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Home Equity Loan vs. Line of Credit: What’s the Difference?

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couple talking to real estate agent about their home financing options

A home’s equity is a key advantage of owning a home. However, you can only access it when you sell your home or take out a home equity loan or a home equity line of credit (HELOC).

Using either a loan or line of credit can be helpful if you need to access a sum of money with favorable rates or low fees. There are some key differences to consider when it comes to choosing which one is best for you. Take a look at our guide below to learn about the differences between both home equity loans and home equity lines of credit.

Home Equity Loan vs. Line of Credit 

Here’s a quick definition of each option:

A home equity loan is a lump sum of cash that is repaid with fixed payments during a set period.

A home equity line of credit is a flexible loan that allows you to borrow and repay multiple times up to the maximum amount agreed on by the lender, similar to a credit card.

There are a handful of similarities between these options:

  • Collateral: Your home is used as security for lenders in the event you cannot pay back the loan.
  • Equity: Both options borrow against the value of the home that you actually own, known as your home’s equity. We’ll go into more detail about how to calculate this later.
  • Second mortgage: These options are commonly referred to as second mortgages since you’re borrowing against the value of your home.
  • Tax deductible: The IRS says that interest payments for either option are potentially tax deductible if the loan is used to improve or remodel your home.

Here are the key differences between both:

Home Equity LoanHome Equity Line of Credit
FundsBorrow up to the
credit limit
Given a lump sum upfront
InterestTypically a variable rateTypically a fixed rate
PaymentsOnly make payments based on the amount borrowedFixed payments during
a set time

Calculating Your Home’s Equity

You can determine your home’s equity by subtracting the amount you currently owe on your mortgage from the value of your house.

Another number you’ll need to know is your combined loan-to-value (CLTV) ratio. This is a percentage found by dividing the total amount you owe on all home loans by your home’s market value. The lower your CLTV, the lower your credit risk and higher your chances are for receiving the loan. 

how to calculate compuond loan-to-value ratio

The amount you’re able to borrow against your equity greatly varies between lenders. For example, Discover offers loans up to 95 percent of your combined loan-to-value ratio. On the other hand, some lenders put a cap on the total amount you can borrow. U.S. Bank, for example, allows customers to borrow $750,000 and up to $1 million for California properties.

You can sometimes borrow more in exchange for higher costs and/or interest rates.

Example

Let’s assume that you meet a lender’s income level, credit score and other requirements for a second mortgage. For this example, let’s also assume the following:

  • Home loan debt: $200,000
  • Home’s worth: $600,000
  • CLTV ratio (home loan debt divided by home’s worth): 33 percent
  • Lender allows a CLTV of 90 percent

With these numbers, we can find the maximum debt amount and the amount you can borrow. The maximum debt amount is the total amount a lender would loan you based on your home’s value. The amount you can borrow is the sum they will lend based on what you currently owe.

  • Maximum debt amount (multiply home’s worth by 90 percent): $540,000
  • Amount you can borrow (maximum debt amount minus current home loan debt): $340,000

Keep in mind that lenders can foreclose your home if you default on the loan since you’re using your home as collateral. Make sure the amount you borrow is a total you’re confident you can repay.

Home Equity Loans Pros and Cons

Home equity loans are a consistent option that can make it easier to predict your monthly budget. They’re also great if you need funds upfront for a large expense. However, you can end up paying a lot, especially in the beginning, since you are paying interest on the entirety of the loan.

Pros

The biggest benefit of a home equity loan is its predictability. Below are a few other benefits to using home equity loans.

  • In some instances, a fixed interest rate
  • Fixed monthly payments
  • Set payment period
  • It’s an amortizing loan, meaning that payments reduce the loan balance and cover some interest costs

Cons

Home equity loans fall short in their inflexibility and potentially high long-term costs. Here are a few other drawbacks to consider.

  • High interest costs in the beginning since you’re borrowing a large sum
  • May pay more than your home is worth if your home’s value goes down over time

When You May Use a Home Equity Loan

A home equity loan may be a good option for those who have large one-time expenses like a home renovation project.

Some also use a home equity loan to wipe out a large amount of debt since it’s sometimes more affordable to get a large lump sum like this using a home equity loan compared to other loans. However, its affordability in comparison to other options is heavily reliant on an individual’s financial situation.

This option is also great for borrowers who prefer consistent terms and want a predictable payment plan. 

home equity loans are predictable options best suited for expenses with defined costs

HELOC Pros and Cons

HELOC’s are flexible options that allow you to borrow only what you need when you need it instead of dispersing the entire amount, similar to a credit card. This way, you only pay interest on what you borrow, but have variable interest rates as a result.

A major difference to note between home equity loans and HELOC’s is that HELOC’s typically have a “draw period” and a “repayment period.”

  • The draw period is the time a borrower can access the funds. They’re able to continually borrow and repay during this time, up to the maximum allowed amount. During the draw period, borrowers are required to pay at least the monthly minimum payment.
  • The repayment period immediately follows the draw period. This is the time borrowers are required to pay back the outstanding balance.

Pros

HELOC’s are great for those who want more flexible payment options. There are a few other benefits to consider with this option.

  • Borrow only what you need
  • Pay interest only on what you borrow
  • Some offer a fixed-rate loan option that allows borrowers to convert variable-rate HELOC balances into a fixed-rate option
  • Some offer options to delay the repayment period
  • Some offer interest-only periods that allow borrowers to pay only interest for a fixed time
  • Borrowers can keep interest costs low if they carry a small or zero balance

Cons

Variability with HELOC’s comes at a price—you may end up paying higher interest rates depending on when and how much you borrow. Get familiar with other HELOC drawbacks.

  • Interest rates can fluctuate based on the market and result in higher interest debt
  • Flexible borrowing may entice some to overspend
  • May need to meet minimum withdrawal amounts and other requirements to borrow
  • Lenders can lower or close your HELOC

When You May Use a HELOC

This option may be more appealing for those with expenses that occur in stages. For example, you may have a long-term home improvement project, but are unsure how much each phase of the project will cost. 

It’s also an option for things like college tuition when you don’t know how much aid you’ll receive from other financial sources. With HELOC’s, you have the flexibility to only borrow what you need.

HELOCs are also great for borrowers who don’t want to be locked in to a long payment plan and don’t want to initially borrow more than what they might need.

home equity lines of credit are flexible options that work well for expenses with variable costs

Other Factors to Think About

Do your research when comparing these offerings with each other and other options to ensure you’re making an informed decision. Here are just a few things to consider:

  • Interest rates: Although second mortgages generally offer more favorable rates than other loans, the amount lenders offer can vary. This variability increases if you choose a HELOC.
  • Fees and penalties: Expenses like closing costs and appraisals can drive up the initial cost of taking out either option.
  • Foreclosure risks: Both options put you at risk of losing your home if you’re unable to pay back what you borrow. 
  • Owe more than your home’s worth: You may end up paying a lot more than what your home’s actually worth, depending on market fluctuations and the loan type. Home equity loans may result in higher interest debt since your rate is locked in from the beginning. If you need to sell your house while you’re using either second mortgage option, you may end up owing more than your home’s worth or end up upside-down on your loan.

You should also consider other types of loans and financing options depending on your needs and financial standing. Work with a trusted mortgage provider or financial provider to help guide you through your decision.

If you find that your credit score is holding you back from the options you want, you can take a look at these tips for securing a loan with bad credit. If you were in the market for a loan because you’re having trouble keeping up with payments, you can also consider refinancing your mortgage.

Refinancing a mortgage with bad credit is possible, it’s just a bit more complicated than refinancing with good credit. When you’re shopping around for any loan, make sure to read the fine print, do your research and explore all of your options before making a decision.

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How minimum monthly credit card payments affect your credit

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credit card monthly payment

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

Many people don’t hesitate to pay just the minimum payment on their credit card. This is especially true if the total balance is high or the cardholder is confused about the credit card lending terms and doesn’t understand the impact of paying the minimum balance. But, making just the minimum payment can have a greater impact on your credit score than most people realize.

Learn how lenders calculate the minimum payment, what it means for your debt and how making a minimum payment affects your credit.

What are credit card minimum payments?

Your credit card minimum payment is the least amount of money your lender will accept toward your credit card balance each month. You need to pay the minimum payment by its due date to avoid late penalties and other fees and to keep a consistent payment history. The minimum payment amount is displayed on your credit card bill and often ranges from one to three percent of your total credit card bill. 

How is a minimum payment calculated?

Your lender calculates the minimum payment based on your total balance and any outstanding interest charges. 

Each credit card lender has a different method for calculating its minimum monthly payment. The two primary methods are formula and percentage.

Formula

Many of the major credit card lenders use a formula to calculate your minimum payment. The formula picks an amount and adds one to two percent of your monthly balance. For example, let’s say your lender picked $35 as the minimum payment amount, plus two percent interest, and you spent $500 in new charges for the month. In this scenario, your minimum payment would be $35 plus $10 ($500 x 2%) for a total of $45.

If your total balance is less than the minimum payment, then your whole balance is due. Following the previous example, if your lender charges $35 plus two percent interest but your credit card balance is $20, you will owe $20 for that month, plus any fees and interest from the previous month.

Percentage

Other lenders—typically credit unions and financial institutions—use a simpler, percentage formula to calculate the minimum monthly payment. This method is most common for high-risk borrowers with poor credit. The percentage can range from four to six percent.

For example, if you had a $1,000 credit card balance with a lender that charges six percent, you would owe a minimum payment of $60 plus any additional fees ($1,000 x 6%). 

Some lenders will include any past-due fees in the minimum payment. 

What happens if you make only the minimum payment on your credit card?

Making the minimum payment on your credit card is better than paying nothing at all. As long as you always make the minimum payment, you should not receive negative items on your credit report, as it relates to your payment history. 

However, making only the minimum payment means you may see greater charges for interest, resulting in you paying more over time.

Take a look at this example: Let’s say you have $5,000 in credit card debt and your lender offers an 18 percent interest rate with a minimum payment of two percent of the balance. In this scenario, your minimum payment is $100 per month, which can look very tempting. But, it will take you almost eight years to pay off your balance and you will pay a total of $4,311 in interest—almost doubling what you originally owed. 

Your minimum payment is generally a small portion of your total debt, and most of that payment goes to interest. As a result, you are slowly progressing toward paying off your principal amount, and you could end up paying minimum payments for many years.

Additionally, your credit card utilization may be high if you make only minimum payments. Credit utilization is the amount of credit extended to you by the lender versus the amount you owe. If you maintain a high credit card balance while only paying the minimum payment, you are at risk of having high credit utilization month after month. 

Several factors determine your credit score, but credit utilization accounts for 30 percent of your overall score. So, maintaining a high utilization ratio can negatively impact your credit score. 

Finally, when you maintain a high credit card balance and a routine of only paying the minimum payment, you may fall behind on payments. When you make late payments or miss the payment entirely, having a negative payment history can also lower your overall credit score. 

What should you do if you can’t afford to pay in full?

If you can’t pay your credit card in full, don’t panic. Approximately 47 percent of Americans have credit card debt, so it’s quite common—but that doesn’t mean you shouldn’t pay off credit card debt. Follow the steps below to tackle your debt efficiently and in a way that works for you. 

Pay as much as you can

As mentioned before, it’s essential to always make at least the minimum payment on time. This will help you avoid negative items on your credit report for late or missed payments. However, whenever possible, try to make more than the minimum payment. This will help you pay down your principal debt faster and pay less interest over time. 

Come up with a repayment strategy

If you have multiple credit cards with debt or various types of debt, it’s crucial to have a repayment strategy. 

There are two popular debt repayment strategies: the avalanche and the snowball. The snowball method recommends you pay off your debt from smallest to largest (like a growing snowball). This method is meant to give people positive reinforcement because they feel motivated as they knock out several of their small debts quickly before moving on to the larger debts. 

The avalanche method is a more systematic approach—you list all your debts and their interest rates and pay the one with the highest interest rate first. This method aims to save you money in the long run by getting of higher-interest debt first. 

Decide which approach fits your style. Both of these methods are highly effective in their own way. 

Budget

A budget is the first step to taking control of your financial health. Without a budget, you may not know where your money is going or where you can save. Often, a budget can highlight unnecessary spending. There are plenty of free apps, such as Mint, that allow you to have an automated look at all your spending and build a budget. 

Talk to your credit card issuer

You can reach out to your credit card issuer if you’re going through financial hardship to see what they can do for you. Some credit lenders will offer to lower your interest rates, which will help you tackle your principal debt much faster. Some financial hardships can include the loss of a job, an injury or a medical incident. Ultimately it will be your lender that decides if your situation merits help. 

Consider a balance transfer

There are a lot of credit card options out there. If your credit card has a high-interest rate, you may consider a balance transfer. Some credit card lenders offer a low-interest promotional rate when you transfer a credit balance to them. During this time, you can make a significant dent in your debt. However, you should know that some balance transfers come with a one-time fee, so make sure to consider this as well. 

Care for your credit

Your credit is your door to many financial opportunities. A healthy credit score can help your chances for approval for auto leases, mortgages, personal loans and more. It can also help you get a much lower interest rate and better borrowing terms when you receive financial products.

Improving your credit takes work. While focusing on your credit card’s impact on your credit score, make sure your overall credit profile is accurate. Errors and inaccuracies can greatly hurt your credit score and put a dent in your debt-relief goals. Professional credit repair companies can help you navigate the challenges of credit reporting inaccuracies.

The first step toward establishing a healthy credit history is making sure all items are listed fairly and accurately—professional credit repair is an easy, effective way to get your credit score back on track.


Reviewed by Shana Dawson Fish, Associate Attorney at Lexington Law Firm. Written by Lexington Law.

Shana Dawson Fish is an Arizona native whose family migrated from Guyana. Shana graduated from Arizona State University in 2008 with her Bachelor’s Degree in Criminal Justice & Criminology, and in 2012 she graduated from Arizona Summit Law School earning her Juris Doctor. During law school, Shana was a Judicial Intern at the United States District Court for the District of Arizona and the Maricopa County Superior Court. In 2016, Shana was awarded a legal defense contract and represented clients as a Trial Attorney in juvenile proceedings. Shana has experience in litigating numerous trials and diligently pursuing the rights of her clients. As a Trial Attorney, Shana identified the needs of her clients and also represented debtors in bankruptcy proceedings. Shana is licensed to practice in Arizona and is an Associate Attorney in the Phoenix office.

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

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What is an escalated information request?

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escalated information request

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

When you discover an error on one of your credit reports, such as an inaccurate address or a record of a late payment that you know you paid on time, you can begin the credit dispute process to hopefully correct the error. This is one of your rights as a consumer, according to the Fair Credit Reporting Act (FCRA).

But what happens if your credit dispute or challenge fails? If you are like many consumers, the process may not initially yield favorable results. This is where an escalated information request comes in. Read on to learn what your options are following a dispute rejection.

What are the steps involved in the credit dispute process?

There are four main steps in the credit dispute process.

First, you send your dispute letter to whichever of the three credit bureaus—Equifax, Experian and TransUnion—shows the error on your credit report. In your letter, identify the information that you want to dispute, explain why you’re disputing it and provide any relevant evidence that supports your case. Ask that they remove or correct the information in question. (You can use this sample letter from the FTC if you’re not sure where to start.)

Second, you may reach out to the data furnisher that provided the inaccurate information to the credit bureaus, such as a creditor or another financial institution.  Data furnishers should conduct a reasonable investigation to verify the accuracy of the information they’re reporting to the bureaus if someone submits a dispute, and this could help you as well.

Third, wait for the credit bureaus and data furnishers to respond to your dispute. They typically have 30 to 60 days to investigate your claim. However, there is the possibility that they might deem it “frivolous,” which might happen if your dispute is inaccurate or if you repeat the same claims without adding new evidence.

Once you get a response, review the results of the investigation. If your dispute is accepted and the information is confirmed to be inaccurate, your report should be updated accordingly. If your dispute is rejected because it’s considered frivolous or the information on your report is seemingly verified, you have a couple of options—you can either let the issue drop, or attempt to escalate your dispute.

What do I do if my dispute is rejected?

Denial isn’t the end of the line. When a credit dispute is rejected, it is up to you to continue your efforts to ensure you have a fair and accurate report. Before resigning yourself to defeat, you may follow the steps below to escalate your information request.

1. Send additional letters

Draft another set of letters to the credit bureaus and a new one for the creditor in question. Outline the following:

  • Your disappointment with the initial credit dispute decision
  • Information about the account and the nature of your dispute
  • Detailed information about the dispute (include supporting documents)
  • And, for the bureaus, a list of the incorrect items on your credit report and how they should be corrected

At the end of your letters, you may document your intention to escalate your claim to the appropriate authorities if needed. Then you may mail your letters and supporting documents to the credit bureaus and relevant creditors with a return receipt requested.

2. Wait for responses

It may take up to 60 days to receive responses. Keep copies of your letters, emails and any phone calls between yourself and the credit bureaus and creditors. Be sure to write down dates, times, names of representatives and a summary of your discussions. In the case that you need this documentation, you will be very glad you kept a record of the events.

3. Review the final decision

If, upon reviewing the final decision you are still not satisfied with the outcome, you may send copies of your escalated information requests and supporting documents to the appropriate authorities, such as the Federal Trade Commission and your state’s Attorney General.

However, you should strongly consider speaking with an attorney to discuss your situation to determine what are your best options. In each of these endeavors, make sure you have enough evidence to prove your case and discredit your claim’s denial.

Protect your rights

Facilitating escalated information requests can be a long and arduous process, especially following an initial credit dispute. However, you have a right to fair and accurate credit reports, and the long-term benefits of accurate credit can make the dispute process worth your time and effort.

Make sure to regularly review your credit reports for errors, and if you find any, take action as soon as you can. You can initiate the credit dispute process yourself, but if you don’t have the time to dedicate to it or if you would rather work with a professional, there are credit repair companies who can help. Contact Lexington Law today to learn more about how we can help you as consumer advocates.

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The COVID-19 real estate paradox: Time to buy or sell?

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The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

According to a September 2020 study by Yelp, the U.S. has witnessed small businesses closing at a rate of 800 per day. The U.S. has seen some of the highest unemployment rates since the Great Depression. And yet the real estate market is booming.

Home sales continue to rise as the new work-from-home economy makes moving to the big city or tiny village of your dreams more feasible than ever. Mortgage applications jumped 26 percent in 2020. How can that be, you might ask, and how does that affect me as a homebuyer, home seller or homeowner?

Let’s take a look at some of the forces at work in the real estate market right now and find out.

Money is cheap for homebuyers

If you listen to the radio or have a friend in the real estate business, you’ve probably heard by now that it’s a great time to buy a house because mortgage interest rates have dipped to record lows. The second part of that statement is objectively true. In the early 1980s, the average interest rate on a 30-year fixed mortgage topped 18 percent. Compare that to June of 2020, when Freddie Mac reported an average rate of just 3.61 percent.

And that’s just the average. Borrowers with excellent credit were able to secure even better mortgage rates. If you’re thinking of buying a home, bear in mind that even a quarter-point drop in interest can save you many thousands of dollars over the lifetime of your loan. That means, among other things, that you may be able to afford more home now than you could last year.

But not so fast.

The second side of the story

As interest rates have plummeted, the demand for homes has climbed sharply. In many parts of the country, there’s a shortage of houses on the market. And that has sent home prices soaring, too. Comparing December 2020 to December 2019, home prices jumped nationally by over 10 percent.

The trend is most pronounced where you might not expect it to be: in small- to medium-sized Midwestern cities. Historically, the price of real estate in large cities drives national averages up. While predictions of a COVID-driven mass exodus from urban centers were never born out, in a few cities, including San Francisco and New York City, more people are seeking to move out than to move in.

Home prices are declining. If you’ve been hankering for a high-rise on the Hudson, now might be a good time to make a move.

But as recent experience confirms, real estate markets are fluid. What comes up might come down. The point is, no matter where you’re moving, your living expenses will ultimately be influenced by multiple factors. And it’s important not to get swept up in the moment. Keep your long-term income outlook and your personal goals in mind as you consider buying a home.

And if you’re thinking of selling your home to take advantage of rising home prices in your neighborhood, remember that you’re going to have to move somewhere.

The chapter everyone has to read

Sure, some of us are lucky enough to be able to pay cash when buying a home. But many of us need a mortgage to purchase a home. And that’s why having a strong credit profile is essential.

Keeping track of your credit score is an important habit to get into. If you’ve never paid much attention to it before, you’re not alone. It’s not something most parents teach their kids to do—many parents don’t talk to their kids about money at all.

A recent survey found that more than 35 percent of U.S. adults don’t know what their credit score is. And at least as many people don’t know how high a score they’ll need before lenders will give them a mortgage or car loan, for example.

Are you on top of your credit score? Before you even begin hunting for a house, it’s time to get a clear picture of where you stand. You can start by downloading a free copy of your credit report from each of the three major credit reporting bureaus: Transunion, Equifax and Experian. Your credit score is the highlight, of course. But it’s important not to fixate on a single number. When it comes to credit, the devil is in the details.

How credit scores are determined

The single most important factor credit bureaus consider when assigning you a score is your payment history. Missed credit card or loan payments take the biggest bite out of your score, and if there’s one piece of advice you remember after reading this article, let it be this: keep on top of your bill due dates and make them on time—religiously.

If you want to improve your credit score before you apply for a mortgage, one of the best things you can do is bring all your accounts up to date. But guess what? Creditors make mistakes. If you discover late payment notations on your credit report, be sure to reconcile them with your own payment records. Having credit reporting mistakes corrected can bring your score up considerably.

Next, review all of the accounts listed on your report. Having too many open accounts can drag your score down. Just make sure you’re considering how closing a particular account will affect your overall credit age and total available credit—you don’t want to close cards that are actually helping you.

Credit bureaus also take your credit utilization ratio into account when determining your credit score: that is, how much of the credit available to you are you actually using? Experts say that 30 percent is the absolute high-water mark and you’ll do much better in the credit market if yours is much lower.

One way to reduce your credit utilization ratio is simply to request an increase in your credit limit on one or more of the credit cards you have in your wallet. Pick one with a low or zero balance to increase your chances of getting approved for a higher limit. Then avoid using the card. You don’t want more debt, just more available credit.

Is it time to call in the experts?

It’s easy to get into credit trouble and, sadly, during the economic crisis precipitated by COVID-19, more and more Americans did. But getting out of trouble is more difficult. It takes time and patience, and there’s a fair amount of drudgery involved.

Some people who are struggling with bad credit enlist the services of a credit repair professional. Many credit repair companies use a combination of human expertise and artificial intelligence to develop and execute a comprehensive credit repair plan for their clients.

They’re trained to detect errors, as well as credit card fraud, which is on the rise and can be devastating to your credit. Some companies offer ongoing credit monitoring along with credit repair. Remember how we said monitoring your credit is a good habit to get into? You can also farm out the job.

Increase the odds of getting a great mortgage rate

While technically not a factor in your credit score, mortgage lenders will take your debt-to-income ratio into account when deciding whether to offer you a loan and at what rate. Most lenders require a DTI ratio of 36 percent or lower. Your credit report will list all your debts, and you already know your income.

You can use a DTI calculator to crunch the numbers. If your ratio is higher than 36 percent, you may want to take some time to pay off your existing debt before applying for a mortgage. With mortgage rates so low right now, why wait? Because buying a home is a life-altering decision on many accounts. Your home may be the single largest purchase you ever make. And at the outset, your mortgage may be your greatest financial liability.

But over time, your home may become your greatest financial asset—if you make well-considered decisions, like securing the best mortgage deal you possibly can. Getting your financial affairs in order before you buy a homeis an investment in time that’s likely to pay off in real dollars down the road.


This article was contributed by Money.com, an online editorial that provides up-to-date news, educational resources, and tools to help everyday people create meaningful investments and lasting returns.

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