-the percentage should be adjusted upward. The 70 percent figure is not a substitute for a thorough analysis of your income needs after retirement, but is only a guideline.

Here are some suggestions for estimating how much of an income stream you will want to have coming in after retirement:

Figure Your Current Annual Expenses. The first step in trying to figure out what your annual expenses will be after retirement is to figure what your expenses are now. Take a year’s worth of checkbook, credit card, and savings account records, and add up what you paid for insurance, mortgage, food, household expenses, and so on.

Figure Out How Your Expenses Will Differ After Retirement. After you retire, your expenses will generally be a lot lower than they are while you are working. To help determine how much lower, here are some questions you might ask yourself:

Will your mortgage be paid off?
Will you still be paying for commuting expenses?
How much will you pay for health insurance?

If you are not among the lucky few that will have post-retirement health insurance coverage from an ex-employer, you will probably pay more for health coverage after you retire and have to take out so-called “Medigap” coverage.

Will you increase or decrease your life insurance coverage?
How much will you pay for travel expenses? (Do you want to travel after you retire, either on vacation or to visit relatives? Will you be commuting between a winter and summer home?)
Will you be spending more on hobbies after retirement?
Will your children be financially independent by the time you retire or will you have to factor in some sort of support for them?
Will your income tax bills be the same, lower, or higher?

If you are planning to retire to another state, take into account the different state taxes you will be paying.

The answers to these questions will help you determine your estimated annual expenses after retirement. Then subtract from this estimate the anticipated annual income from already-viable sources. (Do not subtract the lump-sum payments you expect to receive, for example, lump sum payments from 401(k) plans, which will be discussed later). The difference is the annual shortfall that will have to be financed by the nest egg you will need to accumulate.

How do you determine how much you need to save each year to accumulate a nest egg of that size by retirement age? You can do this by using the table below which, assumes an after-tax return of 5 percent per year. Just multiply the required nest egg by the Savings Multiplier for the number of years until retirement.

You are 40 years old and want to retire at age 65. You determine that you need a nest egg of $350,000 to fund your annual shortfall. To find out how much you must save each year to have that $350,000 nest egg by the time you are 65, multiply $350,000 by the 25-year savings multiplier (2.1 percent). You will need to save $7,350 (2.1 percent times $350,000) a year for 25 years.

Subtract from this nest egg any lump sums that you expect to receive at retirement. To project the value at retirement of a present asset (retirement account, savings, investments, etc.); multiply the current value of this asset by the Growth Multiplier for the number of years until retirement.

You already have $75,000 in a 401(k) plan. To find out what that amount will grow to in 25 years, multiply it by the growth multiplier for 25 years. This $75,000 will grow to $254,250 (339 percent times $75,000) by the time you retire. Subtract this $254,250 from the $350,000 needed in the previous example. This amount ($95,750) is the amount you must accumulate by age 65 to meet the income shortfall. Multiply this $95,750 by the 25-year savings multiplier (2.1 percent). You now know that, after taking the projected lump sum into consideration, you will still need to save $2,010.75 per year to accumulate $95,750.

Years Until Retirement	Savings Multiplier	Growth Multiplier

5	18.1%	128%
10	8.0%	163%
15	4.6%	208%
20	3.0%	265%
25	2.1%	339%
30	1.5%	432%

Deciding on Investments

Generally, the longer you have until retirement, the more of your savings should be invested in vehicles with a potential for growth. If you are very close to or at retirement, you may wish to put the bulk of your savings into low-risk investments. However, this formula is subject to your own financial profile: your tolerance for risk, your income level, your other sources of retirement income (e.g., pension payments), and your unique needs.

Related Guide: Please see the Financial Guide: INVESTMENT BASICS: What You Should Know.

Here is a summary of the pros and cons of various retirement-savings investments and their pros and cons. Please note that each of these is discussed in more detail in related Financial Guides.

Tax-Deferred Retirement Vehicles

Each year, maximize your deposits in a 401(k) plan, an IRA, a Keogh plan, or some other form of tax-deferred savings. Because this money grows tax-deferred, returns will be greater. Further, if the amount you put in is deductible, you are reducing your income tax base.

Lowest Risk Investments

Money market funds, CDs, and Treasury bills are the most conservative investments. However, of the three, only the Treasury bills offer a rate that will keep up with inflation. For the average individual saving for retirement, it is recommended that these vehicles make up only a portion of investments.

Related Guide: Please see the Financial Guide: ASSET ALLOCATION: How To Diversify For Maximum Return.

Bonds

Bonds provide a fixed rate of income for a certain period. The income from bonds is higher than income from Treasury bills.

Bonds fluctuate in value depending on interest rates, and are thus riskier than the lowest risk investments. If bonds are used as a conservative investment, it is a good idea to use those of a shorter term, to minimize the fluctuation in value that might occur.

Stocks

Although common stock is riskier than any other investment yet discussed, it offers greater return potential.

Mutual Funds

Mutual funds are an excellent retirement savings vehicle. By balancing a mutual fund portfolio to minimize risk and maximize growth, a higher return can be achieved than with safer investments.

Related Guide: Please see the Financial Guide: INVESTING IN MUTUAL FUNDS: The Time-Tested Guidelines.

by Donald Hayden

02 Aug 2024

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

Lock-ins And Fees
Locking In The Mortgage
Escrow Accounts

Lock-ins And Fees

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

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

Loan Processing Time

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

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

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

Expiration of Lock-ins

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

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

Locking In The Mortgage

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

Related Guide: For a more in-depth discussion about mortgages, please see the Financial Guide: MORTGAGES ALTERNATIVES: How To Choose The Right One.

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

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

What Is a Lock-In?

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

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

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

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

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

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

Will Your Lock-In Be In Writing?

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

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

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

Will You Be Charged for a Lock-In?

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

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

How to Handle the Options Available for Mortgage Settlement Terms

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

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

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

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

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

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

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

How Long Are Lock-ins Valid?

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

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

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

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

What Happens If the Lock-In Period Expires?

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

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

Complaints about Lock-ins

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

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

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

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

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

Escrow Accounts

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

What Is An Escrow Account?

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

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

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

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

How Are The Payments Calculated?

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

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

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

Why Mortgage Payments Change

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

Interest on Escrowed Funds

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

Escrow Account Balance

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

If You Have a Complaint

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

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

by Donald Hayden

02 Aug 2024

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

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

What Is a Home Equity Line Of Credit (HELOC)?
What To Look For
Costs Of Obtaining A Home Equity Line
How will You Repay Your Home Equity Plan
Line Of Credit vs. Traditional Second Mortgage
How To Compare Costs
The Finance Charge And The Annual Percentage Rate (APR)
Comparing Loan Terms
Special Considerations

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

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

For tax years 2018 through 2025 interest on home equity loans is only deductible when the loan is used to buy, build or substantially improve the taxpayer’s home that secures the loan. Prior to 2018, many homeowners took out home equity loans. Unlike other consumer-related interest expenses (e.g., car loans and credit cards) interest on a home equity loan was deductible on your tax return.

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

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

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

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

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

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

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

What To Look For

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

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

Interest Rate Charges and Plan Features

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

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

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

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

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

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

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

Costs Of Obtaining A Home Equity Line

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

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

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

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

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

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

How will You Repay Your Home Equity Plan

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

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

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

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

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

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

Line Of Credit vs. Traditional Second Mortgage

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

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

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

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

How To Compare Costs

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

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

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

The Finance Charge And The Annual Percentage Rate (APR)

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

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

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

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

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

Comparing Loan Terms

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

The lowest cost loan is available from Lender A.

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

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

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

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

Special Considerations

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

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

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

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

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

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

by Donald Hayden

02 Aug 2024

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

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

Who Can Benefit From Refinancing?
How To Go About Making The Decision
How To Determine Your Refinancing Costs
How Does Refinancing Affect Your Tax Situation?
Tips for Getting the Best Deal
Sample Refinancing Savings

Who Can Benefit From Refinancing?

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

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

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

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

Planning Aid: For information on fixed rates, see the Financial Calculator: Which Is Better: Fixed or Adjustable-Rate Mortgage?

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

How To Go About Making The Decision

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

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

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

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

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

How To Determine Your Refinancing Costs

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How Does Refinancing Affect Your Tax Situation?

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

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

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

Tips for Getting the Best Deal

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

1. Shop Around

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

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

2. Obtain a “Lock-In” or Guarantee

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

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

3. Review the Disclosure Form

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

Related Guide: Please see the Financial Guide: MORTGAGE LOCK-INS: Questions To Ask.

4. Be Aware Of Your Right to Rescind

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

5. Find Out If the Application Fee Is Refundable

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

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

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

* * * *

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

Sample Refinancing Savings

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

Your Present Mortgage Rate	Current Monthly Payment	Monthly Payment at 8%	Monthly Difference in Payment at 8%	Annual Difference in Payment at 8%
9%	603	550	53	636
9.5%	631	550	81	972
10%	658	550	108	1296
10.5%	686	550	136	1632
11%	714	550	16	1968
11.5%	743	550	193	2316
12%	771	550	221	2652

Your Present Mortgage Rate	Current Monthly Payment	Monthly Payment at 6%	Monthly Difference in Payment at 6%	Annual Difference in Payment at 6%
9%	603	450	153	1836
9.5%	631	450	181	2172
10%	658	450	208	2496
10.5%	686	450	236	2832
11%	714	450	264	3168
11.5%	743	450	293	3516
12%	771	450	321	3852

by Donald Hayden

02 Aug 2024

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

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

Traditional Mortgage
Non-Traditional Mortgages
Growing-Equity Mortgage (Rapid-Payoff Mortgage)
Buy-Downs
Rent With Option To Buy
Reverse Mortgage
Some Cautions
Mortgage Terms

Traditional Mortgage

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

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

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

Non-Traditional Mortgages

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

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

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

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

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

15-Year Mortgage

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

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

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

Adjustable-Rate Mortgage (ARM)

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

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

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

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

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

Planning Aid: See The Financial Calculator: Which Is Better: Fixed or Adjustable-Rate Mortgage?

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

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

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

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

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

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

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

Payment Caps

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

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

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

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

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

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

Prepayment and Conversion

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

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

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

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

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

Shopping for a Mortgage

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

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

Balloon Mortgage

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

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

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

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

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

Graduated Payment Mortgage

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

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

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

Growing-Equity Mortgage (Rapid-Payoff Mortgage)

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

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

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

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

Shared Appreciation Mortgage (SAM)

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

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

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

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

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

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

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

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

Assumable Mortgage

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

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

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

Seller “Take-Back” Mortgages

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

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

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

Wraparound Mortgage

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

Land Contract

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

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

Buy-Downs

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

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

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

Rent With Option To Buy

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

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

Reverse Mortgage

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

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

Related Guide: Please see the Financial Guide: REVERSE MORTGAGES: How They Can Enhance Your Retirement.

Some Cautions

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

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

Acceleration Clause

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

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

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

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

Due-On-Sale-Clause

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

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

Mortgage Terms

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

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

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

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

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

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

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

by Donald Hayden

02 Aug 2024

The Patient Protection and Affordable Care Act of 2010, in concert with the enactment of the Health Care and Education Tax Credits Reconciliation Act of 2010, resulted in many changes to the US tax code. As such, there are several tax implications for individuals and businesses.

Individuals

Healthcare Exchanges

Healthcare Exchanges, also called Health Insurance Marketplaces, officially opened for enrollment in October 2013. Some of these exchanges are run by the state in which you reside. The federal government runs others.

Individuals (including self-employed) without insurance or buying insurance independently (i.e., those without employer coverage) can use these marketplaces. The health insurance coverage purchased on the exchange is effective on January 1 of each year. When you get health insurance through the Marketplace, you may be able to get the new advance Premium Tax Credit that will immediately help lower your monthly premium.

Individual Mandate

Background. Under the Affordable Care Act and for tax years 2014 – 2018, United States citizens and legal residents were mandated to obtain minimum essential health care coverage for themselves and their dependents, have an exemption from coverage, or make a payment when filing a tax return. The Individual Mandate is also known as the Individual Shared Responsibility Payment. Only the amount of income above an individual’s tax filing threshold ($10,000 indexed for inflation) was used to calculate the penalty.

Starting in 2019, the individual mandate was eliminated. However, five states – California, Massachusetts, New Jersey, Rhode Island, and Vermont – and the District of Columbia still have their own individual mandates.

Most people already have qualifying health care coverage and do not need to do anything more than maintain that coverage throughout the year. Self-insured ERISA policies used by larger employers, Medicare, Medicaid, and CHIP (Children’s Health Insurance Program), and all of the health insurance plans offered by the exchanges fall under the minimum essential health care coverage category.

Certain individuals were exempt from the tax and include:&

people with religious objections;
American Indians with coverage through the Indian Health Service;
undocumented immigrants;
those without coverage for less than three months;
those serving prison sentences;
those for whom the lowest-cost plan option exceeds 9.12% of annual income (starting January 1, 2023); and
those with incomes below the tax filing threshold who do not file a tax return.

Refundable Tax Credit

Effective in 2014, certain taxpayers can use a refundable tax credit to offset the cost of health insurance premiums so that their insurance premium payments do not exceed a specific percentage of their income. Qualified individuals have incomes between 133 and 400 percent of the federal poverty level. A sliding scale based on family size is used to determine the amount of the credit. In addition, married taxpayers must file joint returns to qualify.

FSA Contributions

FSA (Flexible Spending Arrangements) contributions are limited to $2,500 per year starting in 2013 and indexed for inflation after that. For 2023, the limit is $3,050 (up from $2,850 in 2022).

Rules for HSAs and Archer MSAs

Tax on non-qualified distributions from HSAs and Archer MSAs used to cover the cost of over-the-counter medicine without a script increased to 20 percent starting in 2011. Medical devices, eyeglasses, contact lenses, copays, and deductibles are not affected, nor is Insulin, even if it is non-prescription.

AGI Limits for Deductible Medical Expenses

The deduction threshold of 7.5 percent of AGI for all taxpayers (Tax Cuts and Jobs Act of 2017) was made permanent by the pandemic tax relief package signed into law on December 27, 2020.

Health Coverage of Older Children

The cost of employer-provided health care coverage for children (through age 26) on tax returns is excluded from gross income.

Medicare Tax Increases for High Income Earners

Starting in 2013, there is an additional 0.9 percent Medicare tax on wages above $200,000 for individuals ($250,000 married filing jointly). These amounts are not indexed to inflation.

Also starting in 2013, there is a new Medicare tax of 3.8 percent on investment (unearned) income for single taxpayers with modified adjusted gross income (MAGI) over $200,000 ($250,000 joint filers). Investment income includes dividends, interest, rents, royalties, gains from the disposition of property, and certain passive activity income. Estates, trusts, and self-employed individuals are all liable for the new tax.

Exemptions are available for business owners, and income from certain retirement accounts, such as pensions, IRAs, 401(a), 403(b), and 457(b) plans, is exempt.

Businesses

Self-Employed

If you run an income-generating business without employees, you’re considered self-employed (not an employer). You can get coverage through the Marketplace and use it to find coverage that fits your needs. You are not considered an employer even if you hire independent contractors to do some work.

If you currently have individual insurance, that is, a plan you bought yourself and not the kind you get through an employer, you may be able to change to a Marketplace plan. Furthermore, you can’t be denied coverage or charged more because you have a pre-existing health condition.

Small Businesses (50 or Fewer Employees)

If you have 50 or fewer full-time equivalent (FTE) employees (generally, workers whose income you report on a W-2 at the end of the year), you are considered a small business under the health care law.

As a small business, you may get insurance for yourself and your employees through the SHOP (Small Business Health Options Programs) Marketplace. This applies to non-profit organizations as well.

If you have fewer than 25 employees, you may qualify for the Small Business Tax Credit (see next section). Non-profit organizations can get a smaller tax credit.

As an employer, you must notify your employees of coverage options available through the Marketplace. You must provide this notice to all current employees and each new employee effective October 1, 2013, regardless of plan enrollment status or full or full, or part-time employment. The Department of Labor has sample notices that employers can use to comply with this regulation. One notice is for employers who do not offer a health care plan, and the second is for employers who offer one.

Small Business Health Care Tax Credit

Small businesses and tax-exempt organizations that employ 25 or fewer full-time equivalent workers with average incomes of $56,000 or less in 2021 (indexed for inflation annually) and that pay at least half (50 percent) of the premiums for employee health insurance coverage are eligible for the Small Business Health Care Tax Credit.

Starting in 2014, the tax credit is worth up to 50 percent of your contribution toward employees’ premium costs (up to 35 percent for tax-exempt employers). The tax credit is highest for companies with fewer than ten (10) employees, paid an average of $30,700 or less in 2023 ($28,700 in 2022). The smaller the business, the bigger the credit is. The credit is available only if you get coverage through the SHOP Marketplace.

Additional Tax on Businesses Not Offering Minimum Essential Coverage

Effective January 1, 2015, an additional tax is levied on businesses with 50 or more full-time equivalent (FTE) employees that do not offer minimum essential coverage. This penalty is sometimes called the Employer Shared Responsibility Payment or “Pay or Play” penalty.

For tax years 2015 and after, an applicable large employer is liable for an Employer Shared Responsibility payment only if:

(a) The employer does not offer health coverage or offers coverage to fewer than 95 percent of its full-time employees and the dependents of those employees, and at least one of those full-time employees receives a premium tax credit to help pay for coverage on a Marketplace;

(b) The employer offers health coverage to all or at least 95 percent of its full-time employees, but at least one full-time employee receives a premium tax credit to help pay for coverage on a Marketplace, which may occur because the employer did not offer coverage to that employee or because the coverage the employer offered that employee was either unaffordable to the employee or did not provide minimum value.

Employers with fewer than 50 FTE (full-time equivalent) employees are considered small businesses and are exempt from the additional tax.

Employers subject to the employer shared responsibility provisions (Applicable Large Employers or ALEs) also have information reporting responsibilities regarding minimum essential coverage offered to employees. These responsibilities require employers to send reports to employees and the IRS. Information reporting returns will be filed and furnished in early 2023 for 2022. An employer that sponsors self-insured health insurance coverage – whether or not the employer is an ALE – has insurer information reporting responsibilities as a provider of minimum essential coverage.

The annual Employer Shared Responsibility Payment amount is based partly on whether you offer insurance.

If you don’t offer insurance, the annual payment is $2,000 (indexed for inflation) per full-time employee (excluding the first 30 employees).
For an employer that offers coverage to at least 95 percent of its full-time employees (and their dependents) but has one or more full-time employees who receive a premium tax credit, the payment is computed separately for each month. The monthly payment equals the number of full-time employees who receive a premium tax credit for that month multiplied by 1/12 of $4,320 in 2023. The payment amount for any calendar month is capped at the number of the employer’s full-time employees for the month (minus up to 30) multiplied by 1/12 of $2,880 in 2023.

Unlike employer contributions to employee premiums, the Employer Shared Responsibility Payment is not tax deductible. In addition, Employer Shared Responsibility payments (either $2,000 or $3,000) are indexed to inflation beginning in years after 2014. For 2023, these numbers are $2,880 and $4,320, respectively.

A health plan meets minimum value if it covers at least 60 percent of the total allowed costs of benefits provided under the plan. All plans in the Marketplace meet minimum value, so any coverage offered through the SHOP Marketplace should qualify.

Excise Tax on Indoor Tanning Services

A 10 percent excise tax on indoor tanning services went into effect on July 1, 2010. The tax doesn’t apply to phototherapy services a licensed medical professional performs on their premises. There’s also an exception for certain physical fitness facilities that offer tanning as an incidental service to members without a separately identifiable fee.

Health Care Taxes Repealed

Three healthcare-related taxes enacted to fund the Affordable Care Act – and that had previously been delayed or suspended – were repealed under the Further Consolidated Appropriations Act, 2020:

Medical device excise tax
Annual fee on health insurance providers
Excise tax on high-cost employer-sponsored health coverage (“Cadillac tax”)

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Before You Reach Age 73

Once You Reach Age 73

How Your Heirs Are Taxed

Some Tax Planning Opportunities

Taking Steps To Protect Yourself

Full Retirement

Year of Birth

Full Retirement Age

Early Retirement

Delayed Retirement

Year Of Birth

Yearly Rate of Increase

Tax-Deferred Retirement Vehicles

Lowest Risk Investments

Bonds

Stocks

Mutual Funds

Loan Processing Time

Expiration of Lock-ins

What Is a Lock-In?

Will Your Lock-In Be In Writing?

Will You Be Charged for a Lock-In?

How to Handle the Options Available for Mortgage Settlement Terms

How Long Are Lock-ins Valid?

What Happens If the Lock-In Period Expires?

Complaints about Lock-ins

What Is An Escrow Account?

How Are The Payments Calculated?

Why Mortgage Payments Change

Interest on Escrowed Funds

Escrow Account Balance

If You Have a Complaint

Interest Rate Charges and Plan Features

1. Shop Around

2. Obtain a “Lock-In” or Guarantee

3. Review the Disclosure Form

4. Be Aware Of Your Right to Rescind

5. Find Out If the Application Fee Is Refundable

15-Year Mortgage

Adjustable-Rate Mortgage (ARM)

Payment Caps

Prepayment and Conversion

Shopping for a Mortgage

Balloon Mortgage

Graduated Payment Mortgage

Shared Appreciation Mortgage (SAM)

Assumable Mortgage

Seller “Take-Back” Mortgages

Wraparound Mortgage

Land Contract

Acceleration Clause

Due-On-Sale-Clause

Individuals

Businesses