Your Guide To Basic Estate Planning In 6 Steps

Your Guide To Basic Estate Planning In 6 Steps

“Death is not the end. There remains the litigation over the estate.”

Ambrose Bierce

Have You Created An Estate Plan?

Most of us want to avoid litigation, especially over an estate. Having a plan helps you do that. The best time to think about your plan is when you don’t have a compelling reason to do. Keep your family’s best interests at heart with a well-developed estate plan. Estate planning will give you control over your asset distribution during your lifetime to your loved ones.

A significant portion of your assets can be easily transferred to your intended heirs, avoiding often painful and lengthy probate court procedures. It is a good idea to sit down with an estate planning attorney or a tax attorney who is familiar with asset protection and tax planning. You may have questions about federal estate taxes. You can consult the American Bar Association for estate planning articles or find an estate planning attorney.

What Is Part Of Your Estate Plan?

To design your estate plan in 6 steps, we address the following:

  • Organize your assets into the non-probate property.
  • Know who your designated beneficiaries.
  • Determine if you have joint ownership with rights of survivorship.
  • Set up your will for probate property.
  • Have a letter of instructions to loved ones.
  • Consider a trust if appropriate.
  • Donate assets to your charity.
  • Health care proxy or advance directives documents are essential.
  • Testamentary Letters.

 

Having a plan is essential for your family and is in their best interests. Yet, only 40% of US adults have created a will or a living trust. Even younger people, especially if they have young children, can benefit from putting together an estate plan.

6 Reasons Why You Need An Estate Plan

#1 Assure financial support for your surviving spouse, children and grandchildren, and even later generations. The passing of a loved one is stressful and often traumatic. Adding financial stability is helpful.

#2 Write out your wishes while you are of sound mind. We never know when our mental capacity diminishes through tragedy, or of aging.

#3 Avoid litigation for your family in the future. Make your intentions for distribution known, so your loved ones don’t have to fight out in probate court. That path takes time and is costly.

#4 Arrange your estate plan with capable professionals to steer away from the potential publicity that can sometimes accompany the passing of a loved one.

The Great Aretha Franklin died in 2018 without a trust or will, forcing her sons to file documents in a probate court in Michigan. Prince’s estate was not covered by a plan when he died in 2016, and the distribution of his assets will likely take more time and more public scrutiny. Just recently I read there are questions arising about Nina Simone’s estate, and she passed away in 2003.

#5 Minimize estate taxes and costs when it is time for asset transfers.

#6 Support a favorite charity, address pet care and consider digital assets.

How To Start Your Basic Estate Planning

Start discussions with your estate planning attorney, tax accountant, and financial advisor. Through frank discussions, your goal is to put together the most beneficial plan for your situation at the most effective cost. Make sure that you consider your digital assets in your will, which we fully address in this post.

You built your wealth. Now you want to distribute your assets according to your wishes properly.

Carry out estate planning for your family, make sure your assets go where you intend them to go and that the person you expect to be the executor of your will, will be the one responsible for administering your estate will be that person. Pick your potential executor.

A Simple Estate Planning Guide In 6 Steps:

 

Step 1

Set up most of your assets as non-probate property. These assets outside the will and, for many of us, are the bulk of our estate. 

This property will automatically transfer to your designated beneficiaries upon your death rather than through your will. One of the most important assets you will need to address is your home (e.g., house, condominium, cooperative, vacation home) unless you rent only.

Your non-probate property is an asset that will transfer to survivors by contract based on your designated beneficiary. Name beneficiaries for all of the assets that you can.

Your Non-Probate Assets Will Include:

  • retirement accounts, including 401(k) plans,
  • IRAs, pension plans,
  • payable-on-death clauses in bank accounts, investment portfolio(s),
  • life insurance policies or
  • by owning accounts with another person, usually a family member,  through rights of survivorship.

These assets are generally transferred directly to those beneficiaries that you designated. At the time you opened these accounts, you likely wrote out your beneficiaries on a legal form.

Review Beneficiary Designations Periodically

You may want to change your beneficiaries as you go through life.  For example, if you designated your mom when you first set up your accounts, it is probably a good idea to refresh your beneficiaries. Often, after life changes such as a divorce, remarriage, or the passing of a loved one, we want to update our beneficiaries. Sometimes we can provide for a contingent or secondary beneficiary. To understand the importance of designated beneficiaries, please read here.

Joint ownership with rights of survivorship

Husbands and wives (or parents and children) may have joint ownership of assets called joint tenancy with the right of survivorship.

Make transfers by property ownership designation. These assets can include bank accounts, investment accounts, cars, and home(s). Upon the death of one owner, the surviving owner(s) will receive this property by operation of law rather than through the will.

These assets will be a majority of our assets, and their transfer is simple.

In most cases, your intended recipient need only present an official death certificate, and the bank, for example, will transfer funds or property to his or her name in the ordinary course of business. These assets do not pass through the will or the probate process.

Step 2

 

Set up your will for probate property

A Will, or often known as “Last Will and Testament” is a formal written document that directs how assets not addressed in Step 1.  Upon the death of an individual, the distribution of these assets occurs. 

The individual making the will is called the testator. He or she decides who gets their remaining assets after their death.

Appoint a personal representative, commonly called an executor, and give the executor the powers necessary to fulfill your wishes. Without a will, your state’s intestacy laws will dictate how your assets are to be distributed.

Don’t have co-executors

Sometimes people opt for co-executors, such as a  spouse and an adult child they believe can work in unison. Relatives and friends are not great choices to perform the executor’s duties.

Choose one trustworthy executor. While co-executors may sound harmless, acting in unison, in reality, can be more difficult. Executors may be called on to pay off debts, liquidate assets, file tax returns and estate tax returns. They may need to get the court’s permission to distribute the balance of the remaining assets, including money.

Spouses have legal rights to each other’s estates

State laws presume that married couples share their fortunes equally.

Sharing your property with your spouse is a right. This property sharing is called “the partnership theory of marriage rights.” Property acquired during the marriage and titled in one partner’s name (except for property acquired via gift or inheritance) becomes property of both spouses typically. Any spousal rights to claim an inheritance from the other spouse under the law are void upon divorce.

The estate assumes any debts of one spouse, not personal liabilities of executor or the beneficiaries.

There are nine community property states where all the money, assets, and debts acquired during the marriage are legally part of the joint property of both spouses. The rights of husbands and wives are equally protected.

 

What A Will Does:

  • Decide what property, including personal property that has sentimental value.
  • Determine who will inherit the assets.
  • Designate a trustee and guardian to manage assets if there are children under 18 who may be beneficiaries under your will.  The trustee and guardian can be the same.
  • Handle digital assets that may need you to designate access to family members to see your social media accounts. Digital assets are a broad category and include new types of assets like cryptocurrencies and non-fungible-transfers (NFTs).

For your will to be effective and valid, the will must be signed according to your state’s law.

Generally, a will must be in writing, signed before a minimum of two witnesses who can attest to your mental capacity and soundness at the time of signing the will.

You want a valid will 

You should challenge-proof your will with your attorney’s guidance. The will becomes effective upon the death of the testator. Up until that time, you can change a will as often as you want. The original (not copied) version of the last will should be kept intact and often stored in a safe deposit box or safe place.

Step 3

 

Leave your letter of instructions.

Write a letter of last directions, separate from your will, that may provide your preferences regarding funeral and burial arrangements, who speak at your funeral, contact information for family, friends, colleagues, and such.

There may be items that weren’t part of your will but are essential to you to let your surviving family members know of their existence. If any instructions conflict with the direction provided by the will, typically, the will overrides the information in this letter.

Leaving Guidance For  Family Is Helpful

Organize financial information, people to contact, essential papers (this could be in the form of a memoir, for example), and provide the location of where your family may find these things. This letter doesn’t have the legal force of the will but may amount to personal information that the family could use and you wish to share.

Step 4

 

Who Should Consider A Trust?

 

Trusts have additional features not found in wills.

Most people know what a will is, and it is the first place to handle probate property, but trusts are increasingly more popular in estate planning. Use trusts when you have a more complex estate, have less liquid assets, and desire privacy as trusts avoid probates. Trusts provide some features that a will won’t.

Living Trusts

Before death, you can use a trust as a living trust.  These instruments can take effect while the grantor is alive and can give the grantor the right to make changes. These are called revocable living trusts, and the grantor can be the trustee. However, if the grantor cannot serve because of becoming incapacitated, someone you appoint can name a new trustee.

Living trusts can also be made irrevocable, meaning no changes can be made by the grantor.

Irrevocable Charitable Remainder Trust (CRT)

People who have significantly appreciated assets may want to consider setting up a charitable remainder trust. A CRT is an irrevocable trust that generates a potential income stream for you as the donor to the CRT or other beneficiaries. The remainder of the donated assets goes to your favorite charities. There are several benefits, substantial income tax deductions while preserving the value of your assets. You can read more about it here.

Donating Assets To a Charity

CRTs are tax-exempt irrevocable trusts that reduce the taxable income of the donor during their lifetime. The irrevocable donated assets go to the trust. Distributed income moves from the assets to you and your spouse for a set period or life. The charity you designate will receive the CRT assets when you or your spouse die.

Testamentary Trusts

A different kind of trust is the testamentary trust, usually contained in wills that go into effect after the grantor’s death.

Step 5

Living Wills and Medical Powers of Attorney

 Prepare health care proxies, often called advance medical directives, that is, a living will and your durable powers of attorney.

Write a living will detailing a person’s desires regarding medical treatment when they may no longer express their wishes. The living will provides informed consent.

A living will is separate from your will made in consultation with your attorney and signed by you. This medical directive can help reduce ambiguities during a difficult time using feeding tubes, for example, and keeping a loved one alive unnecessarily.

The Terri Schiavo case

Does anyone remember the legal battle in 2005 surrounding Terri Schiavo? Terri Schiavo was a legal case that spurred a right-to-die movement. As a result of her family’s tribulations, many people recognized a living will as an important document. While challenging, it provided urgent awareness of why you need to address these possibilities. Health care directives are critical parts of your estate plan.

Use the durable power of attorney to appoint someone you trust as your agent, do certain things, and take actions in your name if you cannot do so. This agent is also called “attorney in fact.”

When the grantor is incapacitated or disabled

Under a power of attorney, the agent can bind you to contract obligations, sell, buy or close title to real property in your name, conduct banking, or other transactions. Every state has its requirements for ensuring valid powers of attorney. These powers are “durable,” which means that the agent’s authority survives any incapacity or disability of the grantor. The point is not to go and buy a form online or at a store. You need to designate someone trustworthy.

These powers come into use when the grantor cannot physically appear at a bank, through injury, confinement, or frankly just does not want to go. This instrument is crucial when caring for a person with dementia, Alzheimer’s Disease, or other limited mental capacity diseases. The most common uses of this power of attorney are in banking and real estate transactions.

Step 6

Upon your death, your executor will become the administrator and fiduciary of the will effectively.

After appointing an executor, the probate court will confirm the appointment upon your death. The executor’s role is to be effective and he or she can be expressly relied upon by financial institutions and insurance companies.

This executor will submit a petition to the probate court in the jurisdiction where the testator passed away. Assuming no challenges, the court will formally appoint the executor by issuing Letters Testamentary.

Testamentary Letters

Usually, third parties require original letters, so you have to get these directly from the court. They are not available online. These letters are court documents that allow the executor to act as a fiduciary under the supervision of the court.

These testamentary letters, along with the legally binding death certificate, are the essential documents that give the executor the force to deal with potentially numerous parties that have an interest in your estate.

Final Thoughts

Estate planning decision-making can be complex. However, it provides peace of mind by reducing some of the uncertainty that may arise for your family. Estate planning is in your family’s best interests.

Protecting your assets and having a plan to distribute them to loved ones should reduce potential angst that may follow. Engage a tax accountant with a CPA to help you realize tax efficiencies, an important component of estate planning.

Have you started thinking about estate planning? It is usually easier to do when you have no urgent reason to do so but are thinking of your family’s best interest. This guide should move you to think about your plan but you need careful consideration and professional guidance.

Please share any thoughts or comments you may have. We would love to hear from you! Please visit The Cents of Money for other articles of interest.

 

 

Your Guide To Basic Estate Planning In 6 Steps

How to Choose A Financial Advisor

“A goal without a plan is just a wish.” 

Antoine de Saint-Exupery, The Little Prince

 

“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” 

Confucius

When you are seeking a financial professional, you may be confused by your choices. Many professionals help you with planning when giving you financial advice, whether making investment recommendations for your portfolio or providing tax-efficient savings.

“Financial planner” or “financial advisor” are terms often used interchangeably. They may provide similar financial planning services. However, their level of education, certifications, designations, and standards may be quite different. This post discusses how to choose a financial advisor that is right for you.

The Main Differences When Seeking A Financial Advisor

 

1. Type of Personal Financial Services You Are Looking For

You may be looking for someone to advise you for a single purpose like debt management or a comprehensive plan. Here, we will focus on how to choose a financial advisor or planner. This type of advisor can handle various services (discussed below) to guide you towards your goals strategically. At the end of this article, you should be able to hire a financial advisor.

You may turn to accountants and attorneys for setting up a new business, debt management, bankruptcy, taxes, and estate planning.

2. The Fee Structure

Generally, your fees range from the fee-based only, commission-based, flat fee, or a blend of fees and commissions. However, there may be extra costs for additional services such as insurance.

3. Education, Certification, and Designation Requirements Vary

Financial advisors or planners have a bachelor’s degree with an accounting or finance focus as the minimum requirement. Advanced educational degrees are not uncommon. Their course of study distinguishes certified financial planners (CFPs), with a rigorous exam, required experience, and high standards.

Consider your candidate’s soft skills such as adaptability, communication, and problem-solving and if you have good chemistry. We have a list of questions below you should ask your candidate when choosing your financial advisor.

 4. How They Are Regulated

Different regulators play a role according to the primary designation. Regulation of financial planners may be according to their professional title. Planners with CFP credentials are subject to the requirements of the Certified Financial Board of Standards.

The Securities Exchange Commission (SEC) and the state where they do business regulates investment advisors who provide financial planning.

The  State Board of Accountancy regulates the accountant preparing a financial plan.

Key Financial Services

 

1. Money and Debt Management

Consider a money coach or credit counselor when you need help saving money, setting up a budget, reducing expenses, and debt management. You can often get free assistance from a certified credit counselor by searching on the nfcc.org website.

Accredited financial counselors or AFCs can aid you in money management through their organization 

 

Related Post: How To Pay Down Your Debt For Better Financial Health

2. Investment Advice and Trades

Investment advisers and brokers provide all manner of investment services, from do-it-yourself online trading to full-scale investment advice and money management. Generally, investment advisors and broker-dealers need to register with the SEC and the Financial Industry Regulatory Authority (FINRA), and state regulators. They are subject to the suitability standard, less demanding than the fiduciary duty.

A Registered Investment Advisor (RIA) advises high-net-worth individuals on their investments and manages their portfolios. They have a fiduciary duty to their clients, which means they provide investment advice by acting in their clients’ best interests.

3. Financial Planning

Financial planners are financial advisors who provide clients with a range of personal financial services. They can help you create a simple one-time financial plan if you are just starting, grapple with a specific financial objective, or provide a comprehensive goal-based plan. The latter may encompass savings, investments, college savings, insurance, retirement, tax planning, and estate planning.

Each plan should be tailored to your needs and provide a disciplined approach to achieve your financial goals. Financial planners will want to gather data from your personal and financial life and make forecasts to achieve wealth. Hiring a financial planner is a good starting point when you are in the early stages of accumulating assets or already have substantial assets but need guidance in their complex financial situation.

A core financial plan includes:

Cash flow management will look at the specifics of your current and projected budget and net worth, debt management, creating an emergency fund, savings for a house, vacations, college tuition, and retirement.

Risk management will consider life, disability, and medical insurance protection for you and your family.

Wealth management will address investments, diversification, risk tolerance, and asset allocation.

Related Post: 10 Tips To Diversify Your Investments

Tax and retirement planning should provide strategies to minimize your tax burden using capital gains strategies, charitable giving, tax-free and tax-deferred retirement savings. Advisors should speak with their clients about what kind of lifestyle they expect for their retirement years.

Estate planning involves questions about wealth transfer to loved ones most appropriately and efficiently.

Related Post: Your Guide To Basic Estate Planning

This Designation Is Preferable

Certified Financial Planners, or CFPs, have an essential designation issued by the Certified Financial Planner Board of Standards. This designation is difficult to obtain. It requires passing rigorous exam testing in specific personal finance areas. The CFP certification is distinct from CFAs, also or certified financial analysts who are highly respected in the investment analysis field.

CFPs must commit to continuing education on financial and ethical matters. They need at least three years of experience and must adhere to pretty stringent standards to earn and maintain their title. Before hiring a financial planner, you should verify the status of anyone claiming to be a CFP and whether he/she has undergone a disciplinary process.

When choosing a financial planner, CFP credentials may provide added comfort and confidence in your choice. However, it is not a guarantee of excellent performance. You want to pick the right financial advisor or team with the right fit for your needs.

Look For A Fiduciary

At a minimum, you want planners who are experts, professional and trustworthy. You should pick your planner who adheres to the fiduciary standard. The fiduciary standard is a higher standard requiring the planner or investment adviser to act in the best interests of their clients at all times.

Fiduciary duty standard is the highest standard of care referring to the financial professional.  A fiduciary is someone who holds a legal and ethical relationship with clients. They manage people’s money in their clients’ best interests rather than in their interests.

Registered Investment Advisors or RIAs help you manage your assets, mainly by way of your investment portfolio. These professionals are knowledgeable about market patterns, investing in stocks, mutual funds, and other securities. They are fiduciaries making similar recommendations to a CFP. Their pay structure is fee-based but earns commissions from the sale of financial products. CFAs or chartered financial analysts are highly respected in the investment analysis field, distinct from financial advisors.  

Don’t Paint Advisors With A Broad Brush

Investment advisers and brokers who work for broker-dealers and offer investment advice are primarily commission-based. They may have obtained CFP credentials through the hard work required.

From my experience, you cannot paint these individuals with a broad brush. Many are product salespeople interested in selling the latest service from their firm, yielding commission dollars. Other advisors are problem-solvers for their clients, helping them to manage their assets as a business. If you are fortunate to find one of these value-added professionals, grab them.

In contrast to the stricter fiduciary standard, FINRA requires the suitability standard for financial professionals who work for broker-dealers. Suitability is a lower standard than the fiduciary standard, which means the financial professional should only make recommendations suitable for their clients. A recommendation doesn’t have to be consistent with the individual’s objectives and profile.  For example, buying risky securities would not be suitable for retirees.

Financial Planners With Specialities

You may be seeking a financial planner for a specific goal like buying a house, retirement planning, or estate planning. Some planners specialize in particular areas such as addressing families with special needs, women executives or planning for single people.

Related Post: 10 Ways For Women To A Financial Independence

Look For Fee-Based Only Planners

The pay structure differs for different financial professionals from fee-based-only or charging flat fee, commission-based only, or a blend. When you want to develop a financial plan, I recommend seeking a fee-based adviser with more incentives to help with your financial goals. Fee-based structures can be fees by the hour, a flat fee for your plan, or a percentage of your annual assets.

Hourly rates may be in the $100-$400, with one-time financial plan costs of $1000-$3000+, and annual fees of percentages ranging 1%-2% of assets under management (AUM). Finding a planner that charges a flat rate or by the hour is best for those just starting to make money, who want a simple financial plan, and don’t yet have many assets.

Alternatively, you may want to consider Robo-advisors, such as Betterment, Wealthfront, Vanguard Personal Advisor Services, and  Schwab Intelligent Portfolios. Robo-advisors are an excellent option for those seeking low-cost financial advice and zero account minimum.

These providers have a range of investment and retirement planning services, digital planning tools and may provide access to human financial advisors. Their management fees vary from 0.25%-0.50% or flat annual fees. Some people prefer a human financial advisor for a specific part of their financial plan and several Robo-advisors offer blended services for a higher fee.

It Depends On Your Needs

You may be seeking a one-time financial plan after getting a sizable bonus or an inheritance. Others want to have a planning team to be able to work with them on an ongoing basis. There are a plethora of financial strategies to handle for a family moving through changing life cycles.

Trustworthy financial planners can help you build wealth with a disciplined approach. They may help you alleviate the financial stresses that you encounter when saving for a house, college tuition, insurance, and retirement using the most tax-efficient strategies.

When you have a busy career earning a high income, it may be challenging to wrestle with these personal finance specifics. Paying $10,000-$20,000 annually on a $1-$2 million portfolio that may produce savings isn’t bad.

Many traditional financial planners require a minimum of assets to invest, usually in the $250,000 range or significantly higher, and may not work with you. Other planners may prefer to grow with beginner clients to add a lot of value, particularly as clients have expanding family needs.

Where To Find The Right Financial Planner

The National Association of Personal Financial Advisors (NAPFA)  are fee-only planners who adhere to the fiduciary standard. They accept no commission-based planners. Their standards are high and generally meet or exceed the requirements needed for CFP credentials. Ask your friends and colleagues if they would recommend someone to you.

If you are just starting with fewer initial planning needs, you may consider the Garrett Planning Network. They are certified financial planners or persons working towards obtaining their credentials. They tend to focus on smaller projects for an hourly fee.

XY Planning Network is relatively new, focusing on young professionals looking for fee-based financial planners with the CFP designation. Their organization serves Generation X and Millennials. Their fees appear to be within the ranges of hourly rates or flat fees.

There are great Facebook Groups to visit, such as Females And Finance, run by Sheryl Hickerson, to help you find the right person for you. Women, in particular, have distinct needs for financial planning.

Do I Need A Financial Planner?

You can develop a simple financial plan on your own as you are starting. Even if you do not work with a financial planner, you need to consider your short-term and long-term goals. Managing money well is time-consuming and requires expertise in many areas.

As your assets grow, you may need guidance and assistance in developing financial strategies.

 10 Questions You Should You Ask When Seeking A Financial Advisor

Professional Caliber

  1. What are your qualifications, credentials, and experience?

You will want to know who you are dealing with in terms of expertise, education, certifications, and experience.

  1. Do you work with a team, and how do you work together?

Financial planners often have their specialties and overlap with others who can complement their skills.

  1. Are you a fiduciary?

A fiduciary standard is a more stringent duty of care. When speaking to a professional financial candidate, you want to understand how they view their role to you. It is your money and your financial future. You want your advisor to be working on behalf of your best interests, not theirs.

What Does This Cost

  1. What are your fees, and what are my costs all-in?

Understand their fee structure. Be clear about the extra costs you may incur, such as buying an insurance policy.

  1. How will I be communicating with you and your team?

Biannual plan reviews are common. How often will they be reviewing your financial plan with you?  If you will have an ongoing relationship with your financial planner, it is essential to understand how you will review and update your plan. What kind of communication should you expect, particularly when you are making changes.

  1. How will they work with you?

Will they take the time and have the patience to explain complex concepts to you. This information does matter, and it may take time to build confidence and a good rapport.

Characteristics of Your Financial Planners

  1. What is your investment philosophy? You want to understand your planners’ fundamental beliefs regarding growth and value investing. Markets can be turbulent, so you need to know how they may address investments during recessions.
  2. How should I measure success in our financial plan?

You need to understand the benchmarks that will provide you with results relative to your financial goals. There may be different measurements for various aspects of your plan.

  1. What added value may I expect from you as our financial advisor?

This question is tricky. Of course, you should expect expertise, professionalism, and trust. You want to know what kind of relationship you will have. When you want to make an investment that advisors believe is not a sound one, will they tell you “No”? They must have your back.

  1. What are some of the criticisms your clients say about you and your team?

No one person is perfect, so knowing those criticisms will help you measure your prospective financial planner and how he/she fits with your needs.

Final Thoughts

Prudent financial planning is vital to achieve your short- and long-term goals and to support your family values. We outlined the characteristics of a financial planner or advisor, the varying fee structure, and how to pick the right financial advisor for you.

What are you looking for when seeking out a financial advisor? What traits are essential to you? We would like to hear from you!

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8 Types of Insurance You Need

8 Types of Insurance You Need

We need to financially protect ourselves from events that happen out of our control. You can’t predict everything, but you can shield your income, property, and possessions from the possibility of financial losses resulting in disabilities, injuries, and liabilities. Unforeseen circumstances like accidents, natural disasters, illness, fires, or even death may present risks to our assets and families.

Types of Insurance You Need:

  • Auto
  • Homeowners/Renters
  • Life
  • Disability
  • Long Term Care
  • Health Insurance
  • Umbrella

 

“Insurance is the only product in the world that both the seller and buyer hope it is never actually used.”

Author Unknown

Buying insurance is the best way to manage the risk of losses that could be financially catastrophic to you. There are eight types of insurance you need. Nowadays, there are insurance products for just about everything. Just health insurance alone amounts to 4.3% of our pre-tax income in 2019.

Discussing insurance products are often uncomfortable. It requires us to think about probabilities with dire consequences. However, ignoring the topic could leave you exposed to avoidable losses. First, let’s explain some terminology used by the insurance field.

A Few Simple Terms To Know:

 

What is Insurance

Insurance is a way to have protection from financial losses. That coverage provides a guarantee of compensation for individuals in return for a payment of a premium.

The Premium

Premium is the monthly or annual cost for insurance coverage.

The Policy

An insurance policy is a contract between the person buying insurance (the insured) and the insurance company (the insurer) sold by insurance agents.

Deductibles

The deductibles are the specified money amount the insured must pay before an insurance company pays a claim.

Exclusions

Your policy may not cover everything and may exclude that loss or damage. 

Policy Limits

An insurance limit is the maximum amount of money an insurer will pay toward a claim if the policy covers it.

8 Types of Insurance Your Household Needs:

 

1. Auto Insurance

Driving a car is the single most extensive exposure to catastrophic losses for Americans. Poor driving judgment or adverse weather can result in significant property damage, personal injury losses, and death. It is illegal to operate a vehicle without assuming financial responsibility. Our 17-year-old son with excellent grades passed his road test this week. The first thing we did was add him to our policy, a $2,000 annual hit just like that. Hoorah!

Nearly every state requires motorists to have car insurance. The rules vary in the minimum amounts that are needed. New Hampshire is the only state that doesn’t mandate drivers to carry car insurance. That said, motorists are still responsible for paying bodily injury and property damages if they cause the accident.

Still, one out of six drivers is uninsured in the US. Those uninsured are either refusing to buy insurance or cannot afford it. If caught without coverage, drivers may be subject to fines, suspension, or points on their licenses.

Given these stats, you may want to consider uninsured motorist insurance coverage that will pay for your expenses after an accident caused by a driver who doesn’t have any insurance. This insurance is inexpensive but will be beneficial for repairs and if you have serious injuries. It will cover long-term care that can quite expensive.  You need to get the right car insurance.

The Insurance Information Institute reports in 2017 that the average loss per claim on cars is:

  • Physical damage per claim, on average, is $3,425 for collision and comprehensive losses.
  • Liabilities for bodily damage are $15,270 and $3,638 for property damage.

Car insurance combines the liability and property coverage needed by owners and drivers into a single package. Liability insurance covers the insured if found responsible for losses–bodily injury and property damage– suffered by others.

Medical payments insurance, also known as personal injury protection, can help pay medical expenses regardless of who is at fault. This insurance covers you, your passengers, any family members driving or riding in the insured vehicle at the time of the accident.

Some states require uninsured or under-insured motorist insurance for those injured in an accident caused by a driver with no or insufficient auto liability insurance.

Collision or physical damage insurance protects against losses caused by damages to the car. This insurance kicks in whether the vehicle is repairable or replaced. 

Comprehensive coverage covers losses caused by accident but through theft, vandalism, fire, or flood.

2. Homeowner’s Insurance

Your home is usually your most significant asset. Here is where our families live and spend precious time with our children and pets. We depend on and seek sustenance, privacy, and security in our homes. The shelter is among life’s most essential needs. When your home is damaged, repairs are usually costly and may be rendered uninhabitable.

Whether you own or rent your home, you face the risk of suffering property damage and liability losses. Homeowner’s insurance will combine the property and liability coverage into a single policy.

Dwelling Damage

Property damage should cover damage to the dwelling, other structures on the property, damage to dwelling contents, including personal property, and expenses caused by having to live elsewhere if the home is not livable. Your property coverage should be at least 80% of your home’s replacement value. This estimate is the industry standard. 

Personal Property Damage

Property or dwelling coverage doesn’t cover your personal property.  To determine coverage for personal property, itemize your inventory of furniture, appliances, and furnishings by the purchase price, cash value, and replacement cost.

Your coverage is 50%-70% of the actual contents and personal property value in your home.

Liabilities To Others

Liability losses occur when the homeowners are negligent or fail to exercise due caution in protecting visitors to their home. For example, if you forget that you left the oven door open, you may be liable for the burn sustained by your friend’s child. Liability coverage provides help for our responsibilities to others.

3. Renter’s insurance

You should buy renter’s insurance when renting from homeowners. The homeowner is your landlord and likely has insurance for the dwelling and furnishings if provided as part of your lease agreement. However, their coverage does not protect your possessions.

Three Coverage Benefits:

  1. The renters’ policy will cover a tenant’s personal property if it is damaged, destroyed, or stolen in the event of fire or theft.
  2. Another benefit is the liability coverage it provides for medical bills, damages, and legal defense costs from injuries caused by you, another family member, or a pet.
  3. Finally, your policy should cover temporary living expenses if your place is so damaged it is uninhabitable. Most policies will help you with hotel bills and meals.

Therefore, renters insurance is needed and is generally affordable.

4. Life Insurance

Life insurance is protection for families that are fully or partially dependent on your income. If a working parent passes away, their income is lost. Parents or single parents with young children need life insurance protection to help replace that lost income. Your dependents usually mean your spouse, children, and extended family members like aged parents.

Some employers may provide life insurance as a perk but usually smaller amounts as a “starter” policy for employees to add more coverage.

Your coverage is often associated with your lifestyle needs. You want to cover your families’  living expenses and financial commitments required for the mortgage, car, and expenditures for college tuition for your children. Simplistically, insurance agents often refer to a rule of thumb that you use a multiple of 10 times your income.

There are two main life insurance policies: term life and whole or cash value life insurance. Term life insurance is cheaper but expires at some point. I recommend that you consider combining both term and whole life policies for full coverage. Many families buy term life because it is more affordable but prefer whole life for its more permanent coverage.

Life insurance is an important topic, and we address it more fully here.

When you have a life insurance policy, make sure to designate your beneficiaries. Review and make changes to your designations when life changes occur.

5. Disability Insurance

According to Healthcare.gov, a disability is a limit in a range of major life activities. Impaired activities include seeing, hearing, and walking. It also encompasses tasks like thinking and working. Humans are potentially frail. That is why they invented disability insurance. Accidents or illnesses can happen to just about anyone at any time. More than one in four of today’s 20-year-olds will become disabled by retirement age.

That statistic should be cause for concern. Disability insurance replaces a portion of your earnings when you cannot work due to illness or injury. This insurance is a valuable perk if offered by your employer. You must opt-in before becoming disabled to be covered.

In 2018, 42% of private industry workers had access to short-term plans, while 34% had access to long-term plans. When private employers offer disability insurance to employees, they pay the full cost of short-term coverage for 85% of plans and 94% of long-term plans.

The two forms of disability insurance are:

Short-term plans typically last between 3-6 months, although it could go as long as two years. Employers may partially pay for the short-term plan. Coverage kicks in between 1-14 days after the employees are unable to work. You can skip this policy if you have an emergency fund that may pay for essential living costs like your mortgage, rent, and car bills for six months.

Long-term plans provide coverage of five years or more. This insurance will pay a percentage of your salary, usually 50%-60, depending on your policy. Usually, the employee must pay the premium for such coverage if they are opting-in to the policy. If your employer is offering disability at a group rate, it will likely be less expensive than purchasing a plan on your own.

A disability may result in the primary breadwinner being unable to work for a significant period of years. This event could be a considerable hardship without disability insurance. The average long-term disability claim lasts 34.6 months. Few Americans have enough cash flow to cover income during that length of time.

6. Long Term Care Insurance

Long-term care insurance is a very long-term contract. It provides reimbursements for custodial care costs in a nursing facility, assisted living, or at home. You would usually buy a policy in your 50s and up when you are in good health.

You may qualify to receive Medicaid reimbursements for custodial nursing home care if you have spent down most of your assets. That means you have to show you are medically needy to get home care assistance from Medicaid. On the other hand, the wealthy have enough assets to pay for long-term care. The middle class is most in need of long-term care to protect their savings and have better quality care.

Skilled nursing care is expensive for those requiring 24 hours per day supervision. The average yearly cost in 2017 for these services in a semi-private room was $85,776.

The services provided by this kind of insurance are those not covered by regular health insurance or Medicare. Reasons for long-term care are those needing extended care. This type of care helps with daily living activities: eating, dressing, grooming, bathing, and caring for severe cognitive impairment.

Long-term care insurance has its fans and foes — and for a good reason. Policies can be expensive, especially if you purchase coverage when you’re older and still healthy. It is difficult to know how much coverage you’ll need, let alone if you’ll need it at all.

There may be viable alternatives that have emerged that may be worth pursuing, like health savings accounts, long-term care annuities, and Life Plan Communities.

Some employers may offer long-term care insurance for their employees at a group rate. If you’re planning to self-insure, it may be a good idea to work with a financial planner who can help you evaluate your coverage needs.

7. Health Insurance

According to an HFF report, less than 90% of the US population had health insurance in 2019, below 2017’s level. That level may fall further with people losing their insurance due to pandemic-related high job losses in 2020. 

Even if you have an employer-sponsored plan,  health care insurance is expensive because certain costs are not covered.

What are the costs of a health insurance plan? Review your plan carefully for these features:

  • Know what the premiums are or the amount you pay per month.
  • Exclusions that are typically not covered in your policy.
  • Annual deductibles are required to pay the initial portion of medical expenses.
  • Co-payments, or co-pays, require you to pay a certain dollar amount each time you have a specific covered expense item. Co-pays are for doctor visits and prescriptions.
  •  The out-of-pocket maximum is the most you will pay in a policy period (typically a year) before the insurer pays 100% of your covered costs.

 

The Dangers Of Medical Debt

Even if you have health insurance, you may still have responsibilities for some medical costs. The Kaiser Family Foundation/ New York Times survey found that 26% of Americans have problems paying medical bills.

Medical debt left unpaid will eventually end up as a hit to your credit report. Try to negotiate it with your vendor if you are facing financial problems. Often, you may find out that the insurance only partially covered your bill. It is your responsibility to determine those facts as they could be as harmful to your credit score as defaulting on your credit cards.

Bankruptcies resulting from unpaid medical bills make healthcare the number one cause of those filing or more than 66% of the total.  If you’re uninsured or underinsured, you may be exposing yourself and your family to potential financial catastrophe. One unexpected major medical emergency or adverse diagnosis could amount to hundreds of thousands of dollars of expenses.

My college students often tell me that they do not have health insurance because they are healthy. That may be so for that point in time, but one major medical problem could be devastating costs. Medical insurance is expensive. Some part-time jobs may offer some coverage.

Health Savings Accounts (HSAs)

If you have high-deductible health insurance plans, it may allow you to open a Health Savings Account (HSA). The HSA may pay for current or future healthcare expenses out of your savings.

An HSA is a unique tax-advantaged account that provides for qualified medical cost reimbursements. The money you contributed to your account reduces your taxable income that year. Your HSA account continues to grow annually unless you withdraw money. 

There are annual contribution caps of $3,600 for singles and $7,200 for families in 2021. With a high-deductible plan, the insured is responsible for more of the up-front healthcare costs, but you’ll pay a lower monthly premium.

8. Umbrella Insurance

Umbrella insurance is a tremendous and essential policy to have. It is also known as excess liability insurance. This policy extends the basic liability coverage provided in different policies, including home, auto, boat, and tenant. It offers broad range to protect your assets and future earnings from lawsuits. By buying this policy, you are adding to the liability protection you have already purchased.

For example, if you have $800,000 in assets, you can buy a $1 million umbrella liability policy to add to the $200,000 liability insurance you have on your home and car. This coverage closes a critical gap.

Policy limits are $1 million to $5 million. A $1 million umbrella policy costs about $200-$300 per year. This cost is a small cost for significant protection. Over 75% of umbrella losses are auto-related.

Final Thoughts

Buying insurance is not exciting but is essential. Not having coverage may have financial consequences that could be catastrophic for you and your family. Insurance is a competitive industry, so do comparison shopping.

Review your workplace benefits plan to identify what they may provide on a group basis. Supplement what your employer has provided, but you would likely be paying a reduced price compared to individual plans.

Thank you for reading! What kind of insurance do you think is most important? Not necessary? Please share with us. We would like to hear from you!

 

 

 

 

 

21 Surprising Tips To Know Before Buying A House

21 Surprising Tips To Know Before Buying A House

 

things to know before buying a house

Are you getting ready to buy a home? 

Your first (or even fifth) house purchase is a huge decision. It seems like there are a million things to know before buying a house.

From figuring out how much you can afford to hire the right home inspector, there is a lot to keep in mind.

In order to help you with your home-buying checklist, I interviewed 21 different experts on the top thing they wish they knew before buying their first house. Their answers uncovered a few surprising things even I hadn’t considered!

Read on for the top 21 tips for new home buyers.

1. Hire a Home Inspector

Ryan Luke from Arrest Your Debt says:

A good home inspection will cost you several hundred dollars. When you are already spending so much money, it may be difficult to write another check for a professional to inspect your home.

However, not inspecting the home professionally can have costly consequences. Home inspectors come into the property and take a deep look at everything — the landscaping, wiring, appliances — plumbing, and the roof — before you sign the contract.

Home inspectors can find these problems, and you can either have the seller fix the problems or pull out before you’re stuck with a problem property.

2. Keep the Hidden Costs in Mind

Melanie Allen from Partners in Fire says to think about the hidden costs:

The cost of a home is far more than the purchase price. I wish I would have taken into account how expensive everything else is when budgeting for my first home.

I didn’t think about how much homeowners insurance would add to my monthly bills, or that I would have to furnish my first home from scratch. Remember to consider things like moving expenses, furnishings, closing costs, insurance, taxes, HOAs, and any other hidden expenses of buying a home when first creating your budget.

This will prevent you from getting a nasty surprise that you can’t afford when you should be excited about your new home.

3. Renting Back Isn’t Always at Market Rate

Monica Fish from Planner At Heart warns about lease-back agreements:

In a competitive real estate market, buyers are doing all they can to become “The Chosen One,” including allowing the sellers to stay in the property and rent it back from the buyer for a set amount of time after closing. While you want to make your offer as competitive as possible, keep in mind it’s customary to charge a daily pro-rated portion of your PITI payment (Principal, Interest, Taxes, and Insurance), not the market rate.

So if your PITI is unusually low due to a large down payment or they’ll be renting from you for months, you might want to consider a separate rental agreement based on current rental rates in your neighborhood. We certainly wish we did.

4. Be a Stay at Home Landlord

Brian Thorp from WealthTender wished he had thought about his purchase as an additional income stream:

Mortgage payments can feel intimidating, but especially if you’re buying a house while living alone, it’s easy to offset your mortgage (or even make money each month) by renting a room or your entire house on Airbnb during major events.

I wish I had subscribed to a few real estate blogs before buying my first house as I would have discovered ideas like this one sooner to save money or even pay off my mortgage early.

5. Home Improvement is Expensive

Jeff Cooper from Have Your Dollars Make Sense learned some lessons about home improvement costs:

Many people will buy a fixer-upper when buying a home to save on the initial cost thinking they can simply put money into the home when they can. It is a solid strategy, but many fail to realize how much home improvement can be. Most of us want to fix everything quickly, but fail to realize how much even the smallest of updates can be.

When buying a fixer-upper make sure there isn’t too much to fix!

6. Think About the Future

Derek Carlson from The Money Family suggests thinking about your future plans before buying a home:

Consider your future plans and if this home fits in with them, or if you’re willing to move in 5 – 10 years. If you’re planning on starting a family or changing jobs, will this home fit into those plans? Or will it require you to relocate to another part of town with a different commute, different school district, etc.?

Selling a house and buying a new one is expensive. By planning now for a house you can grow into you can save a significant amount of money down the road.

7. Aggregate Your Paperwork

Sanjana Vig from The Female Professional says:

There are many things to consider when buying a house. While I did all my calculations before taking the leap, I underestimated the amount of paperwork that would be required for the bank.

For example, I had, over time, transferred my down payment into my main checking account. For each transaction, I had to explain where the money came from. In retrospect, I wish I had done the transfers earlier, or in one lump sum so that I could have avoided the headache of phone calls, paperwork, and explanations.

Do yourself a favor and tee up all of your accounts so that you can skip the questions. You’ll save yourself a lot of time and stress!

8. Ask About Warranties

Jessica Bishop from The Budget Savvy Bride wishes she had collected more information on appliance warranties:

Before you buy a home, you’ll want to learn about the history of all the major appliances and if there are any existing warranties. From kitchen items like your refrigerator, oven, and dishwasher, to laundry machines, or even your HVAC unit or water heater, you’ll want to know what’s still within a warranty period and what’s not.

It’s also helpful to know the age of your water heater or air conditioning unit in particular because these costly items generally have to be replaced at regular intervals. If you’re coming close to the 10-year mark on a water heater, you might just find yourself hit with a major emergency plumbing expense right after you move in, so it’s good to be aware of any potential risks ahead of time.

9. Know How Much You Can Offer

Riley Adams from The Young and the Invested offered this advice:

My wife and I recently purchased our first home together, and we, fortunately, decided to contact a lender out of an abundance of caution to understand what our budget would be.

Initially, we thought a larger home with a higher price tag was within reach, however, after learning about the rules for measuring your debt to income ratio, not all of our income would count in that equation. Banks, who tended to be more conservative during the pandemic, only counted certain types of income, making variable income not receive credit in that metric. As a result, we had to lower the range we could afford on a home.

Thankfully, we still found our dream forever home and it didn’t hold us back too much. If anything, it added discipline to our ability to bid. If we had more firepower, we may have opted to use it. We knew buying a house would be one of the best assets to invest in for our part of the country and wanted to find the right one for us to settle down and see appreciation over time.

10. Your House Is Not a Part of Your Retirement Fund

Jesse Cramer from the blog The Best Interest wishes he had considered the impact of his home on his retirement plans:

I was excited to buy my first home because I saw it as a vehicle to build my wealth. And that’s largely true. Real estate is a significant stepping stone in building the average American’s net worth.

But wealth is not the equivalent to your retirement savings, and that’s where I messed up. You cannot both live in your house and sell it as part of your retirement nest egg. Duh! I know, I know, but it’s a mistake I made.

The truth is that you should only count real estate as part of your net worth if it’s not your primary home or if you plan on downsizing prior to retirement. Otherwise, you’re selling yourself a false dream!

11. Consider Furniture in Your Closing Costs

Kevin from Just Start Investing gave the following advice:

Furnishing a home can cost a lot of money, and oftentimes that is an overlooked expense when buying a house. It’s important to consider your furniture budget when looking at your overall housing budget, keeping in mind are needs vs wants.

Remember, you don’t have to fill your entire house right away. Be realistic with your budget and stay within your means.

12. Take Advantage of First-Time Home-buyer Loan Programs

Jonathan from Parent Portfolio added:

Some loan programs allow first-time homebuyers to make a down payment as low as 3% to 5% of the purchase price. Instead of buying a single-family home, consider purchasing a duplex or another multi-unit.

Homeowners can house hack by living in one unit and rent out the other unit(s) to tenants. The rental income can cover the mortgage payment and allow a homeowner to live mortgage-free.

Usually, real estate investors have to pay a 20% to 25% down payment for non-owner-occupied properties. Therefore, a 3% to 5% down payment is a great deal with the benefits of living for free and making extra income.

13. Purchase Price Should be Based on Monthly Affordability

Tawnya from Money Saved is Money Earned advises that the monthly payment is more important than the purchase price:

If you are financing your home, which most are, there are several factors that can drastically affect your monthly payment.

These factors include property taxes, mortgage insurance, homeowners associations fees, and the interest rate you’re able to secure. While your interest rate will likely be the same for each house you consider, the other factors can swing your monthly payment several hundred dollars one way or the other.

Instead of setting a budget at the purchase price of a home, you should instead set a monthly budget when determining the affordability of a house. If you’re pre-approved or working closely with a lender, have them give you a rough estimate of the monthly payment for each home you’re considering to ensure your monthly budget isn’t overstretched.

When I was looking for a home there were several that were within my overall purchase price range that ended up being outside my monthly affordability due to property taxes or one of the other factors discussed.

14. Hidden Fees Add Up

Adam from Wallet Squirrel says to pay attention to the hidden fees:

There are some hidden fees on top of the property taxes and insurance we didn’t know about when we bought our first home.

One example is the sewage and storm-water fee. This isn’t huge because it is only about $250 a year but it is another check to write. I wish I had known to check with the county and city for fees like that.

I would recommend talking to your real estate agent about any county or city fees that might sneak up on you. They should have the resources to help you research.

15. Remember to Budget for Legal Advice

Tim Thomas offers some advice on understanding legal fees in the buying process:

Here in the UK, when it comes to legal advice concerning buying property, the quality of the service you receive and the fees they charge can vary significantly.

In hindsight, we were lucky in finding someone for our first purchase who we used for future purchases, but he wasn’t available on our last house buy. The costs for this last purchase escalated significantly from the initial quote, and it was for things that our preferred lawyer wouldn’t have charged us for.

So get a clear handle on the legal fees you’ll be charged and what is and isn’t included in that price.

16. How to Budget for Maintenance

Josh Hastings from Money Life Wax emphasizes the importance of budgeting for regular maintenance:

Truth be told, when I bought my first home I had no clue that within a few years my A/C unit, washing machine, stove, and dishwasher would all need replacing.

I wish I had budgeted for all of these big-ticket items. After talking to my financial planner, his recommendation was to save 1% of my home value per year for home improvement and maintenance costs. For example, a $300,000 house means you want to set aside $3,000 a year to be safe.

This will help for even bigger projects such as siding, plumbing, or windows.

17. Get Your Finances in Order Before You Buy

Marjolein from Radical FIRE recommends doing a financial check-up before you start looking for a house:

Before you buy your home, you want to make sure that your finances are in order. You can do that by making sure that you’ve paid off your high-interest debts, and you want to have an emergency fund, to name a few examples. Getting your finances in order looks different for everyone, so think about what it means for you and start to take action.

I was in a situation where I wanted to buy a house, and I was in the process of talking to the bank. That’s when I found out that I couldn’t afford the home because of my debt. There are regulations in place in the Netherlands, where your debt influences the amount of mortgage you can get. It didn’t matter that I had a high average net worth in the Netherlands.

If I knew that before, I would’ve started by paying off my debt, and I wouldn’t have wasted my time. Get your finances in order and you’ll be able to buy a home with peace of mind.

18. The Value of Adding Value

Tyler Weaver of Relentless Finances says you should consider ways to add value to get the most bang for your buck:

When buying my first house, I was looking for something of great quality that was ready to go.

As I learned more about real estate, and myself, I realized I prefer to buy a house that needs a little work. On my second house, I took on a much more extensive renovation and was able to capture a lot more equity.

Building equity through renovations is a core principle to the BRRR method which I now do on rental properties.

19. Don’t Overlook Your Wish List

Amanda Kay from My Life, I Guess reminds you not to compromise on your wish list just because of a hot market:

Although I am still a renter, I kind of hate where I live. Not being able to move somewhere better used to really bother me, but as my husband and I are getting closer to buying our first home, I see it as more of a blessing.

I know exactly what I would change about our current home, and my wish list is ready for when we start looking. More importantly, though, is the list of deal-breakers that I have been able to pinpoint and will avoid, so I don’t end up stuck owning a home that I don’t want to live in.

20. Shop Around for Insurance

Robyn from A Dime Saved says:

Insurance costs and needs vary wildly from state to state and area to area. Ask neighbors of the house you want to buy about approximate insurance costs and consult with an insurance agent to find out if you are in a listed flood or zone.

Even if you are not required by the bank holding the mortgage to purchase special supplemental insurance (fire, flood, hurricane, earthquake, etc) you may want to look into purchasing them for your own peace of mind.

Make sure to have enough money in your emergency funds to cover your insurance deductible so you are covered in case of an emergency.

21. Be Aware of Your Own Biases

Linda from The Cents of Money says self-awareness is key in the buying process:

The most reasonable people may become irrational when buying their first home. Biases like the confirmation bias may cause you to be swayed by an eager real estate agent doing their job. As they highlight the best features during the home search, you may overlook negative factors that are more crucial to you, like the tiny kitchen, cracked walls, or low ceilings.

Make sure to revisit the house at different times and honestly appraise what may later become significant problems.

Final Thoughts

There are a lot of things to know before buying a house. By being aware of these tips, I hope it helps you become more prepared for your own home purchase.

Educating yourself before jumping into a big purchase will help you make a better decision, and be more confident in the outcome.

Thank you for reading! What are your best tips for first-time homebuyers? Let me know in the comments!

This article originally appeared on Wealthy Nickel and has been republished with permission.

How To Buy A Home With Bad Credit

How To Buy A Home With Bad Credit

Is it easy to buy a home with bad credit? No, but it’s not impossible to do so. Before engaging in a search for a home, you should find and review your latest credit report and credit score. There is quite a financial difference in the thousands between paying a monthly loan based on a bad credit score and an excellent one.

You want to know where you stand as a potential creditworthy borrower. There may be errors on your credit report that you can be easily correct.

By itself, it is overwhelming to buy a house. The home buying process can be intense and emotional between buyers and sellers, brokers, inspectors, lenders, and attorneys. Having bad credit adds a significant hurdle. Unless you have substantial liquidity and pay cash for the house in full, you will have to rely on a lender who will provide a mortgage.

Can You Buy A House With Bad Credit? Check Your Credit Score

A credit score reflects your creditworthiness based on an analysis of your credit information provided by the three credit bureaus, resulting in your credit report. The FICO scoring system ranging from 300-850 remains the predominant model used by financial institutions. Your creditworthiness increases with the higher the score.

Various people may ask for your credit report and credit score. They are lenders, landlords, employers, cable companies, utility providers or even to obtain a smartphone, a prospective business or life partner. Your creditworthiness reflects your attitude on your finances and paying your bills on time.

What Is Considered A Bad Credit Score?

Generally, there is no stated specific minimum credit score that all lenders will universally accept you and give you a loan. The lower your credit score, the higher the risk for the lenders to view you as a borrower. They may lend you money, but you will be paying a higher monthly loan amount. Others may pass on giving you a loan.

All lenders have different requirements. Once you accept the probability of paying a higher interest rate, recognize that you can improve your credit score and refinance your mortgage later on. It may be challenging, but it will be financially worthwhile to make this one of your priorities.

Some lenders may accept a larger down payment (e.g., 20% or more of the home’s price) to offset a lower credit score. Typically, you will have more borrowing opportunities in the 670 or higher range than below 580, where it will be pretty challenging. You will be able to buy a house with bad credit but be open to options provided by the lenders.

FICO Credit Score Ranges Per Experian:

  • 800-850 Exceptional
  • 740-799 Very Good
  • 670-739 Good
  • 580-669 Fair
  • 300-579 Poor

 

 First, let’s talk about how the FICO Scores formula works using information from your credit report. They use five criteria that are proportionally different in value.

Payment History  (35%)

 Payment history accounts for 35% of your credit score. It carries the most significant weight in your score. This is one area in which you have considerable control. Lenders want to know if you have paid past credit accounts on time. Any late payments will dent your score on this critical factor. You need to exhibit an excellent track record of not missing payments for the length of any credit outstanding.

Those who are new to being approved for their credit cards need to show a consistently positive pattern. 

Amounts Owed  (30%)

Amounts owed reflects on your credit utilization. Lenders do not want you to use a significant amount of your available.

A significant influence on your credit score, credit utilization is the ratio of your total outstanding revolving credit balances divided by full available credit. Revolving credit refers to your credit cards and credit lines you may have but does not include your car loan (unless on your credit card) or your mortgage.

The utilization ratio is known as the balance of debt to available credit or debt-to-credit. It measures how much credit you have used for the amount available to you. You don’t want to “max out” your credit cards.

Having a  30% or higher utilization ratio tells the lender you are using too much credit, impacting your score. I would stay in the mid-20s range so as not to hit the 30% level. To an extent, you have more control over this factor, like payment history. 

 Length of Credit History (15%)

How you handle credit is essential to lenders. The length of time of your oldest credit account and the average age of all of your accounts determine your credit history. When you are just getting your credit card and borrowing, your credit history is short and out of control. The older the account, the better your credit score. If you are new to obtaining credit, it will take time to benefit from showing up in your score.

Don’t Close Any Accounts

You should not do some things, such as closing an account because of not using them actively. Closing a credit card can negatively impact your score in two ways. First, the longer your credit history, the better, so you don’t want to close an older card. At the same time, you will take away the available credit on that card, raising your overall credit utilization rate. Rather than closing your account, leave the card in a drawer where it will do little damage.

 Credit Mix  (10%)

Lenders favor some variety of borrowing in your mix of credit. A borrower handling different kinds of debt products may reflect less risk to lenders. When you don’t yet have a credit card, you may be at higher risk. Don’t go out and apply to get different kinds of loans for the sake of improving your mix. 

New Credit (10%)

When you apply for new credit, a creditor will review your credit file to assess how much risk you pose as a borrower. As such, it results in a “hard” inquiry on your credit report for up to two years. Hard inquiries can negatively impact your credit score, particularly if you are making multiple inquiries. However, don’t let it stop you from doing comparison shopping for the same type of loan.

A soft inquiry occurs when you are checking your credit score or report. Soft inquiries do not generate negative hits. Avoid getting new credit simply because you lack credit history. Over time, you should apply for what you need. 

 How Much Of A Difference Does A Credit Score Make On Your Loan?

According to the following credit scores, using myFICO Loan Savings Calculator,  here are national 30 year fixed mortgage rates with a $300,000 loan on May 26, 2021. The higher the score, the lower the monthly payment. The difference between $1,204 and $1,469 may not seem that vast for one month. However, over 30 years, these costs have become significant. 

      Scores              APR                  Monthly Payment

  • 760-850    2.624%                 $1,204
  • 700-759    2.846%                 $1,240
  • 680-699    3.023%                 $1,269
  • 660-679    3.237%                 $1,303
  • 640-659    3.667%                 $1,375
  • 620-639    4.213%                 $1,469

 

Besides your credit score, lenders will consider your debt-to-income, loan-to-value ratios, and cash reserves as indicators of your overall financial health. They are looking for clues to inform them how comfortable you are with paying down your debt. 

Debt-to-Income Ratio

The debt-to-income ratio or DTI compares how much you owe each month relative to your monthly earnings. Specifically, it’s a percentage of your gross monthly income before taxes that covers your monthly bills, including monthly rent or mortgage, student loans, car payments, credit card payments. Divide the total amounts by your gross monthly income. The lower the DTI, the less risky you are to lenders. Most lenders would prefer a DTI below 36%, with a DTI of 20% is considered excellent.

Loan-To-Value

The loan-to-value (LTV) ratio is typical ratio lenders use to express that amount of borrowing to the appraised value of the asset purchased, such as a home.

High LTV ratios indicate that the borrower is putting a lower down payment on the home they are buying. The calculation is straightforward: divide the loan amount by the asset’s appraised value, which secures the loan as collateral to the lender. A typical LTV is 80%, meaning you are putting 20% down on your home. It means that you own 20% equity in your home. If you can put down more than 20%, that will give a lower LTV than 80%, which is excellent. It is not unheard of for people with excellent credit to have a 50% LTV.

The higher the down payment towards the purchase, the less risky the loan as the borrower puts “more skin in the game” since they own more of the property. If you have poor credit, you can target a higher down payment, which can help you get approved for a loan.

A borrower putting too low a down payment may need to buy mortgage insurance to cover the lender against potential loss if the borrower can’t pay the loan. Federal loans may not require a substantial down payment.

Cash Reserves

Having readily available cash reserves that can cover six months of your basic living needs when you face emergencies is essential. Bankers want to see you have the ability to pay for six months of mortgage payments and prefer you to have some cash reserves on hand.

Homebuyers can apply for a conventional loan from private lenders or government loans, depending on their circumstances regarding their credit scores, ability to put a down payment, and other criteria.

 Conventional Loans

It may be challenging to qualify for a conventional mortgage if your credit score is below 640. Lenders may require a higher down payment of at least 20% to offset your lower score. Most private lenders will require private mortgage insurance (PMI) when borrowers put less than 20% down on their home loans.

You should continually improve your credit score to get a better interest rate for your loan. It takes time and patience but raising your credit score is possible. If a conventional loan is out of the question, you can either work on improving your score or apply for a government-backed loan. 

Government Loans

For those borrowers with bad credit, you can apply for federal government-backed loans. You may have more flexibility on the credit score and require a lower (or even a zero) down payment. However, each entity may require its respective mortgage insurance (similar to PMI) when down payments are less than 20% of the home value.

Federal Housing Administration or FHA Loans

An FHA loan is one of the more lenient options for buyers with bad credit, may have gone through bankruptcy, foreclosure, or first-time homebuyers who may not have saved a large enough down payment.  Created in 1934, the FHA guidelines for borrowers are:

  • A FICO credit score of at least 580  requires a 3.5% down payment.
  • If your credit score is between 500 and 579, you need a 10% down payment.
  • Borrowers will need to buy a mortgage insurance premium (MIP) if down payments are below 20%.
  • The debt-to-income ratio must be less than 43%.
  • The home has to be the borrower’s primary residence.
  • The borrower must show steady income and proof of employment.

All FHA loans require borrowers to buy a mortgage insurance premium (MIP). This insurance protects lenders from losing money should the borrower default on the loan. Mortgage insurance requires an upfront fee of 1.75% of the original loan amount. There is a recurring monthly fee varying from 0.45% to 1.05% of the loan amount. The fee percentage depends on the size of the loan, down payment, and the number of years financing.

An  Example On The Mortgage Insurance Fee

Let’s say you are buying a $200,000 home, with a 10% down payment of $20,000. Your original loan is $180,000. The upfront mortgage insurance fee of 1.75% x $180,000 is $3,150. You will also have a recurring payment, using the fee of 0.45% to 1.05% of $810 to $1,890 in the first year.

Veteran’s Administration (VA) Loans

VA home loans are non-conventional loans available to veterans, those serving in the military, or eligible surviving spouses seeking to become homeowners. Private lenders are the issuers of the loans, but the VA determines who qualifies for the loans and is the guarantor.

If you are qualified for a loan, there is no minimum credit score, and you may buy a home with no down payment. Although you don’t pay private mortgage insurance, there is an upfront VA loan funding fee of 1.4% to 3.6% of the loan amount if you put less than 5% down payment on your home.

USDA Loans

The USDA loans are for rural borrowers who may qualify for a mortgage directly from the US Department of Agriculture or a USDA-approved lender. The loan has specific home requirements, and its location must be in a qualified rural area.

You may not need a minimum credit score if you are getting the loan directly from the USDA. However, to qualify for such a loan when using a USDA-approved lender, you will need to have a minimum credit score of 640.

You don’t need to put any down payment for the USDA loan. However, like private mortgage insurance for conventional mortgages or MIP for FHA loans, borrowers of USDA loans pay mortgage insurance via two fees. There is an upfront guarantee fee equal to 1% of the loan amount and a recurring fee of 0.35% of the loan.

Home Loans From Fannie Mae And Freddie Mac

Fannie Mae and Freddie Mac were government-sponsored entities, transitioning out of conservatorship. Neither entity originates or services its loans but buys loans from private lenders who require PMI if down payments are less than 20%. Their respective loans are designed for low income first-time or repeat homebuyers with limited cash for down payments:

Fannie Mae HomeReady Mortgage requires a 3% down payment with a 620 minimum credit score. They may use alternative data with a lower score. Borrowers will need private mortgage insurance when putting less than 20% down.

Freddie Mac Home Possible loan requires  3% down with a minimum of a 660 credit score. Without that score, borrowers require a 5% down payment.

Final Thoughts

Buying a home with bad credit is possible. Before searching to buy a home, you should understand your credit report and score. Consider improving your creditworthiness so you may get a favorable interest rate. If you are still getting your own home, there are several government-backed options for qualifying for a home loan if you have bad credit. You can buy a home with bad credit, but you need to take more steps.

You will likely be paying higher interest rates than those who have good-to-excellent credit scores. You will have to pay some kind of mortgage insurance if you cannot put a down payment of 20%. As you improve your credit, consider refinancing your loan.

Thank you for reading! If you found this article of value, please visit us on The Cents of Money and consider subscribing to receive other articles and our free newsletter.

This article originally appeared on Partners In Fire and has been republished with permission.

 

 

 

How To Save For A House: 10 Ways To Make Your Biggest Purchase Ever!

How To Save For A House: 10 Ways To Make Your Biggest Purchase Ever!

Buying a home may be the biggest purchase a person can make. And, with home prices rising, it can also feel intimidating or even impossible, especially for a first-time home. However, there is no need to fret. If you’re wondering how to save for a house, you’re in the right place!

Before you start looking for a real estate agent, take some time to self-reflect on your current financial situation to develop a plan for success. Here are ten ways to help you save for a house and make your biggest purchase ever.

What Are the Costs When Buying a House

According to the National Association of REALTORS, the median existing-home sales price for March 2021 was $329,100. Unless you have hundreds of thousands of dollars to spend, you most likely will work with a bank to finance your home purchase. Thus, the two main costs you need to save up for are down payment and the closing costs.

Down Payment

A down payment is an out-of-pocket expense a homebuyer will pay when financing a purchase. The amount is usually a percentage of the purchase price, which can vary depending on the type of loan.

For example, a 10% down payment for a purchase price of $200,000 is $20,000. Therefore, a homebuyer would need to bring $20,000 when signing closing documents while the bank will finance the remaining balance of $180,000.

Closing Costs

When financing a home purchase, there are several closing costs, such as an appraisal fee, termite inspection, and escrow fee. However, unlike a down payment, a homebuyer won’t know the exact dollar amount due until a few weeks or days before closing on the property.

Therefore, as a safe estimation, the closing cost is usually about 2% to 5% of the loan amount. For instance, homebuyers with a loan amount of $180,000 can estimate to pay about $3,600 to $9,000 in closing costs.

Moving Expenses

Although moving expenses are not as large as a down payment, it is still a cost that buyers should save up for. If you have a small family and only have small items, you can save a lot of money by transporting your family’s personal belongings in your car or a friend’s truck.

However, if you have larger and heavier items, you can rent a moving truck or hire a moving company. According to Moving.com, the average cost of a local move is $1,250 and $4,890 for a long-distance move.

How Much is Down Payment?

The down payment amount is usually a percentage of the purchase price. However, depending on the loan program, the percentage can vary. Determining which loans you qualify for is one of the first steps on how to save for a house. The requirements can change every year. So, be sure to check with a mortgage professional to get the latest details.

FHA Loan

The federal government insures a Federal House Authority (FHA) loan. However, the government doesn’t provide the loan to homebuyers. Instead, this program allows lenders to offer a low down payment requirement. The government will ensure the loan in case the borrower stops paying.

According to U.S. Bank, the minimum required down payment for an FHA loan is only 3.5% of the purchase price. Therefore, a 3.5% down payment for a $200,000 purchase is $7,000.

203k Loan

A 203k loan is a subset of an FHA loan based on section 203(k) of the National Housing Act. This program follows the same rules as an FHA loan and includes rehab expenses as part of the loan. Thus, homebuyers can buy a distressed property in need of significant improvements but at a meager purchase price.

VA Loan

The U.S. Department of Veteran Affairs created the VA loan, which is similar to the FHA loan. This loan’s critical difference is exclusively for U.S. service members, veterans, and eligible surviving spouses.

A VA loan doesn’t require any money down nor private mortgage insurance. Additionally, a VA loan allows a seller to pay 100% of the closing costs, unlike an FHA limiting a seller to 3%. Therefore, a homebuyer who qualifies for a VA loan doesn’t have to save up for a down payment.

USDA Loan

A USDA Loan is short for the “USDA Rural Development Single Family Housing Guaranteed Loan Program.” Like a VA loan, this program also allows a homebuyer to fully finance a home purchase, which means a down payment isn’t required.

The property must be a rural single-family home and low to moderate-income homebuyers based on the county’s median income to qualify for this program. Speak with a mortgage professional within your area to check your eligibility.

Conventional Loan

A conventional loan is a loan that is not part of a specific government program. The down payment ranges from 5% to 15%. Therefore, a 5% down payment for a purchase of $200,000 is $10,000.

Why Do People Want a 20% Down Payment?

Home borrowers that make a down payment of less than 20% are typically required to pay for private mortgage insurance (PMI). This insurance is not the same as home insurance. Instead, the purpose of a PMI is to protect a lender if a borrower defaults on their payment.

Thus, on top of the mortgage payment, property insurance, and property taxes, some homeowners will also have to pay for PMI. However, some homebuyers don’t mind paying the PMI because they prefer a lower down payment.

Some loan programs don’t allow you to remove the PMI. On the other hand, some programs will allow PMI removal when the balance is 80% of the original purchase. Homeowners can make extra payments towards the principal balance to accelerate the debt service payment. Alternatively, homeowners can refinance the property and take advantage of the house’s appreciation.

How Much Can You Afford?

Before you start looking at potential houses to buy, it’s essential to know how much you can afford. The general rule of thumb is that the mortgage payment should be no more than ⅓ of your monthly household net income. For example, a person with a monthly net income of $2,500 should aim to have a mortgage payment of no more than $833 a month.

Although this rule of thumb is a quick and easy way to calculate a rough estimate of how much you can afford. Any homebuyer needs to review their financial situation in detail thoroughly. Mortgage payments can easily vary due to property taxes and home insurance and can quickly increase your monthly expense.

Where to Save Your Money

It’s best to save money in a high-yield savings account, such as a money market account. Your account may not accrue a lot of interest. But, you avoid risking your savings by not putting it in an investment account, such as stocks or REITs.

10 Ways to Save For a Down Payment

1. Track Your Expenses

Before you can start putting away money for your down payment, you first need to identify and track all your expenses. Whether the cost is paying for utilities or entertainment, track it all.

 

With the help of online banking, you can see all your transactions in one place. Reviewing your expenses might even surprise you with some items you were unknowingly paying for. Knowing how much you spend on expenses will give you an accurate idea of how much you will have leftover from your paycheck.

2. Create a Budget

After you track all your expenses, it’s crucial to create a budget. A budget does not mean taking the fun out of your life. Instead, a budget is the best way to make sure you have enough money every month. For example, you budget $100 a month for dining out. If you already have exceeded that amount for the month, you will have to postpone any dining plans until next month.

3. Automate Savings

Creating a budget is a great way to be fiscally responsible. However, it can be tempting to spend your paycheck once it hits your checking account. To help overcome this temptation, you can set up automatic transfers to your savings account.

Talk to your payroll department to have them transfer a certain amount or percentage to your desired account. As another option, you can set up an automatic transfer with your bank. Automating your savings is a simple way to keep you honest with your savings.

4. Reduce Expenses

If you don’t have much money, an easy way to start saving is by reducing your expenses. For example, instead of buying lunch when you’re at the office, consider bringing your lunch.

Also, get rid of unnecessary expenses. That’s fantastic you signed up for a gym membership after the new year. But, if you’re not using it, you’re better off canceling it to keep more money in your pocket.

Consider living stingy and downsize, if possible. You’re not cheap. Instead, you are more intentional with your money. For example, you can trade-in your car for a more affordable vehicle or change your cell phone plan. Or move into an apartment with more affordable rent while you work on building up your down payment.

5. Increase Your Income

Aside from reducing your expenses, another way to save for a house is to increase your income. One way to accomplish this task is by requesting a raise from your employer. However, be sure to back up your request with data to justify a promotion.

If you’re unable to get a substantial raise from your main hustle, consider a side hustle to create a second income stream. Depending on your current career, you can leverage that to your advantage to make money in your spare time.

Additionally, if you have an extra bedroom to spare, you could house hack your current residence and rent out the room for extra income. Be sure to consult with your landlord before advertising for a roommate.

6. Postpone Major Activities

You might call me a killjoy, but another option to save for a house is to postpone significant activities or events, such as a family vacation or concerts. Saving on travel alone can save you hundreds and even thousands of dollars.

Remember, I said “postpone” and not “cancel.” There will always be another opportunity to live that experience. At least once you have your house, you can hang those memories in your new home.

7. Get Rid of Debt

Getting rid of debt is another excellent way to help you buy a house. Not only does it reduce your monthly expense, but it can also make you favorable in the eyes of your lender.

According to Experian, two of the four significant factors mortgage lenders consider are payment history and credit utilization ratio. Lenders want to make sure potential borrowers have a good track record of paying on time. Consider raising your credit score by following these steps.

Also, lenders use the credit utilization ratio to determine how much a borrower’s balance is compared to their credit limit. The lower the ratio, the more favorable a borrower, is to a lender. Therefore, it pays to pay down your student loans and credit card debt.

Additionally, lenders will also check a borrower’s debt-to-income ratio (DTI). This ratio compares how much a person owes to how much they earn a month. The better your DTI, credit utilization ratio, and other factors will help qualify you for a loan program to your advantage.

8. Save Your Windfall Income

There will be moments you’ll unexpectedly receive extra income, such as bonuses, gift money, tax refunds, and stimulus checks. Instead of splurging that surprise money on consumer products, save that extra cash in your separate savings account to help you get closer to your goal.

9. Sell Your Things

Another way to boost your savings is to sell items you no longer use. For example, if you’re no longer planning on having kids, you can sell that Spectra S2 to another mother in need. Not only can you make extra money, but you’ll also be reducing your belongings, which can have a positive effect on moving expenses.

A few options to sell your items are holding a garage sale or listing items for sale on Facebook or Craigslist. Aside from selling your TV or video game console, you can go as far as selling your barely used vehicle.

10. Pause or Reduce Retirement Contribution

It’s essential to make regular contributions to your retirement account, especially when you’re young and have time on your side. However, if you need a little more capital to save up for a down payment, you can temporarily pause or reduce your contribution to your 401k or IRA.

Keep in mind that you’ll lose the tax benefits of not contributing to these retirement accounts. Thus, it’s crucial to weigh the pros and cons of pausing or reducing your contributions. You may find more profitable avenues to save more money or may just need to extend your timeline when you can reach your savings goal.

Final Thoughts

Owning a house is a great way to create generational wealth. So, as early as now, start reaching out to various mortgage professionals. A seasoned mortgage lender can help you navigate the financing process and help identify mortgage loan programs that work well for you. They can also let you know what credit score to work towards to get a better interest rate.

While you work on saving up for your down payment, also practice budgeting for monthly payments. So, once you’re ready to make an offer and buy a home, you’ve already developed a habit.

This article originally appeared on Your Money Geek and has been republished with permission.

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