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Is Getting a 401(k) Loan a Good Idea?

Don’t do it!

That’s the conventional wisdom about taking out a 401(k) loan. And as someone who took out one, left her job and found herself shelling out big bucks in taxes and penalties, I’m not about to argue with conventional wisdom.

However, people stretched financially thin may think otherwise. They may see their 401(k) account as a tempting source of cash. To help those of you thinking about dipping into your account, we want to take a moment to review what you need to know about these loans. I also contacted two Certified Financial Planners so you wouldn’t have to take my word for it.

I fully expected both planners to say 401(k) loans are nothing but bad news, and certainly, they both expressed extreme concern about people dipping into their retirement savings. But I was also surprised to hear that a 401(k) loan may make sense in some limited situations. Before we get to those, let’s start with the basics of 401(k) loans.

Basics of 401(k) loans

Named after a section of the tax code, traditional 401(k) plans allow you to put money aside, tax-free, for retirement. After a few years of regular contributions, these plans can carry a nice balance, which may start to look like a handy cash cow.

While there is no requirement that 401(k) plans allow loans, many do. Under IRS rules, those that do allow loans can let participants take out up to 50 percent of their vested account balance, or $50,000, whichever is less. Typically, these loans are paid back over a maximum of five years, although, in some cases, a longer payback period may be arranged. On occasion, the IRS issues special rules, such as after hurricanes Katrina, Rita and Wilma when those affected were allowed to take loans for their entire vested balance.

Loans from 401(k) accounts do charge an interest rate, but that money is paid back into the plan. This is one reason they may appeal to some workers. Rather than paying interest to a bank or other lender, the worker keeps the interest to pad their retirement account. In addition, repayments are made via a payroll deduction, which makes them convenient, another bonus for some workers.

Why they aren’t such a hot idea

Despite being an apparent source of easy cash, some finance experts say you should be keeping your hands off your 401(k).

“Your 401(k) is not a savings account,” says Mark Vandevelde, a CFP and wealth partner with Hefty Wealth Partners in Auburn, Ind. “It is money that should be set aside for long-term goals and never to be touched, in my humble opinion.”

As Vandevelde sees it, there are three problems with 401(k) loans:

  1. Lost investment gains that can reduce your fund balance at retirement.
  2. The risk of defaulting on the loan, which could result in taxes and a penalty.
  3. The chance you may reduce your 401(k) contributions to afford the loan repayment amount, which again could affect your fund balance at retirement.

“It’s not free money,” Vandevelde says. “You have to pay it back with regular payroll deductions. Many people end up reducing their actual 401(k) contributions to compensate for the amount they are having to pay back and, therefore, they actually aren’t saving as much.”

On its website, Principal Financial Group has an example of how this may play out. A 35-year-old who takes out a $5,000 loan and pays it back over five years may find himself with $52,000 less at age 65. The calculation assumes a $150 per-paycheck contribution that is decreased by $44 to accommodate the loan repayment.

Keith Klein, a CFP and owner of Turning Pointe Wealth Management in Phoenix, agrees with Vandevelde that a 401(k) loan shouldn’t be your first choice for cash.

“The key to remember is when you take money out, it has to be paid back in five years,” Klein says. “If you default, that money will be considered income, and you’ll have to pay taxes plus a 10 percent penalty.”

Plus, a lot can happen in five years, and if you find yourself taking a new job opportunity, you’d better be ready to pay up.

“A lot of people don’t realize what happens when you leave [or] get fired from your job and you have an outstanding 401(k) loan,” Vandevelde says. “It becomes immediately due and has to be paid in full. If you cannot pay it back, the remaining balance is considered a distribution and is subject to tax and a 10 percent penalty if [you’re] under age 59½.”

When a 401(k) loan might make sense

Despite the financial perils associated with a 401(k) loan, Klein says there may be times when it makes sense to take one out.

“Now, I’m not recommending you take loans out,” he says, “but there are circumstances when life doesn’t go perfectly.”

For example, an older worker who is losing a job may find taking out a loan and letting it default could be a better option than paying their bills with the credit card until they find other employment or are old enough to claim Social Security. While the money will become taxable income, the 10 percent penalty no longer applies once an individual turns 59½.

Divorce or disability could be other scenarios in which a 401(k) loan may be a better way to bridge an income gap in an emergency situation. Still, Klein says it’s not an ideal option. “Having a [cash] reserve is always the best answer,” he notes.

Both Vandevelde and Klein say that, unfortunately, far too many people rush into a 401(k) loan, or they use them for purchases such as vacations, cars or even big screen TVs. For those sorts of purchases, both financial planners agree a 401(k) is not the right source of money.

So going back to the question in the headline: Is getting a 401(k) loan a good idea? Given the drawbacks listed above, it’s probably not ever a good idea, but in some unique situations, it may be the best of your not-so-great options.

Of course, rather than waiting to find yourself in an emergency with limited options, a better course of action would be to get out of debt and bulk up your savings account now. If you’re not sure how, subscribe to the Money Talks News newsletter to get the best personal finance tips and advice delivered straight to your inbox each day.

For more tips on saving for retirement, watch the video below:

Watch the video of ‘Is Getting a 401(k) Loan a Good Idea?’ on MoneyTalksNews.com.

This article was originally published on MoneyTalksNews.com as ‘Is Getting a 401(k) Loan a Good Idea?’.

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How can I borrow money from my life insurance policy?

A:

While borrowing from your life insurance policy can be a quick and easy way to get cash in hand when you need it, there are a few specifics to know before borrowing. Most importantly, you can only borrow against permanent or whole life insurance. Term life insurance, a cheaper and suitable option for many people, does not have a cash value and expires at the end of the term, generally anywhere from one to 10 years.

A whole life policy is more expensive but has no expiration date. The term lasts the lifetime of the insured. While the monthly premiums may be higher, the money paid in to the policy exceeding what is needed for the death benefit is invested by the life insurance company, creating a cash value after a few years. The whole life policy essentially has two values: the face value, or death benefit, and the cash value that acts as a savings account. Once the money invested increases the amount of the death benefit, the tax-free cash value can then be borrowed against. It is also important to understand that the policy loan is not taken out of your death benefit, but borrowed against it, and the insurance company is using your policy as collateral for the loan.

Unlike a bank loan or credit card, policy loans do not affect your credit and there is no approval process or credit check since you are essentially borrowing from yourself. When borrowing on your policy, no explanation is required about how you plan to use the money, so it can be used for anything from bills to vacation expenses. The loan is also not recognized by the IRS as income, therefore it remains free from tax. However, the policy loan is still expected to be paid back with interest, though the interest rates are typically much lower than on a bank loan or credit card, and there is no mandatory monthly payment.

Even with low interest rates and a flexible payback schedule, it is still important for the loan to be paid back in a timely manner. Unless it is paid out of pocket, interest is added to the balance and accrues whether the bill is being paid monthly or not, putting your loan at risk of exceeding the policy’s cash value and causing your policy to lapse. Insurance companies generally give many opportunities to keep the loan current and prevent lapsing. However, in the event of a policy lapse, taxes must be paid on the cash value. If the loan is not paid back before the insured person’s death, the loan amount plus any interest owed is subtracted from the amount the beneficiaries are set to receive from the death benefit.

[…]

Should you take a loan from yourself?

That 401(k) plan is designed to help you save for retirement. When you take money out of your 401(k), you not only deprive yourself of future earnings but you also owe taxes. Early distributions are also hit with an additional penalty. However, if you absolutely need the money, withdrawing from your 401(k) plan may be your only option. These tips will help steer you through the process.

Basically, you have two ways to use 401(k) assets for an emergency: Take money out permanently or just borrow the cash. On permanent withdrawals, you will pay regular income taxes, presuming all the contributions in the account were pretax. You’ll also likely pay a 10 percent early withdrawal penalty on the money if you are younger than 59½.

If you intend to pay back the money you take from your 401(k), consider a loan instead of a withdrawal. The IRS allows you to borrow up to $50,000 or half the value of your account, whichever is less, although your employer may or may not allow loans. The benefits of a loan are that you don’t have to pay taxes or penalties on it, and you pay back the interest to your own account.

[…]

Is withdrawing from your 401K a smart move?

That 401(k) plan is designed to help you save for retirement. When you take money out of your 401(k), you not only deprive yourself of future earnings but you also owe taxes. Early distributions are also hit with an additional penalty. However, if you absolutely need the money, withdrawing from your 401(k) plan may be your only option. These tips will help steer you through the process.

Basically, you have two ways to use 401(k) assets for an emergency: Take money out permanently or just borrow the cash. On permanent withdrawals, you will pay regular income taxes, presuming all the contributions in the account were pretax. You’ll also likely pay a 10 percent early withdrawal penalty on the money if you are younger than 59½.

If you intend to pay back the money you take from your 401(k), consider a loan instead of a withdrawal. The IRS allows you to borrow up to $50,000 or half the value of your account, whichever is less, although your employer may or may not allow loans. The benefits of a loan are that you don’t have to pay taxes or penalties on it, and you pay back the interest to your own account.

[…]

Top reasons to never borrow from 401(k)

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When you need cash—not the 50 bucks you get from an ATM to tide you over for the day but, rather, $5,000 or $10,000 to handle an emergency—what asset or resource will you tap into to get it?

Historically, the answer to that question was a home-equity loan.

This was the normal course of action, because most people had built up lots of home equity. Prior to 2008, it was routine for many to discover that their houses had increased in value by 50 percent or more even if they had owned them only a decade or so.

DNY59 | iStock | 360 | Getty Images

Therefore, if someone needed $20,000 or $30,000 for an addition to the house, to help pay their children’s college tuition or to cover a medical bill, it was easy enough to tap into that equity. And with interest rates at historical lows, they could do it and still keep their mortgage payments steady.

Well, those days are long gone. It’s all thanks to the 2008 credit crisis, which caused many to lose their houses or watch their values plummet to the point that substantial home-equity loans were no longer so readily available.

Read MoreInvestors fear retirement unknowns

So if you need cash now, where are you looking to get it?

Unfortunately, retirement accounts have replaced the home-equity loan as the predominant source of cash today. They have become America’s new piggy bank.

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We know this because the IRS collected $5.7 billion in penalties in 2011 for early withdrawals from 401(k) plans and other retirement accounts. (This is the latest data available.) The penalty for withdrawing before age 59½ is 10 percent, so this means that Americans in 2011 withdrew $57 billion from their retirement savings long before they were supposed to.

If you’re considering borrowing from your 401(k) retirement plan, you are most likely thinking: “What’s the harm? I’m just borrowing from myself.”

Read MoreLittle-known 401(k) investment options

Well, think again. Nothing could be further from the truth.

Borrowing from your retirement plan for any reason—no matter how serious that reason may seem to you—will hurt you in the long run. It’s a sure way to destroy your retirement savings and put you at risk of having a lot less money than you had planned for in your golden years.

“Discipline yourself to avoid borrowing from your 401(k) retirement plan or any other workplace retirement plan—no matter how badly you need cash.”

A 2013 Fidelity study pointed to yet another danger: It found that, of 180,000 who took out 401(k) loans over the past 12 years, 66 percent took out more than one loan, 25 percent borrowed three or four times, and 20 percent did so five times or more. Thus, initial borrowing could put you in danger of becoming a repeated borrower, thereby causing even greater damage to your retirement savings.

Read MoreAre you prepared to retire? Take this quiz

So for all these reasons, discipline yourself to avoid borrowing from your 401(k) retirement plan or any other workplace retirement plan—no matter how badly you need cash.

Find another way to get the money you need. By doing so, you’ll come to appreciate what a huge favor you did for yourself by allowing your account to grow without setbacks. And it will make for a more comfortable retirement.

—By Ric Edelman, special to CNBC.com. Edelman is founder and CEO of Edelman Financial Services.

[…]

Top 10 reasons to never borrow from 401(k) plan

When you need cash-not the 50 bucks you get from an ATM to tide you over for the day but, rather, $5,000 or $10,000 to handle an emergency-what asset or resource will you tap into to get it?

Historically, the answer to that question was a home-equity loan.

This was the normal course of action, because most people had built up lots of home equity. Prior to 2008, it was routine for many to discover that their houses had increased in value by 50 percent or more even if they had owned them only a decade or so.

Therefore, if someone needed $20,000 or $30,000 for an addition to the house, to help pay their children’s college tuition or to cover a medical bill, it was easy enough to tap into that equity. And with interest rates at historical lows, they could do it and still keep their mortgage payments steady.

Well, those days are long gone. It’s all thanks to the 2008 credit crisis, which caused many to lose their houses or watch their values plummet to the point that substantial home-equity loans were no longer so readily available.

Read More Investors fear retirement unknowns

So if you need cash now, where are you looking to get it?

Unfortunately, retirement accounts have replaced the home-equity loan as the predominant source of cash today. They have become America’s new piggy bank.

We know this because the IRS collected $5.7 billion in penalties in 2011 for early withdrawals from 401(k) plans and other retirement accounts. (This is the latest data available.) The penalty for withdrawing before age 59½ is 10 percent, so this means that Americans in 2011 withdrew $57 billion from their retirement savings long before they were supposed to.

If you’re considering borrowing from your 401(k) retirement plan, you are most likely thinking: “What’s the harm? I’m just borrowing from myself.”

Read More Little-known 401(k) investment options

Well, think again. Nothing could be further from the truth.

Borrowing from your retirement plan for any reason-no matter how serious that reason may seem to you-will hurt you in the long run. It’s a sure way to destroy your retirement savings and put you at risk of having a lot less money than you had planned for in your golden years.

Here are my top 10 reasons why you should never, ever borrow from your 401(k) plan:

Borrowing defeats the purpose of the account. The money is there for one reason only: to provide for your retirement. No matter how urgent you think your present situation is, it will be nothing compared to what you’ll experience when you’re in your 70s or 80s without adequate funds. You simply must find another solution to today’s problem.The magic of compounding will be lost. Pulling money from your 401(k) means that you’re selling some of your investments. If they continue to rise in value, you won’t get the profits and the compounding power that goes with them.You’re likely to sell low and buy high. As you pay back the “loan,” you’re rebuying the previously sold shares-but at current (and probably higher) prices. You shouldn’t need me to tell you that that’s the exact opposite of what an investor should do.You will be charged added interest and fees. Most plans charge an origination fee of $75 regardless of loan size, and this goes to the administrator-not back into your account. Thus, if you borrow $1,000, you’ve lost 7.5 percent right away. While the interest you pay, which is based on prevailing rates (about 5 percent for many plans last year), goes back into your account, that’s money you otherwise could have invested for potentially higher returns. So paying interest-even to yourself-reduces the amount of wealth you could otherwise generate.Contributions could be suspended. Many plans won’t allow you to contribute to your 401(k) until you’ve paid off your loans. In some cases that could mean years, during which period you’ve lost the advantage of reducing your taxable income.Your take-home pay will be reduced. Most plans require you to start repaying your loan via automatic paycheck deduction starting with your next pay. Thus, your take-home pay is reduced, possibly by more than the amount you were contributing to the plan before. And this repayment isn’t tax-deferred, so your taxes could rise, lowering your net pay even further.Failure to repay by the deadline will trigger a tax risk. Most 401(k) plan loans must be repaid within five years. If you fail in that, your employer will treat the loan balance as a distribution, triggering income taxes and the 10 percent early withdrawal penalty if you’re under age 59½. You could also be forced out of your plan and prevented from contributing in the future.There’s additional risk if you quit or lose your job. If you leave your employer, the loan will be due within 90 days. But wait-you’ve already spent the money. If you don’t meet the deadline, the IRS will consider the unpaid balance to be taxable income, and you’ll face the same tax issues previously noted. And now you’re in trouble with an unrelenting lender-the IRS.You’ll incur double taxation. Loans from your 401(k) actually cause you to pay taxes twice. Why? Because you’re repaying with after-tax money and then later, when you withdraw the funds in retirement, you’ll pay taxes on that same money again.You will still be in debt. If you borrow from retirement savings to pay off other debts, you’ve simply exchanged one debt for another-and taken on all the above disadvantages in the process. A study by T. Rowe Price found that borrowing $10,000 from a retirement plan will reduce your account balance at retirement by $100,000.

A 2013 Fidelity study pointed to yet another danger: It found that, of 180,000 who took out 401(k) loans over the past 12 years, 66 percent took out more than one loan, 25 percent borrowed three or four times, and 20 percent did so five times or more. Thus, initial borrowing could put you in danger of becoming a repeated borrower, thereby causing even greater damage to your retirement savings.

Read More Are you prepared to retire? Take this quiz

So for all these reasons, discipline yourself to avoid borrowing from your 401(k) retirement plan or any other workplace retirement plan-no matter how badly you need cash.

Find another way to get the money you need. By doing so, you’ll come to appreciate what a huge favor you did for yourself by allowing your account to grow without setbacks. And it will make for a more comfortable retirement.

-By Ric Edelman, special to CNBC.com. Edelman is founder and CEO of Edelman Financial Services.

LoansInvesting Educationretirement savings […]

Bad Credit? No Problem. Here's How to Get a Home Loan

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Image Source: Images Money

You’ve found the house . You have the savings for a down payment and the cash flow in your budget to afford the payments. Everything is great, except for one thing: Your credit score is bad. Is this a death knell for your home purchase?

Maybe. But then again, maybe not. Here are the best strategies and tactics you can follow to overcome that credit score and buy the house in spite of it.

What is a bad credit score?
Generally speaking, credit scores break down as follows:

760+ Excellent 710-760 Good 650-709 Average 620-649 Below Average Below 620 Poor

There are tons of different reasons a credit score could fall; however, moving into that below average or poor range takes a pretty serious event like several missed payments, bankruptcies, foreclosures, or collection accounts. But don’t worry… life happens to even the best people, and a missed payment in the past is not the end of your home buying journey.

A bad credit score simply indicates to a bank that you’ve had trouble repaying debts in the past. To overcome that history, you must take extra steps to prove to the bank that history won’t repeat itself. To do this, you must think like a bank.

How to think like a bank
Banks care first and foremost about getting repaid. That means you must prove to the bank that the loan will be repaid. Remember, as we work through these concepts, you probably won’t have every “i” dotted and “t” crossed. That’s OK. At the end, we will bring it all together with a solution for the worst-case scenario.

Question 1 : How are you going to repay the loan?
Typically, the answer to this question is through your monthly cash flow. This is the income from your job after you subtract your living expenses like food, water, electricity, debt, etc. Banks use a ratio called the debt-to-income ratio to determine if your monthly cash flow is sufficient to afford the debt. The ratio is calculated by dividing your total monthly debt payments into your total monthly income (before taxes).

Image Source: Images Money .

For borrowers with good credit, a 40%-50% debt-to-income ratio is typically enough to qualify for the loan. For those with credit problems, this ratio needs to be much less.

Question 2 : If that doesn’t work out, what is the backup plan?
What happens if you lose your job? That could be the reason your credit score isn’t the best in the first place. The reality is that this can happen and, when it does, both bank and borrower feel the financial pressure. That’s why banks always look for a backup plan.

Do you have any savings or cash hidden under the mattress? Banks will want to see enough savings to cover your living expenses and debt payments for at least six months. The more savings, the better.

Image Source: Images Money

It gives the bank comfort that, if something goes wrong, you, your family, and the bank will all be financially stable until you can find another income source.

Question 3: What happens if your backup plan fails?
It may seem like overkill, but banks want a backup plan for the backup plan. When all else fails, the bank wants to make sure that if the house must be sold, the loan will be repaid. Unfortunately, this often means foreclosure.

To you, that means a bigger down payment. By putting in more of your money up front, it creates breathing room for the loan if it must be sold quickly. If a conventional mortgage requires a 20% down payment, try to put down 30%, 40%, or more.

You may be thinking, “Why should my family put in more money now just so the bank won’t lose money later?” Well, if you don’t do this, you most likely won’t get the loan. And if you accept the loan, you’re giving your word that you’ll repay the debt. As long as you pay the monthly payments as you’ve agreed to do, you have nothing to worry about.

Putting down a bigger down payment will benefit you by lowering the monthly payment, as well, making it less likely that you’ll ever be in the worst-case scenario in the first place. Even further, it gives you more leeway to sell the house yourself prior to foreclosure, saving your credit score from further damage in the future.

Again, the idea with all of these considerations is that, because your credit score is low, you need to prove beyond a shadow of a doubt that you can and will repay the loan.

The worst-case scenario
What if you’ve worked hard, saved up, dotted your “i’s” and crossed your “t’s,” but the bank still won’t approve your loan? You have the cash flow, the savings, and the down payment, but you still get declined for a conventional mortgage?

At this point, it’s time to look at subprime options. Subprime is a kind of dirty word in the post-financial crisis world; but that doesn’t mean it’s not a viable solution for many families.

Image Source: Images Money

With a subprime loan, the specialized banks and lenders mitigate the perceived risks of a loan by charging a substantially higher interest rate. They lower their lending standards so that you can get the money you need. The higher interest rate is, in essence, the bank charging more for lowering those standards.

The subprime loan will be much more expensive, but at least you’re able to get the financing you need to buy the home. Over time, as your credit score improves, you should be able to refinance that subprime loan into a conventional loan with a better rate.

Take advantage of this little-known tax ;”loophole”
Recent tax increases ;have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report, ” The IRS Is Daring You to Make This Investment Now! ,” you’ll learn about the simple strategy ;to take advantage of a little-known IRS rule. Don’t miss out on ;advice that could help ;you cut taxes for decades to come. Click here ;to learn more.

The article Bad Credit? No Problem. Here’s How to Get a Home Loan originally appeared on Fool.com.

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[…]

Why You Should Avoid Payday Loans

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Payday loans have become a life-line for many American families strapped for cash. Payday loans are basically high-interest, high-risk, short-term loans largely made to sub-prime borrowers who don’t have any other means of obtaining much needed funds.

According to research figures released by the Pew Charitable Trust in 2012, 12 million American adults depended on payday loans in 2010 to make ends meet while figures will most certainly have further risen until 2014.

In 2010, the average borrower took out eight loans per year with a loan size of $375 each and paid a whopping $520 on interest.

Payday loan companies providers clearly take advantage of cash-hungry, vulnerable consumers who need quick cash and are desperate enough to turn to these financing companies.

Source: Wikimedia Commons

While it is widely accepted in American society to take on consumer debt, payday loans should clearly be the absolutely last solution for people who need a short-term cash influx.

Payday loans are usually available on the spot, but they pose the very real danger of creating a dependency that could lead to a devastating debt spiral. So when you think about taking out a payday loan, you better understand very well what you are getting into.

The dangers of easy cash
The popularity of payday loans can largely be explained by how easy it is to obtain them. All you have to do is fill out on application, possibly on the Internet, agree to the lending terms and you get your cash fairly quickly.

Unfortunately, the availability of easy cash can seduce consumers and encourage them to adopt unhealthy spending habits.

Of course, there might be situations in which a short-term cash infusion will help you with an emergency such as paying for a car repair or a medical bill.

However, be aware that payday loans can push you in a debt spiral in which you are required to roll over one payday loan into the next one, with little hope of breaking the cycle.

Excessive interest rates
Make sure you understand, that payday loans are very short-term loans that need to be paid back in full plus sizable interest and fee components.

Annualized interest rates (also called annual percentage rates, or APRs) can be as much as a couple of hundred percent according to information from the Consumer Financial Protection Bureau and it is not unusual for borrowers to pay back a total of interest and fees that exceeds the amount borrowed.

If you take out a payday loan, be prepared to pay 100% or more of your requested loan size in interests and fees. There is a reason why payday loan companies can be compared to loan sharking operations.

Payday loans as a last resort
Given the excessive interest rates and fees being charged, payday loans clearly should be avoided at all costs. If you have any other chance of making up for your cash shortfall, by all means use it.

Do not use payday loans to finance purchases of consumption goods and resist the urge of taking advantage of easy credit. You will pay dearly.

The Foolish Bottom Line
Payday loans should be the absolutely last resort if you are strapped for cash. You are well advised to tap all other possible funding sources first and avoid payday loans like the plague.

The easy availability of fast credit also poses a significant risk of creating a short-term debt dependency in which consumers roll over their expensive payday loans into new loans on a consistent basis.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it’s not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy ;to take advantage of a little-known IRS rule ;that can help ensure a more comfortable retirement for you and your family. Click here ;to get your copy today.

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What it takes to borrow against home equity

Home Equity What It Takes To Borrow From Home Equity

Breaking into the home equity nest egg is becoming a very real possibility for more Americans as home prices rise. But raiding the house bank is not as easy as it was before the recession, and not everyone meets the requirements to borrow from home equity.

Consumers must have a trifecta of enough equity, a high credit score and a healthy relationship between their debt and income to take money out of their house via a cash-out refinance, home equity loan or home equity line of credit, also called a HELOC.

Home equity loan

A second mortgage for a fixed amount, at a fixed interest rate, to be repaid over a set period.

Home equity line of credit (HELOC)

A second mortgage with a revolving balance, like a credit card, with an interest rate that varies with the prime rate. Pronounced HE-lock.

Cash-out refinance

A mortgage refinance for more than the amount owed. The borrower takes the difference in cash. Also called a cash-out refi.

“The standards were already fairly tight, but now with a lower volume of refis being done, you have more people looking at every file,” says Paul Anastos, president of Mortgage Master Inc. “There’s more scrutiny from banks and the agencies.”

You can extract equity in multiple ways

Some banks remain hesitant to offer equity lines of credit to homeowners. Lenders also must follow stricter mortgage rules that went into effect this year about a consumer’s ability to repay the debt.

Some lenders offer HELOCs as well as home equity loans and cash-out refinances.

“I have only one lender, U.S. Bank, that does HELOCs, but they must have the first mortgage,” says John Stearns, a senior mortgage banker with American Fidelity Mortgage in Milwaukee. “As for cash-out refis, I do those every once in awhile and am doing one now.”

Stearns said the borrower is taking out $50,000 in home equity. After the loan closes, the borrower will still have a 40 percent stake in the property. That translates to a healthy 60 percent loan-to-value ratio, or LTV — a figure that reflects how much debt remains on the property. The lower the ratio, the better.

You need lots of equity to borrow from it

Home prices rose year over year for the 22nd straight month in March, according to the SandP/Case-Shiller index of home prices. That run helped 4 million mortgaged properties regain equity in 2013 and boosted Americans’ overall stakes in their homes to over 50 percent for the first time in six years.

Still, lenders require a hefty amount of equity before homeowners can borrow against their home. In general, a homeowner cashing out into a fixed-rate mortgage must have at least 15 percent equity left over, or a loan-to-value ratio of 85 percent, according to rules spelled out by Fannie Mae and Freddie Mac, which guarantee the majority of U.S. home loans.

If the homeowner chooses an adjustable-rate mortgage when cashing out, then the maximum LTV is 75 percent. The LTV requirements for cash-out refis differ even more if the home is a second house, an investment property, a mobile home or a multiple-unit dwelling.

For HELOCs, lenders generally want the LTV to be 80 percent or less, says Pava Leyrer, manager of training and implementation for Northern Mortgage Services in Grand Rapids, Michigan.

“The reason why most want to keep that 20-percent stake is because it will cover the cost to take back the property in foreclosure and turn around and sell it,” Leyrer says.

Lenders scrutinize total debt payments

LTV is not the only key percentage to tap home equity. The ratio between a consumer’s total debt and income is also part of the qualification equation. And again, the lower the percentage, the better. The magic number, according to Fannie Mae and Freddie Mac, is 45 percent.

Lenders will add up the total monthly payment for the house, which includes principal, interest, taxes, homeowners insurance, direct liens and home association dues along with any other outstanding debt that is a legal liability. That can include child support, installment loans, credit card bills, IRS payments and even student loans that are not yet being repaid, Leyrer says.

That total debt is divided by a borrower’s gross monthly income, which is comprised of base salary, commissions, bonuses and any other income such as rental income or on-time, up-to-date spousal support.

“Lenders want to see if after making your monthly debt payments, is there any money left over at the end of the month,” says Dave Norris, president and chief operating officer of loanDepot.com.

And then there’s the credit score

Even if a borrower’s income shows ability to repay the loan, that doesn’t mean the borrower will, Norris says. That’s where a borrower’s credit score comes in. For HELOCs, Leyrer says most borrowers with a credit score between 660 and 680 will probably qualify, but a score of 700 is “more of a shoo-in.”

For cash-out refis, generally, the lowest credit score on a home that the borrower lives in is 640, according to Fannie Mae’s standards. But such a loan comes with caveats. The borrower can’t have an LTV ratio higher than 75 percent, must have six months of reserves in the bank and a debt-to-income ratio of 36 percent or lower. Those stipulations disappear as the credit score, LTV or debt to income improves.

Requirements for cash-out refinance on primary home

36% or lessmore than 75%680n/a36% or less75% or less660n/a36% or lessmore than 75%660636% or less75% or less640645% or lessmore than 75%700n/a45% or less75% or less680n/a45% or lessmore than 75%680245% or less75% or less6602

Source: Fannie Mae

“They all play off one another,” says Norris. “You would also get a better interest rate as each factor improves.”

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Tax refund loan alternatives

Taxes » Tax Refund » Tax Refund Loan Alternatives

Just discovered you’ll be getting a tax refund? Don’t let your enthusiasm for spending that unexpected money get the better of you.

Some taxpayers, upset at the delay until Jan. 31 of the start of the federal tax-filing season, might consider offers to get their refund money sooner via private programs. In recent years, attorneys general have filed suits against refund anticipation loan, or RAL, operations for failure to disclose full costs of the products to consumers. Consequently, RALs are effectively unavailable. But alternatives, such as refund anticipation checks, remain and, say consumer advocates, can be just as costly.

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Thanks to today’s technology, there’s really no need to pay extra just to get your hands on your tax money a tiny bit sooner. If instant cash is more a desire than a need when considering a quick refund, consider these alternatives:

Go electronic. Abandon the traditional paper return sent via the U.S. mail and file from your computer. You’ll get the money almost as fast as you would with a refund anticipation loan and get it without paying any loan fees or interest. In fact, you may not need to pay for anything. An Internal Revenue Service partnership with tax preparers and software companies offers free online tax preparation and e-filing to some taxpayers. For the 2013 filing season, the Free File program kicks off Jan. 31. Last year, the income cutoff was $57,000, regardless of filing status. An inflation adjustment of $1,000 increases that amount slightly to $58,000.

For the past few years, the IRS has also expanded the online program to include taxpayers who make more money. Via the Free File Fillable Tax Form option, anyone, regardless of income, can enter their tax data onto online forms and then file them for free directly with the IRS. This is not a tax software program, but simply blank forms you can use via computer, and file directly, rather than filling them out by hand.

The IRS says that any e-filing option you use will get you your tax refund much more quickly than mailing a paper return. Whereas paper filers could wait up to eight weeks for their refunds, most electronic filers can expect their tax checks to show up in their mailboxes in half that time or less. The agency also points out that the error rate is less than 1 percent for electronic filers.

Direct deposit. Electronic filers who opt for a refund via direct deposit do even better. The IRS says the money generally shows up in taxpayer bank accounts in 10 to 14 days. Even if you file the old-fashioned paper way, having your refund deposited directly into a bank account cuts the time you have to wait for your tax cash. Plus, it’s added protection against lost or stolen refund checks sent via the mail.

Use store financing. If you want your refund to finance a must-have new appliance, store interest rates usually will be better than a refund anticipation loan. Many stores offer free financing for limited time periods. By then, the refund should have arrived and you can use it to pay off the store credit — and pay no interest at all.

Impatience usually wins. “Theoretically, with electronic filing and quicker turnaround on refunds, the need for tax anticipation loans has become obsolete,” says John L. Stancil, CPA and professor of accounting at Florida Southern College in Lakeland.

But ultimately, a refund anticipation product is a personal preference, not a fiscal issue for taxpayers. The prospect of cash a few days earlier appeals to those who value speed over cost, such as the person who stands impatiently in front of the microwave complaining that it’s taking too long for dinner to be ready.

Companies that offer quick refund options are well aware of such impatience, and that’s why some opportunities survive even as electronic filing increases, especially in the past two years when official filing was delayed.

But if you can squelch your refund appetite for just a few days, then you — and your bank account — will be better off.

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