How to Finance Your Wedding

With even a modest wedding party running into tens of thousands of dollars, it's never too early to begin setting aside some savings for that special day.

Topics

1. Financing Your Wedding
2. Tapping Into a Home Equity Loan
3. Taking a Loan Against Your Whole Life Insurance Policy
4. Borrowing From Your 401(k)
5. Does a Margin Loan Make Sense?
6. Sample Wedding Budget
7. Bargain Hints

1. Financing Your Wedding

Expensive weddings are the reality these days for most couples. The average American wedding costs approximately $19,000 for about 175 to 200 guests. And for a smaller event with at least some of the trimmings, many wedding planners will tell you to set your minimum budget at $5,000. As with most major purchases, the cost may exceed that price by roughly 15%.

Traditionally, the bride's family paid most wedding expenses. Today, with higher costs and many people marrying at a later age, those rules have changed drastically.

What are your options? You could, of course, use your short-term emergency cash fund or sell some of your investments. But would it be worth it? Do you really want to jeopardize your financial security for just one day, albeit a special one? Many financial planners suggest delaying the wedding until you've saved enough for your wedding.

But if you can't wait months to be with your intended, and you simply must throw a big celebration with all the bells and whistles, here are four funding sources for the big day -- with the appropriate pros and cons -- that you may want to consider.
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2. Home Equity Loan

If you own a house or condominium, a home equity loan may be tempting. But be careful. If you miss a payment, you run the risk of losing your home. The good news is that most home equity loans run one to three points above the prime rate and the interest may be deductible. Be sure you understand that some loan agreements initially require you to pay only the interest on a monthly basis, which may leave you with a balloon payment down the road. In addition, some lenders may offer very low interest rates for the first few months with higher rates later, triggering a corresponding increase in your payments.
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3. Taking a Loan Against Your Whole Life Insurance

This is one source for quick cash, provided you've held the policy and paid premiums for a number of years. You may be able to borrow up to the full cash value of the policy at a reasonable interest rate and not have to repay the loan. This action, however, will reduce the policy's death benefit. In the event of your demise, your beneficiary would receive the policy's face value minus the amount of the outstanding loan.

It's also important to understand that while the advertised interest rate of the loan may be low, you don't actually borrow the cash from your policy -- it is only collateral against your loan. In that case, the rate you earn on the cash value may be reduced on the portion you use as loan collateral. You not only pay interest on the loan, you reduce the overall earnings on your policy. Of course, if your insurance policy is affected by interest rate changes, the terms will be quite different. Ask your insurance agent what kind of policy you have.
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4. Borrowing From Your 401(k)

The interest rate on any loan you take from your employer-sponsored retirement plan is likely to be low, and you are, in essence, paying the interest to yourself. However, you must repay the loan within five years; otherwise, the IRS may view the unpaid portion of your loan as a distribution. You could be responsible for taxes on the withdrawn amount and may have to pay a 10% early withdrawal penalty, if you're younger than age 59 1/2.

In addition, should you leave your job, you risk paying taxes and an early withdrawal penalty if you don't repay the loan within the specific time period that is noted in your plan (e.g., 30 days). And, if the interest on the loan is less than the rate of return your money would have earned if it remained in the plan, you may find that you have less money for retirement.

Here's why. If you borrow money in an account earning 10% and you pay 6% interest on the loan, you may lose out on a potential 4% return on the balance of the loan. Over time, those potential missed earnings could add up, resulting in an overall lower account balance.
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5. Does a Margin Loan Make Sense?

A margin loan allows you to use your investments as collateral. Your brokerage firm may lend up to 50% of the value of your stock investments and nearly 90% of the value of your Treasury securities at an interest rate that's a point or more above prime. If you purchased your mutual funds through a discount broker, you can borrow against these investments as well.

A big risk: Should the value of your investments decline, a "margin call" may be made on the loan. This means you'll have to make up the cash difference, or conversely, the lender may sell some of the remaining securities in the account.
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6. Sample Wedding Budget

The sample budget below lists the main expenses associated with a wedding. Space is provided for you to itemize projected expenses.
Attire	___________________________
Rings	___________________________
Ceremony	___________________________
Flowers	___________________________
Hair/Cosmetics	___________________________
Transportation	___________________________
Reception	___________________________
Entertainment	___________________________
Video/Photos	___________________________
TOTAL	___________________________

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7. Bargain Hints

Of course, you can reduce expenditures and still have a memorable celebration. There are many books to assist budget-conscious couples in planning their weddings, including:

• The Budget Wedding Sourcebook.
  Madeline Barillo, 2000, McGraw-Hill, $17.95.
• How to Have a Big Wedding on a Small Budget.
  Diane Warner, 1997, 2002, Betterway Publications, Inc., $12.99.
• How to Have an Elegant Wedding for $5,000 (or Less).
  Jan Wilson and Beth Wilson Hickman, 1999, Prima Lifestyles, $16.95.
• Priceless Weddings for Under $5,000.
  Kathleen Kennedy, 2000, Three Rivers Press, $14.

There are also a number of specialty magazines such as Modern Bride, and Web sites such as The Knot (www.theknot.com), that offer tips for cutting wedding costs. Money concerns are a major cause of stress in many marriages. Why not give you and your betrothed a gift by beginning your new life together with minimal debt?
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Summary

• The cost of a wedding can easily exceed $19,000. Many wedding planners estimate a minimum cost of $5,000 for a wedding with a full reception.
• Many financial planners recommend saving the money for a wedding rather than
  financing it.
• While a home equity loan is an attractive source of cash, some financial institutions may require you to pay monthly interest, followed by a balloon payment.
• A loan against your whole life insurance policy may offer a reasonable interest rate and not require repayment of the loan. However, if you borrow against the policy, you reduce the death benefit, as well as the earnings on the policy.
• Consider borrowing from your 401(k) plan only if your job is stable and you can repay the loan in five years or less. Keep in mind that the borrowed money will lose the benefit of compounded interest until it is repaid.
• Carefully consider the risks of taking a margin loan, which is secured by your investments. Should the value of your investments decline, the loan may be called, requiring you to make up any shortfall in your account.

Managing Retirement Assets in the Event of a Layoff

Being laid off is often unavoidable. But losing your retirement nest egg at the same time can be prevented. Find out what your retirement savings plan distribution options are and identify some better short-term funding sources.

Topics

1. In the Event of a Layoff...
2. Evaluate Your Options
3. Consider Other Short-Term Funding Sources
4. Compare Retirement Plan Distribution Options

1. In the Event of a Layoff...

These days, layoffs are a fact of corporate life as companies try to grapple with economic cycles and global competition. One of the first choices laid-off workers face is what to do with their retirement plan assets. Many, confronted with the prospect of meager unemployment checks and a long job search ahead, opt to cash out of their plans.

But cashing out is expensive, involving a large tax bite and forfeiture of one's hard-earned retirement nest egg. Moreover, there are far better ways to make ends meet while unemployed than dipping into retirement savings.
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2. Evaluate Your Options

If you get caught in a downsize and you're not immediately moving to a new company, you generally have three options for your retirement plan assets: (1) leave your money in the existing plan; (2) take a cash, or a "lump-sum," distribution; or (3) transfer the money to another retirement savings account, such as an individual retirement account (IRA). Consider the merits of each option.

Option #1 - Stay Put. You may be able to leave your savings in your existing plan if your account balance is more than $5,000. By doing so, you'll continue to enjoy tax-deferred or tax-free compounding potential and receive regular financial account statements and performance reports. Although you will no longer be allowed to contribute to the plan, you will still have control over how your money is invested among the plan's investment selections.

Option #2 - Cash Out. You may elect to have your money paid to you in one lump sum or in installments over a set number of years. A lump-sum approach has a number of drawbacks, including a 20% withholding on the pre-tax contributions and earnings portion of the eligible rollover distribution, which the plan is obligated to pay the IRS to cover federal income taxes, and a 10% early withdrawal penalty if you separate from service before age 55. Depending on your tax bracket and state of residence, you may be liable for additional taxes. Taken together, you could lose up to 50% of your money to federal, state, and local income taxes and penalties. An installment approach, whereby distributions are made in substantially equal payments over the participant's and/or participant's and spouse's life expectancy, is not subject to withholding or penalty. But this is a fairly complex option that may require the assistance of a financial advisor.

The Costs of Cashing Out

Lump-sum cash distribution	$10,000
less 20% tax withholding	($2,000)
equals the amount in your pocket	$8,000
Lump-sum cash distribution	$10,000
less 10% IRS penalty	($1,000)
less ordinary federal and state income tax*	($3,300)
equals your after-tax distribution	$5,700

*This hypothetical example assumes a federal tax rate of 28%, a state tax rate of 5%, no local tax, and that plan balances are held in a traditional tax-deferred plan. Tax rates vary from state to state and your rates will differ. This example has been simplified for illustrative purposes and is not meant to represent advice. Investment returns cannot be guaranteed.

Option #3 - Roll Over. You can move your retirement plan money into another qualified account, such as an IRA, using a "direct rollover" or an "indirect rollover." Note that traditional plan balances can only be rolled into traditional IRAs and new Roth-style plan balances can only be rolled into Roth IRAs. With a direct rollover, the money goes straight from your former employer's retirement plan to your IRA without you ever touching it. The advantages of a direct rollover include simplicity and continued tax deferral on the full amount of your plan savings. IRAs may also afford more investment choices than many employer-sponsored plans. In an indirect rollover, you take a cash distribution, less 20% withholding, but must redeposit your qualified plan assets into an IRA within 60 days of withdrawal in order to avoid paying taxes and penalties. With this approach, however, you'll have to make up the 20% withholding out of your own pocket when you invest the money in the new IRA, or else that amount will be considered a distribution and a 10% penalty will be applied.
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3. Consider Other Short-Term Funding Sources

During times of economic hardship, it may be tempting to take money intended for future needs and use it to supplement a temporary income shortfall. But before choosing a retirement plan cash distribution, look hard at other potential sources to meet your current income needs. Some of these might include:

• Savings accounts or other liquid investments, including money market funds or other easily liquidated investments. With short-term interest rates at historically low levels, the opportunity cost for using these funds is relatively low.
• Home equity loans or lines of credit are an excellent way to tap into the equity in your home. Not only do they offer comparatively low interest rates, but interest payments are generally tax deductible. The best approach here may be to set up an equity line of credit beforehand, while you are employed, so that funds will be available when you need them.
• Roth contributions. If you do find it necessary to resort to using some of your retirement savings, consider first cashing in the contributed portion of your Roth-style plan or Roth IRA, if you have one. Amounts you contributed to a Roth-style plan or Roth IRA can be withdrawn tax and penalty free, since you've already paid taxes on them.

If, after everything else, you still find it necessary to cash in your retirement savings plan, consider rolling it into an IRA first, then withdrawing only what you need. Also, try to time it after year-end, when you may be in a lower tax bracket. But remember that any funds you take out today will ultimately reduce your retirement nest egg tomorrow.
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4. Compare Retirement Plan Distribution Options

By leaving your money in your former employer's plan...you may keep your long-term goals on track by continung to pursue tax-deferred growth potential.

By taking a lump-sum cash distribution... you may satisfy an immediate need for cash, but impede the long-term growth potential of your retirement portfolio and expose yourself to substantial tax liabilities and premature withdrawal penalties.

By making a direct rollover to an IRA... you will continue to pursue tax-deferred or tax-free growth while potentially having greater control over the assets.
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Summary

• If you are laid off and you're not immediately moving to a new company, you generally have three options for your retirement plan assets.
• The first option is to leave your money in the existing plan, which you may be able to do if your account balance is more than $5,000.
• The second option is to take a cash, or a "lump-sum," distribution. But this approach will trigger a mandatory 20% withholding, a 10% penalty fee, and ordinary income tax on some or all balances withdrawn.
• The third option is to roll over the money to another retirement savings account, such as an IRA. The advantages of a direct rollover include simplicity and continued tax deferred or tax-free growth on the full amount of your plan savings.
• Other potential income sources to meet your current needs include savings accounts, other liquid investments, and home equity loans or lines of credit.
• If you have a Roth-style plan or Roth IRA, you can also tap into your contributed portion without incurring a tax penalty.

Checklist

• Consider delaying your anticipated retirement date in order to make up for lost wages and missed investment opportunities.
• If you decide to transfer money from a former employer's plan to an IRA, opt for a "direct rollover" that relieves you of the responsibility to withdraw and then re-deposit the money yourself.
• Begin replenishing your emergency savings account as soon as you start working again.
• Sign up to participate in your new employer's retirement plan as soon as you become eligible to do so. Contribute as much as possible.

Starting Out: Begin Funding for Your Financial Security

An overview of financial planning geared toward young people just entering the workforce. The importance of saving for the future will be stressed, and tips on budgeting, insurance, and paying off student loans will be offered.

Topics

1. Starting Out: Begin Funding for Your Financial Security
2. Get Out From Under
3. What You Really Should Buy
4. Build a Cash Reserve
5. Shopping for the Best Credit Card
6. Build Your Financial Future
7. Stop Waiting for the Next Paycheck

1. Starting Out

Congratulations! You've graduated from school and landed a job. Your salary, however, is limited, and you don't have much money (if any) left at the end of the month. So where can you find money to save? And, once you find it, where should this cash go?

Here are some ways to help free up the money you need for current expenses, financial protection, and future investments -- all without pushing the panic button.
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2. Get Out From Under

For most young adults, paying down debt is the first step toward freeing up cash for the financial protection they need. If you're spending more than you make, think about areas where you can cut back. Don't rule out getting a less expensive apartment, roommates, or trading in a more expensive car for a secondhand model. Other expenses that could be trimmed include dining out, entertainment, and vacations.

If you owe balances on high-rate credit cards, look into obtaining a low-interest credit card or bank loan and transferring your existing balances. Then plan to pay as much as you can each month to reduce the total balance, and try to avoid adding new charges.

If you have student loans, there's also help to make paying them back easier. You may be eligible to reduce these payments if you qualify for the Federal Direct Consolidation Loan program. Though the program would lengthen the payment time somewhat, it could also free up extra cash each month to apply to your higher-interest consumer debt. The program can be reached at (800) 557-7392.
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3. What You Should Buy

How would you pay the bills if your paychecks suddenly stopped? That's when you turn to insurance and personal savings -- two items you should "buy" before considering future big-ticket purchases.

Health insurance is your first priority, as hospital stays can be extremely costly. If you're not covered under a group plan, see if you can join any trade associations, which often offer group-rate policies. Otherwise, start obtaining quotes on individual policies by calling the major insurers in your state.

Life insurance is the next logical step, but may only be a concern if you have dependents. In fact, at the age of 25 you're statistically more likely to become disabled than to die prematurely, according to a 2004 report funded by the nonprofit Actuarial Foundation. Disability insurance will replace a portion of your income if you can't work for an extended period due to illness or injury. If you can't get this through your employer, call individual insurance companies to compare rates.
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4. Build a Cash Reserve

If you should ever become disabled or lose your job, you'll also need savings to fall back on until paychecks start up again. Try to save at least three months' worth of living expenses in an easy-to-access "liquid" account, which includes a checking or savings account. Saving up emergency cash is easier if your financial institution has an automatic payroll savings plan. These plans automatically transfer a designated amount of your salary each pay period -- before you see your paycheck -- directly into your account.

To get the best rate on your liquid savings, look into putting part of this nest egg into money-market funds. Money-market funds invest in Treasury bills, short-term corporate loans, and other low-risk instruments that typically pay higher returns than savings accounts. These funds strive to maintain a stable $1 per share value, but unlike FDIC-insured bank accounts, can't guarantee they won't lose money.

Some money-market funds may require a minimum initial investment of $1,000 or more. If so, you'll need to build some savings first. Once you do, you can get an idea of what the top-earning money market funds are paying by referring to imoneynet.com, which publishes current yields. Many newspapers also publish yields on a regular basis.
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5. Shopping for the Best Credit Card

Extensive lists of the latest low-interest-rate cards in the United States are available at www.bankrate.com and www.cardtrak.com.
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6. Build Your Financial Future

Some long-term financial opportunities are too good to put off, even if you are still building a cache for current living expenses.

One of the best deals is an employer-sponsored retirement plan such as a 401(k) plan, if available. These tax-advantaged plans allow you to make pretax contributions, and taxes aren't owed on any earnings until they're withdrawn. What's more, new Roth-style plans allow for after-tax contributions and tax-free withdrawals in retirement, provided certain eligibility requirements are met. Another big plus is direct contributions from each paycheck so you won't miss the money as well as possible employer matches on a portion of your contributions.

Don't underestimate the potential power of tax savings. If you invested $100 per month into one of these accounts and it earned an 8% return compounded annually, you would have $146,815 in 30 years -- nearly $50,000 more than if the money were taxed annually at 25%. Bear in mind, however, that you will have to pay taxes on the retirement plan savings when you take withdrawals. If you took a lump-sum withdrawal and paid a 25% tax rate, you'd have $110,111, which is still more than the balance you'd have in a taxable account.

If you're already participating, think about either increasing contributions now or with each raise and promotion.

If a 401(k) isn't available to you, shop around for individual retirement accounts (IRAs), both traditional and Roth, at banks or mutual fund firms. In 2007, you can contribute up to $4,000 to traditional IRAs or Roth IRAs. Generally, contributions to and income earned on traditional IRAs are tax deferred until retirement; Roth IRA contributions are made after taxes, but earnings thereon can be withdrawn tax-free upon retirement. Note that certain eligibility requirements apply and nonqualified taxable withdrawals made before age 59 1/2 are subject to a 10% penalty.
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7. Stop Waiting for the Next Paycheck

Beginning your working life with good financial decisions doesn't call for complex moves. It does require discipline and a long-term outlook. This commitment can help get you out of debt and keep you from a paycheck-to-paycheck lifestyle.
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Summary

• Outstanding debt is one of the biggest obstacles to saving.
• Disability insurance is a major safeguard against financial trouble if you're out of work for an extended period.
• Most experts recommend saving at least three months' worth of living expenses in case income stops. An easy and painless way to fund an emergency cash account is through an automatic savings plan.
• Money-market funds are a potentially higher-earning alternative to bank savings accounts. But money-market finds can technically lose money (though they have met their financial obligations), and yields will fluctuate, unlike savings accounts. Also, savings accounts are FDIC-insured.
• Tax-advantaged retirement plans are a terrific way to help build long-term financial security.

Checklist

• Buy additional insurance coverage if necessary.
• Use savings from your newly revised budget to pay off debt ahead of schedule and accumulate enough money for your emergency savings account.
• Consolidate high-interest debt in a single low-rate account.
• Consider scheduling a meeting with a financial professional to review your plans for pursuing your entire range of goals.

Home Refinancing Basics

In recent years, millions of homeowners have taken advantage of low rates and refinanced their mortgages. This article describes the advantages and possible pitfalls associated with a "refi."

Topics

1. Home Refinancing Basics
2. To Refinance or Not
3. Remember -- All Mortgages Are Not Created Equal
4. Stick With What You Know?

1. Home Refinancing Basics

In recent years, Americans seeking to take advantage of low interest rates have lined up to refinance their mortgages. In fact, refinancings hit an all-time high in 2003, and remained high in both 2004 and 2005, according to the Mortgage Bankers Association of America.

But while it's true that refinancing has the potential to help you reduce the costs associated with borrowing money to own a home, it is not necessarily a strategy that makes sense for every individual in every situation. So before you make a commitment to refinance your mortgage, its important to do your homework and determine whether such a move is the right one for you.
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2. To Refinance or Not

The old and arbitrary rule of thumb said that a refi only makes sense if you can lower your interest rate by at least two percentage points for example, from 9% to 7%. But what really matters is how long it will take you to break even and whether you plan to stay in your home that long. In other words, make sure you understand -- and are comfortable with -- the amount of time it will take for your overall savings to compensate for the cost of the refinancing.

Consider this: If you had a $200,000 30-year mortgage with an 8% interest rate, your monthly payment would be $1,468. If you refinanced at 6%, your new monthly payment would be $1,199, a savings of $269 per month. Assuming that your new closing costs amounted to $2,000, it would take eight months to break even. ($269 x 8 = $2,152). If you planned to stay in your home for at least eight more months, then a refi would be appropriate under these conditions. If you planned to sell the house before then, you might not want to bother refinancing. (See below for additional examples.)
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3. Remember -- All Mortgages Are Not Created Equal

Don't make the mistake of choosing a mortgage based only on its stated annual percentage rate (APR), because there are a variety of other important variables to consider, such as:

The term of the mortgage -- This describes the amount of time it will take you to pay off the loan's principal and interest. Although short-term mortgages typically offer lower interest rates than long-term mortgages, they usually involve higher monthly payments. On the other hand, they can result in significantly reduced interest costs over time.

The variability of the interest rate -- There are two basic types of mortgages: those with "fixed" (i.e., unchanging) interest rates and those with variable rates, which can change after a predetermined amount of time has passed, such as one year or five years. While an adjustable-rate mortgage (ARM) usually offers a lower introductory rate than a fixed-rate mortgage with a comparable term, the ARM's rate could jump in the future if interest rates rise. If you plan to stay in your home for a long time, it may make sense to opt for the predictability and security of a fixed rate, whereas an ARM might make sense if you plan to sell before its rate is allowed to go up. Also keep in mind that interest rates hovered near historical lows in recent years and are more likely to increase than decrease over time.

Points -- Points (also known as "origination fees" or "discount fees") are fees that you pay to a lender or broker when you close the deal. While a "no-cost" or "zero points" mortgage does not carry this up-front cost, it could prove to be more expensive if the lender charges a higher interest rate instead. So you'll need to determine whether the savings from a lower rate justify the added costs of paying points. (One point is equal to one percent of the loan's value.)

How Much Would You Save?
A homeowner with a 30-year, $200,000 mortgage charging 8% interest would pay $1,468 each month. The table below illustrates the potential monthly savings and the various break-even periods that would result from refinancing at different rates.
Rate After Refinancing	New Monthly Payment	Monthly Savings	Months to Break Even*
7.5%	$1,398	$70	29
7.0%	$1,331	$137	15
6.5%	$1,264	$204	10
6.0%	$1,199	$269	8
5.5%	$1,136	$332	7
5.0%	$1,074	$394	6
*Assumes $2,000 closing costs. Rounded up to the next highest month.

A Closer Look at Mortgage Fees

Using data collected during 2003, researchers at Bankrate.com determined the average fees charged to consumers who borrow money to buy a home. Based on a loan of $180,000, the fees broke down as follows: Average Lender/Broker Fees Administration fee: $336 Application fee: $205 Commitment fee: $498 Document preparation: $194 Funding fee: $228 Mortgage broker fee: $839 Processing: $320 Tax service: $73 Underwriting: $269 Wire transfer: $31 Third-Party Fees Appraisal: $327 Attorney or settlement fees: $445 Credit report: $29 Flood certification: $17 Pest & other inspection: $68 Postage/courier: $45 Survey: $174 Title insurance: $605 Title work: $200 Government Fees Recording fee: $76 Various taxes: $1,339

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4. Stick With What You Know?

Finally, keep in mind that your current lender may make it easier and cheaper to refinance than another lender would. That's because your current lender is likely to have all of your important financial information on hand already, which reduces the time and resources necessary to process your application. But don't let that be your only consideration. To make a well-informed, confident decision you'll need to shop around, crunch the numbers, and ask plenty of questions.
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Summary

• The decision to refinance should only be made if the long-term savings outweigh the initial expenses. To calculate your break-even point, divide the cost of the refi by your monthly savings. The resulting figure represents the number of months you will need to stay in the home to make the strategy work.
• Don't select a new mortgage based only on its annual percentage rate.
• Also evaluate the term of the loan, whether the interest rate is fixed or variable, and the relative merits of paying up-front fees in exchange for a lower rate.
• Your current lender already knows you and has your financial information on file, so you may be able to get a better deal that way, instead of going to a new lender.
• To get the best possible refinancing deal, you'll need to shop around, crunch some numbers, and ask a lot of questions.

Checklist

• Shop around and conduct a detailed cost assessment (with a financial professional, if necessary) to identify which mortgage offers the greatest financial benefits.
• Read the entire contract before signing. Don't let anyone pressure you or rush you to make a hasty decision.
• If refinancing results in lower monthly payments, use those savings to pursue other important goals, such as preparing for retirement and college costs.

Mortgage Basics

Adjustable or floating rate, 15-year or 30? How much mortgage can you afford? These are just a few of the many questions home buyers will find information on in this report.

Topics

1. Financing the American Dream
2. Put Your Own Financial House in Order
3. How Much Mortgage Can You Afford?
4. Types of Mortgages
5. Interest Rate Points
6. Other Alternatives

1. Financing the American Dream

Buying a home is the biggest financial investment most of us will ever make. As with any large project or goal, it requires dealing with a variety of complex issues. The best approach is to divide the process into manageable tasks. The following deals with the first steps of gathering your records, determining what you can afford, and understanding mortgage options.
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2. Put Your Own Financial House in Order

Before you go looking for a home, you should determine how much home you can afford. Most lenders will prequalify you to borrow up to a certain amount. Prequalification allows you to focus in on a realistic price range and makes you a more attractive buyer. Whether or not you want to prequalify, eventually you'll need to complete a loan application and it may take some time to gather and assemble the required information.

It's also a good idea to review your credit report. Contact local lenders to determine which credit bureaus they use. Then contact the credit bureaus and request a copy of your credit report (in most states, credit bureaus are required to provide individuals with a free copy of their report). Review your report to ensure that all information is correct. If you have past credit problems, don't lose hope. Be prepared to present a rationale for each slipup, and demonstrate an improvement in your ability to pay bills on time.
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3. How Much Mortgage Can You Afford?

The Federal National Mortgage Association (Fannie Mae) is a government-sponsored organization that purchases mortgages from lenders and sells them to investors. Two income-to-debt ratios established by Fannie Mae are standard requirements for conventional mortgages. The first requirement is that monthly mortgage principal and interest payments (P&I), plus insurance and property taxes, cannot exceed 28% of the buyer's gross monthly income (some exceptions may apply to increase this limit to 33%). The second requirement limits total monthly debt payments (housing, credit cards, car payments, etc.) to 36% of gross monthly income. In addition to these requirements, you may have to pay 10% to 20% down on the total purchase price to qualify for a conventional mortgage.

Mortgage Rates and Minimum Incomes Needed to Qualify
Interest Rate	Monthly Payment	Minimum Annual Income
4%	$454	$21,770
5%	$510	$24,479
6%	$570	$27,340
7%	$632	$30,338
8%	$697	$33,460
9%	$764	$36,691
10%	$834	$40,017
11%	$905	$43,426
12%	$977	$46,905
Mortgage companies use ratios to analyze your mortgage payment. The above example shows the monthly payments of principal and interest, and income needed to qualify for a $95,000 mortgage at various interest rates, amortized on a 30-year schedule, assuming a payment ratio of 25%. Source: National Association of Home Builders, Economics Division.

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4. Types of Mortgages

How much house you can buy also depends on your mortgage's term and interest rate. The term is the length of time (usually 15 or 30 years) over which payments will be paid. The rate can be fixed (meaning it doesn't change over the loan's term) or adjustable (it fluctuates with market conditions). Thirty-year fixed-rate mortgages remain the most popular. The longer term lowers the monthly payment, while the fixed rate provides stability over the life of the loan. Given relatively low interest rates, these mortgages are attractive to buyers planning to stay at least six or seven years in their new home. The drawbacks are low principal payments in the early years, and the risk that market rates will decline over the term. However, if your credit history is sound and you have sufficient income, you can usually refinance your mortgage when rates decline.

A 15-year term lowers the interest rate, reduces total interest payments, and increases principal payments. But it also increases monthly payments. If you can't afford the higher payments now, you might opt for a 30-year mortgage. If there are no prepayment penalties, you can make additional principal payments as your income increases. Making just one extra monthly payment a year will pay off a 30-year mortgage in less than 22 years and can save tens of thousands of dollars in interest costs. If you plan to stay in a home no more than three years, you might want an adjustable-rate mortgage (ARM). ARMs offer initial rates that are lower than fixed mortgages. At some point, usually after the first year, rates are tied to market conditions and are subject to potential rate increases. Most ARMs include a cap on rate increases in any given year, as well as over the life of the loan. Some ARMs offer initial rates at least 2% below fixed rates and limit increases to 1% annually and 5% to 6% over the life of the loan. Many home buyers are attracted by the affordability of an ARM during the initial period. However, you should be confident that your future income will be sufficient if both interest rates and your monthly payments increase.

Another popular mortgage involves a balloon payment. A balloon is a lump-sum payment that pays off the loan in full after a fixed period of time. Generally the rates on balloon mortgages are 1/4% to 3/4% less than on 30-year fixed mortgages, but during an initial period of between 3 and 15 years, payments are similar. After this period, the remaining outstanding principal balance is either due in full or subject to refinancing. This is a good option for home buyers who plan to sell before the final payment is due. But because property values fluctuate, you may not be able to sell when you want. You may also face higher payments if you are forced to refinance at a higher rate, and there is also a risk that you may not be in a position to refinance when the balloon becomes due.

Three Steps to Finding the Right Mortgage

Estimate how long you expect to live in the house. If the answer is less than three to five years, consider an Adjustable Rate Mortgage (ARM), which typically starts out with a lower rate. If you plan to live in your new home longer than five years, a fixed-rate mortgage offers protection against rising interest rates. Shop around for mortgage rates. Banks, credit unions, and mortgage companies all offer mortgages. Compare at least six lenders in your area. Add up all the costs for each lender. Include fees, points, closing costs, etc., to arrive at the total mortgage cost for each lender.

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5. Interest Rate Points

Points are interest paid in advance to reduce the rate on a loan. One point is equal to 1% of the mortgage amount. The general rule is that 1 point is worth 1/8 of 1% off the loan rate. The decision to pay points for a lower rate is based on how much the seller is willing to contribute to points, how long you plan to stay in the house, and how important lower payments are compared to higher closing costs. You will need to calculate the long-term value of points based on these factors, keeping in mind that points are generally tax deductible in the year paid.
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6. Other Alternatives

If you cannot afford a conventional mortgage, there are a variety of alternatives. An anxious seller will sometimes offer owner financing. Federal Housing Administration (FHA) loans offer down payments as low as 3%, but may require the buyer to purchase mortgage insurance. (The FHA is a government agency responsible for insuring affordable housing mortgages.) The Veterans Administration (VA) offers no-money-down mortgages to qualified veterans of the U.S. military. Finally, there are local affordable housing advocates that offer low-cost, low down-payment loan alternatives. For further information, contact the FHA, VA, Fannie Mae, or your local mortgage lender or real estate broker.
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Summary

• The first step in acquiring a home mortgage is to gather the information you'll need to include in a mortgage application.
• Review your credit report by ordering a copy from the credit bureaus used by local mortgage lenders.
• Prequalifying for a mortgage lets you know how much you can afford and makes you a more attractive buyer.
• Conventional mortgages limit housing costs to 28% of gross income and total debt payments to 36% of gross income.
• Mortgage terms are usually 15 or 30 years. The longer the term, the lower your monthly payment, but the higher your overall interest costs.
• Thirty-year loans often permit additional principal payments. One additional monthly payment per year will reduce a 30-year loan to 22 years.
• Interest rates are fixed or variable over the term of the loan. Variable rates may be best for buyers who plan to sell within three years.
• Generally speaking, one point is worth 1/8 of 1% off the loan rate.
• A balloon payment is a lump sum payable at the end of a specified term.
• Points and interest on mortgages or home equity debt are usually tax deductible.