Real Estate and Housing

Choosing the Right Mortgage Loan: 15 or 30 Years?

Miranda Marquit — Wed, 22 May 2013 09:48:31 +0000

When my husband and I decided to refinance our home earlier this year, we were faced with the major decision all home loan borrowers face — 15-year mortgage or 30-year mortgage?

Whether you are buying a home for the first time or whether you're an old pro at the refinancing game, you need to determine whether it makes more sense for you to get a 15-year mortgage or a 30-year mortgage. (See also: The 7-Year Mortgage: Take It or Leave It?)

While you will also need to decide whether you want a fixed rate loan or an adjustable rate loan, the first big decision you make has to do with the length of your mortgage term.

In the end, the decision is usually made based on monthly cash flow.

15-Year Mortgage

The biggest advantage of the 15-year mortgage is that you can save money over the life of your home loan. Not only do you have the loan for a shorter period of time, but you also usually have a lower interest rate.

Consider a $200,000 loan. A 15-year mortgage has a rate of 2.6% fixed, and a 30-year mortgage has rate of 3.4% fixed. This calculation doesn't include PMI, taxes, insurance, and other costs that might come with a mortgage.

With a 15-year mortgage, your total on that loan would be $241,742.46. The total on a 30-year mortgage would be $319,306.49. You can see that you save a great deal by choosing a 15-year mortgage. Plus, you pay off the mortgage much faster. It can be a great choice for someone who is interested in saving money and paying off the house as soon as possible.

The main downside with a 15-year mortgage is that you have a higher mortgage payment.

In our scenario above, the 15-year monthly payment is $1,343.01. That, of course, doesn't include your other costs, from property taxes and insurance to utilities and maintenance. Compare that to the $886.96 monthly payment that comes with a 30-year mortgage.

30-Year Mortgage

30-year mortgages are popular mainly because they are more affordable on a monthly basis. When you get a 30-year mortgage, you can usually shave off between $300 and $500 a month, depending on the interest rate and the size of the mortgage.

For someone just starting out, a 30-year mortgage is desirable because it makes the home more affordable. Many couples buying a first home have a hard time affording the monthly payment associated with a 15-year mortgage.

Payment Flexibility

Another advantage of a 30-year mortgage is that you have a certain degree of flexibility — even if you can afford the payments associated with a 15-year mortgage. When my husband and I refinanced our home, we decided to go with the 30-year mortgage, in spite of the fact that we could afford a 15-year loan. We realized that we have a certain amount of payment flexibility with a 30-year loan. This is comforting, since our income is variable.

We can make 15-year loan payments with our 30-year mortgage. So, even though we have a lower monthly payment, we can pay more each month, applying the extra toward the principal. If you are interested in paying off your loan as quickly as possible, there is nothing preventing you from making payments as though you have a 30-year loan. If you run into financial trouble, you can stop making your extra payment, and return to the payment that you agreed to.

With a 15-year mortgage, you are stuck with that higher payment — no matter what. If you miss payments because of financial difficulty, you run the risk of foreclosure. If all you need is $300 or $400 of breathing room for the month, and you are used to making 15-year payments on your 30-year mortgage, you have that option to cut back without jeopardizing your credit rating or your home.

How to Decide Which Mortgage to Get

Whether you choose a 15-year mortgage or a 30-year mortgage, it's important to make sure that you can handle your payments right now. Even the lower payments associated with a 30-year mortgage can be a problem if the mortgage is just barely affordable for you.

In some cases, it's a straightforward look at the numbers. Can you afford the monthly payment with a 15-year mortgage? If not, you have little choice but to go with the 30-year mortgage. You can refinance to a 15-year mortgage, with a lower rate and a higher payment, after your income situation improves.

However, if you have income flexibility, weigh the pros and cons. Decide what is most important to you. If paying off your mortgage as quickly as possible is the most important consideration to you, a 15-year mortgage will force you into disciplining yourself to make those payments. At the same time, though, a 30-year mortgage can allow you the same ability (just make extra payments) while providing you with a level of flexibility in your payments.

Another consideration is whether or not you really need to pay off your mortgage so quickly. While it sounds nice in theory to pay off your mortgage in 15 years, while building up equity, for many that isn't a particular concern. This is especially true in a low interest rate environment like we are experiencing right now. If you can lock in a low interest rate for 30 years, and then invest the money you are saving each month over the 15-year payment, you can actually come out ahead, depending on market conditions.

Bottom Line

For those who want to maintain cash flow flexibility, the best option is a 30-year mortgage. A certain amount of peace of mind comes with a 30-year mortgage, too, since you know that you might be able to handle a payment if an emergency strikes. However, if you want to lock in a lower interest rate, paying less and getting out of your mortgage sooner, a 15-year mortgage might be the better choice.

What do you think? 15-year or 30-year? Why do you have the mortgage that you do?

Written by Miranda Marquit and published on Wise Bread. Read more articles from Wise Bread.

Fixed or Adjustable? Choosing the Right Mortgage Loan

Miranda Marquit — Wed, 15 May 2013 10:24:31 +0000

Part of the home buying process is choosing a mortgage. Most of us can't afford to pay cash for a home, so borrowing to complete the purchase is necessary.

However, when you use a mortgage to buy your home, you have options. What you choose depends on how much you can afford each month, as well as what interest rate you want to pay, and how long you expect to be in debt with the mortgage. (See also: 5 Things Our Realtor Told Us That Weren't True)

Before you begin the process, make sure you understand your mortgage choices, and choose what is likely to work best for you.

Fixed-Rate Mortgage

Fixed-rate mortgages are popular because they allow homebuyers to plan ahead. With a fixed-rate mortgage, you "lock in" your interest rate for the entire period of the loan. When you have a fixed-rate mortgage, the principal plus interest portion of your payment remains the same for the whole term.

Shorter Term = Higher Payments

Usually, you choose between getting a fixed-rate mortgage for 30 years (most common) or 15 years. Often, you can get a better interest rate if you choose the 15-year fixed-rate mortgage. However, the monthly payments are usually higher. A 30-year loan will cost you more in the long run, but it is also more manageable on a monthly basis. If you are concerned about cash flow, a 30-year loan can be helpful.

Plan for Flexibility

One strategy is to agree to a 30-year mortgage, but make payments as if it's a 15-year mortgage. There will be a higher interest rate on the loan, but paying it off faster means that you save overall. The reason some homebuyers go this route is to retain flexibility. If the higher 15-year payment becomes untenable, the borrower can cut back to the agreed upon 30-year payment.

Adjustable Rate Mortgage (ARM)

The other broad category of loan types is the ARM. With this type of mortgage, the interest rate changes periodically. With the changing interest rate, you are also subject to changing mortgage payments. If the market rates rise, then you will end up with a higher monthly payment. On the other hand, if the market drops, you see a reduction in your mortgage payment.

Rate Resets Mean Unpredictability

Interest rates are usually set by adherence to a particular index. The lender will tell you how the rate is set, and how often it is set. Many rates are set quarterly, semi-annually, or annually. It's common to find an ARM with a rate that sets annually. On a particular day each period, the current rate is used to set your interest charges for the following period. If you are on a semi-annual schedule, your rate will be set for the next six months.

ARMs can make it a challenging to plan your finances, especially if the rate changes every quarter or every six months. It can also be difficult if rates begin rising. With the rate going up regularly, you find yourself paying more and more for your home each month. In some cases, if you remain in your home for the full term of the mortgage, the rate decreases (and subsequently lower payments) are not enough to offset increases. An ARM can be more costly over time than a fixed-rate mortgage, depending on the market conditions.

Low Initial Payments

With an ARM, one of the biggest advantages is that you often start out with an interest rate that is very low. Most ARMs have initial rates that are lower even than a 15-year fixed-rate mortgage. If you think you will move soon, or if you are confident that you can refinance to a fixed-rate mortgage before rates really start rising, an ARM can make sense. You have the advantage of a low rate initially, and as long as you can sell or refinance before a higher rate starts costing you, and ARM can be a good choice.

If you decide to use an ARM, make sure that you find out about interest caps. Many ARMs have caps on the interest rate, which means that you have some measure of protection in the event that interest rates rise dramatically.

Hybrid ARM

A subset of the ARM is the hybrid ARM. This type of mortgage is fixed for a set period of time, and then adjusts after the initial period is up. One common type of hybrid ARM is the 5/1 ARM. With this type of mortgage, your rate is fixed for five years, and then the rate is adjusted each year after that.

It's also possible to get a 7/1 ARM or a 3/1 ARM and lots of other ARMs. Realize, though, that the longer you have a fixed rate, the higher your rate will be. With a 7/1 ARM, you will pay a slightly higher interest rate than with a 5/1 loan. The 3/1, on the other hand, usually has a lower initial interest rate. If you want a lower rate, you have to be prepared to give up a certain amount of certainty.

Loan caps on hybrid loans also operate a little differently. You are likely to see three different types of caps with a hybrid ARM:

Initial Adjustment: This cap represents the first adjustment made after your initial fixed term is up. If you have a 5/1 hybrid, the cap might be 5%. This means that the lender can add up to 5% to your initial rate in its first adjustment.
Rate Adjustment: A rate adjustment cap is the maximum adjustment made each period. If you have a cap of 2%, it means that the lender won't adjust your rate up by more than 2% above your current rate at adjustment time — no matter what the market indicates.
Lifetime: Finally, the lifetime cap represents the highest an interest rate can go. Once you hit the lifetime cap, your interest rate won't go higher.

Depending on your situation, a hybrid ARM with a reasonable cap can be a good choice.

If you are looking for a low initial rate while you start your career, or a business, or if you have variable income, it can make sense to start with a mortgage that has an adjustable rate. However, you need to be prepared for the possibility of higher interest down the road. It makes sense to save extra money, or to refinance when you can to a fixed rate so your payments are more predictable over time.

What type of mortgage do you have? Fixed, adjustable, or hybrid?

Written by Miranda Marquit and published on Wise Bread. Read more articles from Wise Bread.

Coming to Terms With Your Long-Term Debt

Kelly Kehoe — Fri, 10 May 2013 09:48:33 +0000

Investopedia.com defines "long-term debt" as loans and financial obligations lasting one year or more. Think home mortgages, student loans, and car loans.

Since the 2008 housing crisis and ensuing recession, many families have taken on greater debt loads to cope with the volatile economy. Some may have lost their long-term debt to foreclosure or personal bankruptcy along the way, while others are still shouldered with debt from supposedly short-term credit card loans, or long-term mortgage, student, and auto loans.

With all the governmental incentives offered to first-time homebuyers and the Federal Reserve keeping interest rates low to promote investment and growth in the economy, perhaps you've taken on more long-term debt in these past few years.

The word "debt" has a negative stigma attached to it, and while most personal finance gurus advocate for debt-free living, having long-term debt isn't always a bad thing, if you can come to terms with it. (See also: Good Debt, Bad Debt)

Assessing the Situation

First step — assess your financial situation.

What is your overall debt load, both short-term and long-term? What loans or payments incur the most interest each month? How are the loans benefiting you (or how did they benefit you originally)?

For example, say you have student loans leftover from your college days. American Student Assistance says that 37 million Americans currently have outstanding student loans totaling nearly $1 trillion. Taking out a student loan and working to pay it off carries a lot of implications (such as higher interest rates), but remember that having a certificate or degree improves your chances of getting hired in a rough job market. Ergo, you may have incurred some long-term debt to receive an education, but rather than chiding yourself for taking on more debt, think of it as a valuable investment to boost your employability.

And what about credit card debt? A February 2013 Bankrate survey reported that only 55% of Americans have more money in savings than they have in credit card debt. If you have credit card debt, rest assured you're not alone — the average American household has almost $15,800 in debt. Again, think of your debt accumulation as a valuable lesson, rather than focusing solely on the negative aspects, like what you would've done with the money if you weren't too busy making monthly interest payments.

All of these factors must be considered when tackling your financial situation, regardless of the type of debt involved. Once you account for your debts and the consequences of having these loans, it's time to do something about them.

Taking Action

Where debt is concerned, gloom and doom surrounds us. It seems to have taken permanent residence in American society: media reports about debt, politicians bemoaning the debt woes of the government and the people, and the digits under the "to pay" section of our bills all appear to be multiplying.

But don't despair; prioritizing your debts and paying them off — not randoml, but based on simple principles of finance and psychology — is key to stabilizing your finances.

Prioritize

When it comes to prioritization, you have a couple of options: either continue paying the minimum balance required every month or funnel more money into your payments in order to pay off the loan quicker. It won't be as simple as paying off a small credit card balance within a few months, so don't get impatient.

If you have multiple credit cards, determining which one to pay off first presents a unique problem to tackle. Common sense may argue that you should pay off ones with highest interest first, but psychologists argue that it's better to tackle smaller debts first because, in paying those off, it feels like we're making progress — thus, we'll be more likely to continue making debt payments rather than throwing our hands up in frustration. If you have a debt load similar to or greater than the average American household, it will probably take a few years to pay off all your credit cards, but by prioritizing your card payments, you'll be able to pay them off much sooner.

As for mortgages, these are generally paid off in the span of decades, and the timeline for student loans can span between a few months to a lifetime (in extreme scenarios). Payments on interest accrued often outweigh payments on the original, principal amount, but in the case of mortgages, at least there's a tax deduction for interest payments.

To shrink the timeframe for paying off these loans, consider options such as extra payments or refinancing, among others.

Staying Motivated

Paying off long-term debt is quite a journey, but the benefits of owning your own home (or having a car and a good education) don't always mask the potential frustration of shouldering thousands of dollars in debt for a major chunk of your life.

Although it may decrease the number of payments over time, stinginess can prove more of a psychological hindrance than help when you're paying off long-term debts. Celebrate the milestones. Every time you pay off another $5,000 on your student loan or pay off yet another credit card, mark it on your calendar, and don't hesitate to treat yourself and your family to a nice dinner after making significant progress towards your debt-free goals. Always remind yourself why you're doing this — to fulfill your dream of going to college, being able to ditch rental living and own your own home, or take the vacation of a lifetime. Keeping things in perspective and staying organized will help you come to terms with your long-term debt and eventually, pay it off.

Have you come to terms with your long-term debt? What keeps you upbeat despite the burden of repayment?

Written by Kelly Kehoe and published on Wise Bread. Read more articles from Wise Bread.

FHA Home Loans: You Can Buy a Home Even If Your Finances Aren't Perfect

Michael Kling — Thu, 09 May 2013 09:48:36 +0000

If you have marginal credit, a moderate income, and little money for a down payment, you can still buy a house with the help of an FHA home loan. Yes, even after the housing boom and crash.

Home buyers can obtain FHA mortgages, which are insured by the Federal Housing Administration but made by private government-approved lenders, with a down payment as little 3.5% of the home's purchase price. (See also: Buying a Home Without the Money)

FHA home loans can be used to buy single-family homes and duplexes, triplexes, and four-unit homes, condominiums, cooperatives, and manufactured homes. Unlike other home loan programs, the down payment funds can come from a gift from a relative, employer, or charity.

They can be used to buy single-family homes for up to $417,000 as of 2013, but the limits are higher, up to $729,750, in high-priced counties, areas that cover much of coastal California the Northeast. To find price limits for your county, visit the FHA's mortgage limits page.

When subprime lending disappeared with the real estate market tumble, FHA home loan programs became the only alternative for borrowers with imperfect credit or low down payments. FHA mortgage standards have tightened recently and may become more stringent as the agency deals with more defaulting loans. Nevertheless, FHA loans are still the best option for some borrowers.

Easier on Credit Scores

Credit score requirements for FHA mortgages are much more relaxed than conventional loans. For that reason, FHA loans may be the only option for home buyers with spotty credit.

Minimum credit scores can be complicated because they can depend on different factors, such as the amount of equity the homeowner has in the property.

In addition, lenders may have their own credit requirements on top of FHA rules, but they're still likely to be more relaxed since the loans are government insured.

The FHA's rules can change over time. For instance, the agency recently started requiring lenders to manually underwrite loan applications from borrowers with credit scores under 620 and total debt-to-income ratios over 43%. That means those with poor credit will need compensating factors, such as large bank accounts, to win approvals. The agency also increased the minimum down payment for loans over $612,500 to 5%.

Borrowers Pay Mortgage Insurance Premiums

It's important to understand mortgage insurance premiums, or MIPs, the FHA equivalent of private mortgage insurance. Unless they put 20% or more down, home buyers pay monthly mortgage insurance that protects the lender if the homeowner defaults.

In addition to the monthly MIP, borrowers pay an upfront MIP of 1.75% of the loan amount. The good news is that the upfront premium, as well as other loan closing costs, can be wrapped into the mortgage and repaid over time.

The annual premium is currently 1.35% of the loan balance and 1.3% for borrowers putting 5% or more down.

Until recently, homeowners were able to dispense with the annual premium when their loan balance fell to 78% of the original loan balance. However, as of June 3, new borrowers will pay the premium for the life of the loan or until they sell the house and move or refinance into a new mortgage.

Mortgage Refinancing and Funds for Fixer-Uppers

Besides helping home buyers, FHA programs are available to help homeowners refinance into today’s current low mortgage rates, even if they have little or no home equity, lower credit scores, or low or moderate income.

Seniors can use FHA reverse mortgages to cash out equity from their homes without having to make monthly payments, and borrowers can use an FHA home improvement loan to purchase and renovate a home.

With the FHA 203(k) home buyers can purchase a home with a single mortgage with the FHA home improvement loan that releases funds from an escrow account as home improvement work proceeds. Homeowners can also use an FHA home improvement loan to refinance their mortgage and simultaneously finance home improvement work.

Have you taken advantage of low interest rates or the FHA to buy or refinance a home recently?

Written by Michael Kling and published on Wise Bread. Read more articles from Wise Bread.

21 Real Estate Terms Every Home Buyer Should Understand

Miranda Marquit — Wed, 08 May 2013 10:24:34 +0000

One of the most complex transactions most consumers will ever complete is buying a home. If you decide that you want to purchase a home, it's vital that you understand what you are getting into. (See also: You Shouldn't Buy a Home If...)

Before you even begin looking for a home, here are 21 home buying terms you should understand.

1. Acceptance

This is an agreement to the terms of an offer on a home. If the seller decides to accept the offer, you are both considered under contract. If you try to back out after this point, you face consequences that can include losing any deposit or earnest money you might have fronted.

2. APR

This represents your interest rate each year. The APR on a mortgage must include any fees you pay upfront, including loan origination fees. Your average compound interest and fees over the term of the loan are expressed as a percentage that you can use to compare offers from different lenders.

3. ARM

An adjustable rate mortgage is one with an interest rate that changes as market conditions change. A new rate is often set at regular intervals, such as twice a year or once a year. If you choose an ARM, read the terms, since many of these mortgages put caps on the top interest rate.

4. Appraisal

When you decide to buy a home, the lender wants to know what the home is worth. Lenders don't want to provide a loan for an amount that exceeds the value of the home. An appraisal is a process that determines the value of your home, and it includes factors such as the condition of the property, location, upgrades to the home, and selling prices of similar homes in the neighborhood.

5. Closing

This is the formal and final transfer of a home's ownership between parties.

6. Closing Costs

These are all the costs that you pay as part of the buying process, beyond the cost of the property. Sometimes, the seller pays a portion of the closing costs. Some of the expenses included in closing costs include appraisal fees, credit check fees, escrow fees, points, loan origination fees, and any other fees. All of your costs should be spelled out and itemized in the paperwork.

7. Contingency

If certain terms aren't met, a contingency item in the contract allows you to get out of completing the purchase. One of the most common contingencies — and one that you should make sure is included in your contract — is the ability to void the contract if the home you plan to buy doesn't pass its home inspection.

8. Counter Offer

A way to void an original offer. This is often used by a seller when your offer is considered too low. You might offer $200,000, and the seller might come back with $225,000. You then need to decide whether or not you will accept the counter offer.

9. Credit Report

Your credit report is a history of all of your credit dealings. All of your loans will be included. Lenders look at your credit report for an idea of what you owe, and where your finances stand. You normally have to cover the fee the lender pays to pull your credit report. Realize, too, that the lender will get a report from each of the three major bureaus. Each agency offers a score based on the information in the report. Normally, the middle score carries the greatest weight with regard to decisions about your loan.

10. Earnest Money

A buyer pays this money as an indication that he or she is serious about the transaction. You pay this money as you enter into the agreement to buy. The remainder of the money owed for the house is paid at closing (usually with funds borrowed from a lender). If you fail to complete the purchase, the seller gets to keep the earnest money.

11. Equity

Basically, this is the amount of ownership you have in your home. It is found by subtracting what you owe on your mortgage from the market value of your home. If your home is worth $200,000 and you owe $175,000, you have $25,000 equity — or ownership — in your home. If you owe more than your home is worth, you are said to have negative equity.

12. Escrow

During large purchases, a third party is often involved in order to manage the funds. Your money is held in escrow so that the seller can see that you have it — and that you are ready to pay. Then, once the paperwork is signed and you have the title/deed in your name, the funds are released. Using a trusted third party can smooth the process.

13. Fixed Rate Mortgage

With this type of mortgage, the interest rate remains the same throughout the term of the loan. No matter what happens with the markets, the interest rate remains the same.

14. Homeowners' Association

Some neighborhoods have associations designed to encourage certain behaviors and cultivate a specific feeling. These are often associated with condo communities and gated communities, but many open subdivisions have them as well. You pay fees meant to help with certain upkeep, and you agree to abide by rules about home appearance and noise, and other items. Before buying a home, make sure you understand the rules associated with the local homeowners' association.

15. LTV

This is the term that denotes how much equity you have in your home. Loan-to-Value looks at how much you owe as a percentage of the value of your home. If your home is worth $200,000, and you owe $150,000, your LTV is 75%.

16. MLS

Multiple Listing Service that allows real estate professionals to see all the details related to a house.

17. Mortgage Broker

A lending agent who has access to a number of different loan programs. A mortgage broker is paid a commission and can help you compare numerous mortgage options.

18. PITI

Jargon that is used to denote principal, interest, taxes, and insurance — the major costs associated with homeownership and included in many monthly home payments.

19. PMI

Private mortgage insurance is required if you don't have a down payment of at least 20%. PMI is designed to protect the lender, and if you default, the lender is reimbursed by the insurance. Once your home reaches 80% LTV, you aren't required to pay PMI premiums anymore.

20. Real Estate Agent

Someone licensed to show properties and facilitate selling transactions.

21. Title

Indication of ownership of the home, usually recorded on a deed. A report, verifying that the title is "clean" and without liens against the property, or that there are no other claims on the property, is required before the purchase.

Written by Miranda Marquit and published on Wise Bread. Read more articles from Wise Bread.

Cut Your Electric Bill With Solar Panels

Michael Kling — Fri, 03 May 2013 10:24:34 +0000

Thinking about reducing your carbon footprint by going solar?

Besides helping the environment, installing solar panels can dramatically reduce your electric bills.

Solar panel installers say the panels can cut monthly electric bills by 50 to 90%. The Department of Energy confirms that a solar electric system can meet "nearly all the needs" of an energy-efficient home.

A two-kilowatt system could cost $16,000 to $20,000 including installation, or $8 to $10 per watt, according to the Department of Energy. Cheaper PV systems are available, but they only slightly cut electricity costs. At the high end, a five-kilowatt system that completely meets the energy needs of many conventional homes can cost $30,000 to $40,000 or $6 to $8 per watt, installed.

What's more, the cost of solar panels has fallen substantially in recent years, due to improving technology and low-cost imports. According to Clean Edge, a renewable energy research firm, solar costs for the panels themselves have dropped from $7.50 per watt to $2.50 since 2000.

In addition, photovoltaic, or PV, panels will protect you from rate increases in the future, which run at 4% or more a year, since the sun will never charge more for its power. That means 10 or 20 years from now the cost of electricity may have doubled, but you'll be getting your power for free or for very little.

Solar panels also increase the value of homes, so homeowners should get their investment back when they sell their homes. A Berkley Lab study of California homes found that homes with photovoltaic panels sold for a premium over homes without the panels.

How much you can save depends on how much sunshine you get, the solar system you install, the cost of electricity in your area, and how much electricity you use, all factors that vary widely.

If your utility has net metering, you'll be credited for excess energy the PV system creates during the day. In effect, your meter will run backwards. That means your electric bill could potentially be zero. In some areas, utilities may pay homeowners for excess energy.

Tax Credit Where Credit Is Due

Homeowners can currently obtain a federal tax credit for 30% of installation costs.

Many states also offer rebates and tax credits. Eligibility criteria, incentives, and installer equipment requirements vary widely. For listings of state, local, utility, and federal incentives, visit the National Database of State Incentives for Renewable Energy (DSIRE). The Department of Energy also has a nifty online tool for finding state incentives for solar energy, as well as other alternative energy sources.

How Much Can You Save?

After getting quotes from installers and calculating the state and federal tax savings, use your past year's electric bills to estimate your savings.

Divide the installation costs after tax incentives by 25 years to find the system's annual cost, and compare the annual cost to last year's electric bill to estimate your savings. If you borrow money to pay for your solar system, take into account the interest you'll pay, too.

California, the largest solar energy market, is pushing PV panels in a big way with its Go Solar California campaign, a joint effort of the state's Energy Commission and the California Public Utilities Commission. The California Solar Initiative offers rebates to customers of its investor-owned utilities — Pacific Gas and Electric, Southern California Edison, San Diego Gas & Electric — with rebate amounts depending on the performance of the solar panels. All you need is roof or ground space that gets unobstructed sunlight from 11 a.m. to sunset year-round.

Customers of municipal utilities may also qualify for incentives through their municipal service providers. For the California Solar Initiative program, you first must complete an energy efficiency audit done through your utility's program manager. It can be done online or over the phone.

Buying Sunshine's Electricity on Credit

Installing a solar system may cost tens of thousands of dollars, but you might be able to lease the equipment with little or no money upfront. If you opt for leasing, you pay a fixed monthly fee, typically for 15 to 20 years, while the solar company maintains the panels. Solar leases, or third-party financing, is relatively new and is expected to energize the solar business, says a report from GTM Research. To date, leasing is available in 14 states, including California, Arizona, and Colorado.

A downside of leasing is that the company, not you, gets the federal tax credit. And you can't be certain the company maintaining the system will be around for 15 or 20 years, especially given the young solar industry's record of turmoil and bankruptcy.

Getting Started

In California, the state maintains a database of solar contractors who are eligible to apply for state incentives; other states may have similar programs. Talk to at least three installers. Ask about their warranties, how many systems they've installed, the average cost per watt they charge, the peak generating capacity, and the total cost including hardware, connecting to the grid, and permits.

The contractor will handle the state rebate paperwork. Utility customers get a monthly incentive based on the PV system's output, but owners of systems under 30 kilowatts are also eligible for an upfront rebate.

Other states also offer tax credits or rebates. For instance, Arizona, another sunny state, has a 25% tax credit for residents installing solar energy systems, up to $1,000, and Nevada offers a tax rebate of up to $12,500 for residential solar electric systems. Ask your utility company for referrals for installers.

So if you live in a sunny spot, you can say goodbye to rising electric bills while feeling good that you're doing something to help the environment.

Have you upgraded your home or property with solar panels? Are the savings meeting your expectations?

Written by Michael Kling and published on Wise Bread. Read more articles from Wise Bread.

What You Need to Know Before Buying Your First Home

Miranda Marquit — Wed, 01 May 2013 09:48:35 +0000

Even after the recent real estate crash, buying a home remains an important financial milestone for many. And, thanks to record low interest rates and still reasonable home prices, many first-time home buyers are hoping to find a good deal.

Before you decide to buy a house, though, it's important to study up a little bit. A home purchase is a large and complex transaction, and you need to know what that entails before you take the plunge. (See also: Buying Your First Home: What to Do and When to Do It)

Your Credit Score

When you buy a home, your credit score matters a great deal. Your score not only determines whether or not you qualify for a mortgage, but it also influences the interest rate you pay.

Before you start shopping around, check your credit situation. You can get your credit report free, once a year from each of the three major bureaus, via AnnualCreditReport.com. It's also possible to check your general progress using truly free consumer credit resources.

Check your credit report for errors now, before you talk to a lender. My husband and I were unpleasantly surprised during our home search to find that duplicate student loan accounts were driving up our debt to income ratio. If there are mistakes or fraudulent accounts, you want to get the problems fixed before you apply.

Pull your credit scores from each of the major credit bureaus. While any score that you receive as a consumer won't exactly match what the lender sees, you can get an idea of where you stand. You can get some of your scores through myFICO.com, or from the credit bureaus. You will likely have to pay for your score.

But it's worth it to know what you need to work on before you apply for a home.

How Much You Can Afford

Decide how much you can afford before you go house hunting. And don't just think about your mortgage payment. In addition to principal and interest, your homeownership costs will include:

Property taxes
Homeowners insurance
Utilities
Maintenance
Repairs

You might also need to buy furnishings as you prepare to move in. Think about all these costs, and what you can comfortably afford. The rule of thumb is that you should keep your home payment to 30% of your net (after tax) monthly income. I'm more comfortable if my total housing expenses are no more than 25% of my monthly net income. My variable income as a freelancer means that I need to know I can still keep up with the house if I experience a setback.

Take a look at your net income, consider your other expenses, and decide how much you can afford each month in housing costs. Base your house hunting on this number, and don't use "creative" financing to help you "afford" a bigger home.

Don't forget to factor in your down payment. The best case scenario is 20% down, but you can get a mortgage with as little as 3% to 5% down in most cases. You down payment will reduce the amount you borrow and can also help ensure the best possible interest rate for your loan.

When you have a firm idea of where you stand, and what you can afford, you can make better decisions and better direct your home search efforts.

How to Research a Home

You shop around when you want to save $100 on a computer. Shouldn't you do the research when you plan to buy a house?

Before buying your home, do the research. Learn about potential locations, and find out as much as you can about historical home prices in the area. Prioritize characteristics of the home and the neighborhood. Do you want to be near a good school? Do you prefer to be near public transit? What activities are nearby?

Think about what you want most in your home and in the location, and then research homes that fit your requirements. Find out what the market value is of a home as well, so that you know that you are really getting a good deal.

The Mortgage Process

Know the mortgage process before you buy a home. Understand that you will need various forms of identification, as well as documentation proving your income and your assets. If you are self-employed (like me), you might even be required to go through an income audit. Call the lender to find out what documentation they will need ahead of time so that you are prepared.

The mortgage process is a long one that usually takes weeks to complete. After you have a good idea of what you can afford, and where you stand as to credit, you can get mortgage quotes from a variety of lenders.

Pre-Qualification Is Not Pre-Approval

Using information you provide, a lender can pre-qualify you for a home mortgage. This is a somewhat informal look at the amount you can potentially borrow, and the rate you might be eligible for. While this can be useful when comparing offers and for your own information, it won't help your house-hunting efforts. If you want to know what you'll really end up with, you need pre-approval, an official process that involves checking your credit. A pre-approval letter can show buyers that you're serious, and that you will be able to pay for the home.

You Must Maintain Strong Credit Throughout the Process

Realize, too, that you might not be subject to just one credit check. Many lenders run a second credit check, just before you close, to make sure that nothing major has popped up since the process started. If you are buying a home, you need to put the spending on hold, and avoid adding more debt to your situation. Dramatic changes to your credit profile can end the whole deal, just days before you were set to close.

Find out what fees you will pay for closing costs, as well. You will have a number of fees including title, insurance, loan origination, credit check, and others. Get a list of fees you are paying, and make sure you understand what they entail. You don't want any surprises.

Where to Find Help

Many first-time home buyers would benefit from a little guidance. In many cases, it can help to use the services of a buyer's agent. Usually, the cost involved with a buyer's agent is paid by the seller (the commission to the seller's agent is split), so it doesn't cost you anything. A good real estate agent can help you with the ins and outs, and make sure all of the paperwork goes through.

You can also ask someone you trust to look over the terms of your mortgage before you sign. Make sure that extra costs and problems — like prepayment penalties — haven't made their way into the agreement. A real estate attorney can look at the paperwork and make sure everything is in order.

Written by Miranda Marquit and published on Wise Bread. Read more articles from Wise Bread.

Big Lessons From the Tiny House Movement

Kentin Waits — Wed, 24 Apr 2013 10:24:32 +0000

Have you heard the buzz about the tiny house movement or seen one moving down the road toward its new (semi) permanent home? If not, chances are you soon will. (See also: McMansion to McCottage: Why Smaller Houses Are Smarter)

The tiny house movement is a social movement in which people voluntarily reduce their living space in order to live more simply, to live debt-free, or to reduce their carbon footprint. Tiny homes come in all shapes and designs and are as varied as their occupants. Although there are no formal parameters, these houses can be fixed or on wheels and range in size from 250-400 square feet.

As the movement gains steam and evolves from a fringe curiosity to a full-blown phenomenon, I thought it might be interesting to explore what we’re learning from tiny houses and the lessons that continue to motivate new converts every day.

Smaller Can Be Better

According to data from the U.S. Census Bureau, the size of the average American home in 2012 was 2,480 square feet. Since the size of families is shrinking, one has to wonder what we’re doing with all that extra space. Is it really worth it to finance, heat, clean, and furnish rooms we don’t need? Tiny homes start conversations about expectations, wants, needs, and norms that we seldom explore.

Houses Are for People

We spend a lot of time and money building bigger to house more...things. The beauty and logic of the tiny house movement challenges the notion that our homes need to be large enough to warehouse our unchecked and always-growing inventory of stuff. The primary purpose of a home is to shelter people and — secondarily — the optimal amount of useful, beautiful, and sentimental objects that support and enrich our lives.

Simple Living Requires Constant Editing

The British craftsman and poet William Morris said, “If you want a golden rule that will fit everything, this is it: Have nothing in your houses that you do not know to be useful or believe to be beautiful.” Wise words.

Reaching that optimal level of “stuff” requires constant attention and editing — especially in tiny spaces. But isn’t editing something that should be happening anyway, regardless of the size of our homes? Do we really revel in stuffed closets, garages that no longer fit our cars, basements that look like the National Archives, attics that creak with the weight of dozens of storage bins? Tiny houses require us to do what larger houses let us neglect — minimize the material albatrosses we travel through life with.

Our Lives Are Mobile; Our Housing Should Keep Pace

Since I graduated college in 1992, I’ve lived in four different cities in three states, and for my peer group, that’s a relatively low number. Society is more mobile and adults are more transitory than ever before, but our housing options are still tethered to old social norms. Tiny houses offer ownership benefits that apartments can’t, design considerations that traditional mobile homes don’t, and financial flexibility that typical houses can’t come close to matching.

Prefab Can Be Fab

The reputation of prefab is changing. The old idea that prefabricated structures are quickly and cheaply tacked together is fading away.

Prefabricated tiny houses are designed, customized, and built with an unrivaled attention to detail and durability — often using reclaimed and repurposed materials. Their potential to revolutionize the way we build on a much broader scale shouldn’t be underestimated. With reduced waste, greater cost controls, and year-round climate-regulated building processes, the new prefab really is fab.

Design Matters

Optimizing the costs of any structure begins and ends with the maximizing the space within it. Many tiny homes feel much larger than their footprints because great care has been paid to design, space planning, and other efficiencies. Vaulted ceilings with sleeping lofts, Murphy beds, vertical storage, and versatile furnishings make every square foot matter. It’s a lesson that can be applied to any house, regardless of size.

Mortgage-Free Living Is Possible

Perhaps the most profound lesson we can take away from the tiny house movement is its lesson about debt-free living. Mortgage typically represents the single largest debt that most of us will ever face — one that will track and tax our financial freedom decade after decade. The notion that we can rethink our housing, still enjoy the benefits of home ownership, and reduce or completely avoid long-term debt should be sparking conversations across the country.

Maybe you’re not ready to downsize to a 250 square foot home — and I’m not sure that’s even the point. This style of living isn’t for everybody, but there are important lessons we can all learn from it. If we start reexamining the notions that more is always better than less, bigger is always preferable to smaller, debt is an unavoidable part of life, and traditional employment is necessary to fuel a constantly-expanding cycle of consumption, then the tiny house movement has challenged a narrative that is seldom questioned. And to me, that’s really big news.

Do you know someone who lives in a tiny house? Have you daydreamed about living small? Share your story below.

Written by Kentin Waits and published on Wise Bread. Read more articles from Wise Bread.

Buying Your First Home: What to Do and When to Do It

Tara Struyk — Tue, 02 Apr 2013 09:36:40 +0000

Buying your first home is a beautiful thing. Actually, scratch that. Moving in to your first home is the beautiful part. Most of the stuff that comes before that is demanding, difficult, and often downright stressful. After all, for most people, that home purchase is the most money they’ll ever spend in one shot and the biggest loan they’ll ever ask for. But before you run screaming for the closest rental property, there is some good news — much of the stress associated with home buying can be mitigated through preparation and organization. (See also: 9 Costly Things New Homeowners Don't Prepare For)

Is a new home on your horizon? Here’s what you should be doing before, during, and after the big purchase.

As Soon as You Start Thinking About Homeownership...

The desire to own a home often starts with the idea that you’d like a yard, a better neighborhood, or just to move out of a rental you can’t learn to love. That’s all daydreaming though. What you really need to start thinking about is money. So whether you think you want to move this year, next year, or at some unspecified time down the road, now’s the time to start thinking about the following.

1. Your Credit

It’s possible to get a mortgage with poor credit and sometimes even with rather awful credit, but it isn’t a good idea. Those who go this route will pay considerably more in interest, which can increase the final cost of your home by tens — or even hundreds — of thousands of dollars over the life of the loan. Plus, the worse your credit, the fewer options you’ll have in terms of lenders, which will reduce your ability to shop around and negotiate the best deal. If you want to be a homeowner soon – or even someday - start working on good financial habits that’ll improve your credit score now.

2. Your Down Payment

It’s also possible to get into a new home with little or no down payment, but just like buying a home with a poor credit score, this one isn’t a good idea either. In fact, the more you save, the more you’ll...well, save.

FHA loans require only 3% down — sometimes less, but most experts recommend 10 to 20% of the purchase price of the home (or more!). If you buy a $300,000 house with no down payment, you’ll pay more than $213,000 in interest on a 30-year loan (assuming a 4% interest rate). Put 10% down ($30,000), and you’ll cut that by more than $20,000. By paying upfront you’ll pay a lot less, so make saving for a down payment a priority.

3. Decide If You’re Ready

Most experts say that you shouldn’t buy a home unless you think you can hang on to it for at least five years. Having a longer time frame in mind can help reduce the risk that you’ll sell at a loss when you do decide to move and will allow you to build some equity before having to spend on closing costs and other fees again. If you want to buy a house, think about where you want to live and work before you start looking. That way when you do buy, you’ll be more likely to be able to stay put and reap the benefits of your purchase.

Up to Three Months Before You Start Shopping...

Before you start shopping for a house, you should do a few key things.

1. Shop Around

There is no shortage of mortgage lenders offering a range of rates, features, and services. So shop around to ensure you get the best possible mortgage at the best rate.

2. Get Prequalified

Many people start shopping for a home based on what they want. In reality, you need to focus on what you can afford. The last thing you need is to start looking at listings for homes out of your price range. Start by getting a pre-approval. That way, you can start browsing homes that could actually become yours.

3. Narrow Down Neighborhoods

Where you live has a huge impact on how you live, so think about what you want out of the neighborhood you live in. Maybe it’s proximity to work, certain amenities, or a great walking path. Whatever it is, find the neighborhoods that fit your criteria and throw out the rest.

4. Think About the Home Itself

Another thing that can save time and frustration when it comes time to view homes for sale is to decide on what features are important to you. Want a garden in the backyard? A south-facing yard may be important. Do you plan on holding big family dinners? In that case, the kitchen and dining room may be key factors in your decision. Whatever those deal breakers are for you, decide what they are before you start house hunting. That way, you’ll be able to rule out the houses that aren’t a good fit and focus on the ones that have real potential.

Up to One Month Before...

Start getting ready with these action items.

1. Seek Out Professionals

If you plan on using a real estate agent (and I know that people have very strong feelings on this one way or the other!) start seeking referrals among your friends and coworkers to find someone you’re comfortable working with. The same goes for other professionals you may use, such as a lawyer and even an inspection company.

2. Mobilize Your Money

When you buy a home, you need to be able to mobilize money fairly quickly when it comes time to make an offer. Besides your down payment, you will need a deposit (generally a few thousand dollars) and money for closing costs (about 2-3% of the cost of the home), as well as money for an inspection. Plan for these expenses before you start shopping and move them to an account where they’ll be accessible fairly quickly.

While You’re Shopping...

Looking at houses can be stressful. Keep calm, and follow this advice.

1. Ask Questions

Not sure if that crack in the ceiling is bad news or not? Wondering how possession works? Curious about the neighborhood? Ask, ask, ask. A house is a big purchase, so if you have questions, find someone who can answer them. That might be a realtor, an inspector a lawyer, or even a friend or family member. Whoever you ask, take the time to get answers that satisfy you. The last thing you want is to find out the answer isn’t what you’d hoped when it’s already too late.

2. Take Notes

When you’re viewing a lot of properties, it can be easy to get them mixed up. As you’re viewing, take notes about the homes you see. You can also use this to list out what you like and don’t like, and to write down any concerns or questions you want to address.

3. Consider Going Back

If you think you’ve found the winning home, consider going back for a second look to make sure before making an offer. It can’t hurt to be really sure this is the house you want to spend your money on.

4. Get an Inspection

Inspections cost money, but a good inspector should be able to uncover all kinds of things that homebuyers can miss. Unknown problems in a home can lead buyers to pay too much for it based on its condition or, in a worst-case scenario, to buy a lemon that’s more trouble than it’s worth. If you put an offer on a house, make an inspection a condition of purchase.

5. Be Reasonable

When you make an offer, there’s nothing wrong with trying to get a better deal (and you should!). Just don’t get carried away. Why? Because there is a seller in this agreement too. The idea is to get a fair price on a home you like. Unless there’s something seriously wrong with the seller’s judgment, that’s all he or she’s going to accept. If you try to run them to rock bottom, you might end up with no deal at all.

After the Deal Closes...

Congratulations! But your financial journey isn't over yet. Here are some things to keep in mind.

1. Set a Budget

A home’s expenses don’t start and end with the purchase price. Once you’re responsible for a home, anything can happen; the roof can leak, the furnace can break, or a baseball could fly through the picture window. Those things cost money. Once you buy your house, make a budget that’ll allow you to make your mortgage payments and save for contingencies.

2. Pay Down That Mortgage

Making extra payments on your mortgage is the best way to reduce how much you end up paying for your home. If you get a raise, a bonus, or a big, fat tax return, consider funneling it into your loan. The faster you pay it off the more you’ll save, and the sooner you can start enjoying the freedom of being debt-free.

3. Forget About the Market

Once you move in, enjoy your home whether the market goes up, down, or sideways. A house can be an investment, but as long as you plan on living in it, what the market does really doesn’t matter.

Buying a house isn’t easy, but it doesn’t have to be hard either. Stop the stress by getting informed and being prepared and organized. Once you turn the key in your new home, the rest will be smooth sailing.

Written by Tara Struyk and published on Wise Bread. Read more articles from Wise Bread.

You Shouldn’t Buy a Home If…

Tara Struyk — Thu, 21 Mar 2013 10:24:35 +0000

Buying a home has often been held up as the “American dream.” Problem is, the idea that home ownership is a goal that everyone can — and should — aspire to is exactly what got a lot of homeowners in trouble during the housing U.S. mortgage meltdown. In pursuit of the dream to own a home, people threw logic (and basic math) out the window and bought into homes that were not only bigger than they needed, but also more expensive than they could afford. Of course, many lenders were only to too eager to help them get in over their heads. The rest, as they say, is history. (See also: Quiz: Am I Really Ready to Buy a Home?)

The reality is that home ownership isn’t for everyone. And even if it’s right for you, it might not be right for you right now. Whether you’re tired of renting, looking to settle down or just want to put your money toward something bigger, there are a few factors that should serve as a warning against taking the leap. You shouldn’t buy a home if …

You Aren’t Planning to Stay

Whether your job situation is a bit uncertain, you’re in a relationship you’re not sure will last, or you’re longing to make a move to another city in the not-too-distant future, renting is your best bet. That’s because home values tend to fluctuate a bit throughout the year and from year to year. If you are forced to move out in the near future, you may suffer a loss on the sale of your home. That’s why most experts recommend that unless you can stay put for at least five years, you’re better off renting. It’ll take at least that long to make up the costs associated with a home purchase.

You Don’t Have a Down Payment

It’s still possible to buy a home without a down payment, but that doesn’t mean it’s a good idea. The simplest reason is that forgoing a down payment costs you a lot more over the life of the loan. The more money you borrow to buy your house, the more interest you pay.

Unfortunately, that’s not the only extra you’ll be on the hook for. The other major cost you’ll have to pay is Private Mortgage Insurance (PMI), which is typically charged to borrowers who put down less than 20% of the price of the home. On a $300,000 house, PMI will cost you almost $1,000 per year. You’ll keep on paying that insurance every year until you’ve paid down more than 20% of the appraised value of your home. And unlike with a down payment, you don’t get anything for that money — it’s just there to protect the lender in case you default.

Last but not least, having a down payment protects you from going underwater on your loan, or owing more than the house is worth. This can happen when you buy without a down payment and then home values drop. It’s a real bummer if you want to sell.

You Aren’t a Saver

Speaking of a down payment, if you find saving for one to be a challenge, that in itself may be a sign that you aren’t ready to own your own home. When you’re a renter, all you have to worry about is covering your rent. Once you’ve done that, the rest is up to your landlord. When you own your home, the responsibility is all yours. So, whether your problem is a leaky toilet or a broken water pipe, you will have to pay to fix it (and in many cases, it’ll cost you dearly). Without a strong habit of saving, you’ll lack the cash to take care of all the expensive repairs you will face as a homeowner. If you’re already living paycheck to paycheck, the ongoing financial responsibility of owning a home is likely to land you in debt.

You Have a Debt Problem

Another sign that you may not be a good candidate for home ownership is that you’re carrying a lot of debt or you struggle to avoid taking on debt of any kind. Not only will debt keep you from saving for emergencies, but those who can’t resist tapping into available credit may find their home’s equity irresistible. It’s not uncommon for homeowners to be tempted to use their home equity as a piggy bank through a home equity line of credit (HELOC) or home equity loan. This is especially true when home prices are rising (thus creating more equity). According Bloomberg, HELOC lending rose by 30% in 2012, the highest level since the start of the financial crisis in 2008. If you’re not someone who can resist using available credit, steer clear of homeownership; not only will it allow you to dig yourself deeper into debt, but using your house as collateral could also leave you homeless.

You Have Bad Credit

If you have lousy credit, you may be able to find a lender who’s willing to give you a mortgage. That lender isn’t doing you any favors though. Bad credit makes you a high-risk borrower, which means that any lender you can get to give you the loan will charge you considerably higher interest and offer fewer options. This can make it more difficult to pay down your mortgage in a timely way — or at all.

You Think a Home Is an Investment

Real estate can be an investment — and a good one — but your home doesn’t count. In order to really be able to capitalize on any kind of investment, you have to be able to sell it when the time is right. That’s hard to do with the real estate you call home because, after all, you’ll still need somewhere to live. Plus, even if you are able to high-tail it out of your home when it appreciates, chances are you’ll have to plunk that gain right back down into your next house.

You Aren’t Into Maintenance

Whether it’s painting, weatherproofing or general repairs, homes require lots of ongoing maintenance. If you’re the type to put things off, homeownership may not be for you. After all, the longer you leave your rotten porch, the more rotten it’ll get – and the more expensive it’ll be to fix.

Many people feel that they should aspire to home ownership; many are even ashamed to call themselves renters. But while we tend to view a home of our own as a status symbol, we often overlook the fact that it’s a very big — and usually very expensive – responsibility. Owning your own home can be a great experience, but only under the right conditions. If home ownership isn’t a good fit for you and your current financial situation, chances are you’ll be too broke to enjoy it.

Written by Tara Struyk and published on Wise Bread. Read more articles from Wise Bread.

The Paradox of Choice and the Mortgage Crisis

Emily Guy Birken — Tue, 26 Feb 2013 11:25:04 +0000

If you're interested in having an illuminating (if possibly boring) evening, ask your parents or grandparents to tell you about the details of buying their first house. After getting over your indignation at the fact that homes a mile from Washington D.C. could be had for less than $50,000 in the early '70s, you might be surprised to hear how easy the process of getting a mortgage was back in the day. (See also: Quiz: Am I Really Ready to Buy a Home?)

That's not to say that saving for the down payment, getting approved, and going through the mind numbing stack of paperwork at closing was any simpler or more fun when our parents were newlyweds — it's just that they had fewer options for their mortgages.

In fact, they basically only had one option — a 30-year fixed-rate mortgage for which they had to put down 20%. While they could shop around for the best annual percentage rates, that shopping around was fairly easy since they were only comparing APRs for the same kind of mortgage. Choosing the best mortgage was as simple as finding the lowest interest rate.

Fast forward to the new millennium. Anyone who bought a house during the housing bubble can remember the dizzying array of choices available for mortgages: traditional 30-year fixed-rate mortgages (as well as other fixed-rate mortgages with different term lengths), adjustable rate mortgages, sub-prime mortgages, interest-only mortgages (a misnomer if there ever was one), piggyback loans, mortgage buydowns — and those are just the options that I understand. Compared to our parents and grandparents, we were offered (and are still offered) a veritable wonderland of mortgage choices.

That ought to be a good thing, right?

You would think so. As Americans, we have a basic understanding that more choices mean more freedom — and boy do we love our freedom. But there's a reason why we had a mortgage crisis after all of these mortgage choices became available. It's part of what author Barry Schwartz describes as the Paradox of Choice in his book by the same name. Basically, having all this extra choice available does not make us any more likely to take the most rational and intelligent course of action — and according to Schwartz, extra choice actually has the opposite effect, making our choices less rational and less likely to make us happy.

While there's no denying that many different issues worked together to create the mortgage crisis, I would suggest that the paradox of choice at least played a part in why our housing market collapsed in 2007-2008. Here's why.

The Optimism Bias

Human beings are spectacularly bad at predicting the future. This doesn't just mean that we're lousy at picking stocks or the winning team for the Super Bowl — we're also horrible at figuring out what the heck we ourselves will want in the future.

If you've ever felt the Netflix dread that occurs after you receive the disc for the 17-hour award-winning documentary on beet farms in Romania when all you want to do is watch "Weekend at Bernie's," you know exactly what I mean. You may think when you choose it that you'll want to watch "Love and Death in the Beet Farms" by the time it comes up in your queue, but you're making some assumptions about your future self that simply aren't true. Namely, that you will someday be the type of person who watches thought-provoking beet-related cinema, when in fact you're always a slapstick comedy kind of guy.

An important aspect of our inability to predict what will make us happy in the future is a phenomenon called the optimism bias. We all experience this bias, even if it's just the false optimism about your ability to raise the tone of your movie preferences.

In most cases, however, the optimism bias works to make us blind to possible negative consequences. No matter how pessimistic an outlook you may have, you are more likely to think that bad things will not happen to you and that good things are in store for you, than is statistically likely. The optimism bias is the reason why smokers feel comfortable with their risk of cancer and lung disease ("It won't happen to me!") and why traders feel as though they can take big financial risks ("Losses can't touch me!").

In terms of the mortgage crisis, the optimism bias led many borrowers to take on more debt than they were able to handle. For instance, many of these innovative mortgage options allowed borrowers to increase the maximum amount they could borrow. While these new mortgages were designed to give borrowers more flexibility, that's not what happened. According to Dan Ariely, a behavioral economist at Duke University and author of Predictably Irrational,

When deciding on a mortgage, borrowers were told by the banks and by any mortgage calculator the maximum amount that they could borrow and not the optimal amount that they should borrow. So given a borrowing max of $400,000 with a regular mortgage or a borrowing max of $650,000 with an interest-only mortgage, would the average consumer borrow $400,000 with the interest-only mortgage and this way gain flexibility, or would they borrow to the new max? (Emphasis mine.)

It's fairly clear that the flexibility intended to make paying the mortgage simpler was often used to buy a bigger house instead. When this happened, the borrower may have believed he was making a rational decision. This was an option made available to him by the bank, and he was certain he could make his payments in the future — because a foreclosure would never happen to him. And of course, the fact that the bank was willing to lend him that maximum amount meant he could afford it, right? Why would the bank lend him more money than he could pay back?

Many people made this type of irrational choice because it was one of the many options available to them. They would certainly have been happier in the long run with a smaller house that they could comfortably pay for, but given extra choices, the optimism bias is likely to kick in and make it difficult to determine what will really make them happy in the future — particularly when a 4,000 square foot house with gleaming marble countertops and a lagoon-like backyard pool is staring them in the face right now.

Analysis Paralysis

Another major reason why borrowers ended up taking on more house/mortgage than they could afford has to do with a common choice problem known as analysis paralysis. Every new employee faced with an overwhelming number of options for enrolling in their company's 401(k) has experienced this paralysis. Making a choice seems too difficult, and so it gets put off.

Barry Schwartz talks about a study of this phenomenon in a TED talk from 2005. A researcher found that for every 10 mutual funds offered by a company's retirement program, employee participation went down 2%. This means that having 50 mutual fund options to choose from means a 10% decrease in participation compared to having only five options. It's much easier to choose the best of five options rather than comb through 50 in order to determine which option is best. So much easier that you're likely to just skip the task altogether if it seems too hard.

I suspect that a similar phenomenon was going on during the housing bubble. The enormous number of mortgage options available was overwhelming to the average borrower. How would she know if it was better to take a tradition mortgage or an ARM or a piggyback mortgage, etc.? But rather than a paralysis that led to no decision whatsoever, this type of analysis paralysis likely made borrowers more susceptible to sales pitches from their banks. With a dizzying number of options, having your friendly neighborhood mortgage lender tell you that Mortgage X was a wonderful option is an easy way to make your choice. No need to investigate the various options — this one is the best, according to the lender.

I saw this type of paralysis first hand when my husband bought his first house (which became ours after we married). He purchased the home in 2005, at the top of the housing bubble, and at the time he had no down payment saved. (You could get away with those kinds of shenanigans back then).

He was offered a huge menu of different potential mortgages, including several adjustable rate mortgages that had incredibly low introductory rates. Staring cross-eyed at the options available to him, he found himself silently screaming, "I just want this house!" Many borrowers, when feeling this sense of helplessness and paralysis, might simply choose whatever option will get them the house for the cheapest amount in the short run.

Luckily, my husband spent a little time researching and took the most conservative option available to a borrower who was putting no money down — a piggyback loan wherein he took out a home equity line of credit to pay for the down payment and a traditional 30-year fixed-rate mortgage for the remaining 80%. But his analysis paralysis could have led to him taking one of the tempting ARM options available, which would have been devastating for us down the road. (As it was, he had two payments to make each month, which was less than ideal.)

Making Rational Decisions

Anyone who has gone mortgage shopping in the last four or five years knows that the wonderland of mortgage options is more limited than it once was. But we still have mortgage choices available to us that would have been completely alien to our parents and grandparents back in the day. Considering the potentially disastrous consequences of making a poor choice, how can we cut through the noise of those extra options?

Richard Thaler, an economist at the University of Chicago Booth School of Business, outlines an intriguing regulation idea in a New York Times article:

Lenders could be required to offer some mortgages they call 'plain vanilla,' with uniform terms. There might be one vanilla 30-year, fixed-rate mortgage and one five-year, adjustable-rate mortgage. The features of these plain mortgages would be uniform, much as in a standard lease used in most rental agreements…Lenders would also be free to offer other exotic mortgages — perhaps called "rocky road" mortgages? — along with the vanilla variety, but these offerings would receive more intense scrutiny from regulators.

Such a regulation would allow first-time borrowers to stick with (and be steered towards) the traditional loans that will work out best for them, while still allowing lenders and experienced borrowers to experiment with other mortgage products.

Unless and until this type of regulation is put in place — and as of right now, the new mortgage rules that will come into effect in 2014 do not include this particular regulation idea — the path for the rest of us is pretty clear.

Stick with the traditional fixed-rate mortgages of our parents' day. Ignoring the other options available to you is probably the best choice of all.

Written by Emily Guy Birken and published on Wise Bread. Read more articles from Wise Bread.

Best Money Tips: Save Money on Your Mortgage

Ashley Jacobs — Fri, 18 Jan 2013 11:00:34 +0000

Welcome to Wise Bread's Best Money Tips Roundup! Today we found some stellar articles on saving on your mortgage, ways to make extra money and keep your day job, and how to ace a group interview.

Best Money Tips: Mistakes to Avoid When Selling Your Home

Ashley Jacobs — Fri, 11 Jan 2013 11:00:31 +0000

Welcome to Wise Bread's Best Money Tips Roundup! Today we found some great articles on mistakes to avoid when selling your home, changing your life for the better, and revitalizing your finances.

What to Look for in a Fixer-Upper

Xin Lu — Tue, 01 Jan 2013 10:30:20 +0000

The housing market is definitely improving, and many of my friends are looking to purchase a new house. The problem is that in many areas inventory is quite low, and it is getting difficult to snatch a perfect house at a great price. However, if buyers are willing to put in some time and work, they are still able to find fixer-uppers that are worthwhile. Here are some tips on what to look for in a fixer-upper. (See also: 9 Costly Things New Homeowners Don't Prepare For)

Location

Location is extremely important in choosing a house. It is better to buy a fixer-upper in a nice neighborhood rather than a pristine and perfect house in a war zone area riddled with crime. Generally, houses in nicer neighborhoods have greater value to begin with, and whatever improvements you make will give you more return on your money. You should also look at the neighbors' houses on the same street and see how much you need to improve the house to make it fit in.

Age of House

Generally, newer homes have certain features that are more updated. For example, plumbing and electrical systems are usually better, and newer homes are up-to-date with modern building codes. From what I've seen, newer homes also have better insulation and are more energy efficient. These features may not be so visible, but they can be very expensive for you to fix. If you do buy an older home, you should check if these major systems have been updated. If you need to upgrade a house's infrastructure to comply with current laws or insurance requirements, then it can be quite expensive.

Costs and Savings

One reason to buy a fixer-upper is to save a little bit of money. To do that you need to assess how much the repairs will cost and have a reserve fund of cash to pay for those fixes. You should definitely get a professional home inspection and also estimate how much cosmetic repairs would cost. If there are major structural issues that cost tens of thousands of dollars to fix, it may not be worthwhile to purchase the house.

The fixes that get you the most bang for the buck are really the cosmetic ones, and that is why the best fixer-uppers are the ones that have great "guts and bones" but need a fresh coat of paint and some new flooring. The cost of paint and flooring is usually pretty easy to figure out, but major structural changes to the foundation and walls may become a real money pit.

Your Time

If you want to deal with a fixer-upper, then you really need to figure out how much time you have to devote to it. If you don't do the work yourself, then you will need to research which contractors to use, and for cosmetic changes you will need to pick out all the colors and styles. Depending on how much work there is to be done, it may take weeks to months before you can actually move into the house.

Some people love customizing their homes, but some really just want a move-in-ready house. If you do not have a lot of time to deal with a project, then it might be better to just pay a little more for a pristine house.

While the market is tightening, I think that it is still possible to get a deal on fixer uppers if you are willing to do the research and follow up work. However, it may not be a great idea for those who do not have a decent cash reserve and the time to do the legwork. I've only purchased houses that needed cosmetic fixes, and that is because I don't have a lot of time and money to devote to major fixer uppers.

One last consideration — it is better to get a house at a lower price because your tax basis will be lower, and that may save you money for many years to come.

Have you purchased a fixer upper?

Written by Xin Lu and published on Wise Bread. Read more articles from Wise Bread.

Best Money Tips: Ways to Save Money for a House

Ashley Jacobs — Fri, 07 Dec 2012 10:48:36 +0000

Welcome to Wise Bread's Best Money Tips Roundup! Today we found some fantastic articles on ways to save money for a house, steps to take before a job interview, and how to protect your stuff.

Real Estate and Housing

Choosing the Right Mortgage Loan: 15 or 30 Years?

15-Year Mortgage

30-Year Mortgage

How to Decide Which Mortgage to Get

Bottom Line

Fixed or Adjustable? Choosing the Right Mortgage Loan

Fixed-Rate Mortgage

Adjustable Rate Mortgage (ARM)

Hybrid ARM

Coming to Terms With Your Long-Term Debt

Assessing the Situation

Taking Action

Staying Motivated

FHA Home Loans: You Can Buy a Home Even If Your Finances Aren't Perfect

Easier on Credit Scores

Borrowers Pay Mortgage Insurance Premiums

Mortgage Refinancing and Funds for Fixer-Uppers

21 Real Estate Terms Every Home Buyer Should Understand

1. Acceptance

2. APR

3. ARM

4. Appraisal

5. Closing

6. Closing Costs

7. Contingency

8. Counter Offer

9. Credit Report

10. Earnest Money

11. Equity

12. Escrow

13. Fixed Rate Mortgage

14. Homeowners' Association

15. LTV

16. MLS

17. Mortgage Broker

18. PITI

19. PMI

20. Real Estate Agent

21. Title

Cut Your Electric Bill With Solar Panels

Tax Credit Where Credit Is Due

How Much Can You Save?

Buying Sunshine's Electricity on Credit

Getting Started

What You Need to Know Before Buying Your First Home

Your Credit Score

How Much You Can Afford

How to Research a Home

The Mortgage Process

Where to Find Help

Big Lessons From the Tiny House Movement

Smaller Can Be Better

Houses Are for People

Simple Living Requires Constant Editing

Our Lives Are Mobile; Our Housing Should Keep Pace

Prefab Can Be Fab

Design Matters

Mortgage-Free Living Is Possible

Buying Your First Home: What to Do and When to Do It

As Soon as You Start Thinking About Homeownership...

Up to Three Months Before You Start Shopping...

Up to One Month Before...

While You’re Shopping...

After the Deal Closes...

You Shouldn’t Buy a Home If…

You Aren’t Planning to Stay

You Don’t Have a Down Payment

You Aren’t a Saver

You Have a Debt Problem

You Have Bad Credit

You Think a Home Is an Investment

You Aren’t Into Maintenance

The Paradox of Choice and the Mortgage Crisis

The Optimism Bias

Analysis Paralysis

Making Rational Decisions

Best Money Tips: Save Money on Your Mortgage

Top 5 Articles

Other Essential Reading