Economic Recession – Definition, Causes & What Happens to Employment

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For over a decade, the U.S. economy was going pretty strong. Unemployment and inflation were both under control. The COVID-19 pandemic brought that to an end, driving the country into a brief but severe recession. 

Now, as the pandemic slowly fades, trouble may be brewing on the horizon once again. Inflation is climbing, and the Federal Reserve (Fed) is planning a series of interest rate hikes to control it. Many economists believe these measures could drive the U.S. into a second, milder recession. 

This news has many Americans troubled. Internet searches for “recession” are trending as people wonder whether a slowdown is coming and what it could mean for them. To answer that question, you need to know what a recession is and what it does to the economy.

What Is an Economic Recession?

A recession is a period of reduced economic activity. Consumers spend less, which means businesses earn less. In response, they produce less and cut wages or lay off workers. This can lead cash-strapped consumers to spend still less, so the recession feeds on itself.

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One common definition of a recession is two consecutive quarters, or six months, of negative economic growth. Julius Shiskin of the Bureau of Labor Statistics proposed this definition in 1974. His exact definition also factored in other measures, such as jobs and manufacturing. 

However, the National Bureau of Economic Research (NBER), which is in charge of declaring recessions in the U.S., uses a different definition of a recession. It says it’s “a significant decline in economic activity spread across the economy, lasting more than a few months.” 

Official Indicators of a Recession

To determine when the U.S. economy is in a recession, NBER economists look at five economic indicators:

  • Real GDP. The gross domestic product, or GDP, is a measure of all the goods and services the economy produces. Real GDP is the same figure measured in inflation-adjusted dollars. The NBER checks monthly estimates of real GDP from the U.S. Bureau of Economic Analysis and from private research firms
  • Real Income. This is a measure of personal income adjusted for inflation. It does not count government benefits such as Social Security as part of income. A drop in real income usually goes with a drop in consumer spending.
  • Unemployment Rate. Employment is another good measure of the health of the economy. More people out of work means lower incomes and less spending.
  • Industrial Production. The NBER also looks at measures of how much U.S. manufacturers are producing. It gets this information from the monthly Industrial Production Report produced by the Fed.
  • Wholesale-Retail Sales. Finally, the NBER looks at measures of how much businesses are selling. This gives a more complete picture of how U.S. companies are responding to consumer demand.

The NBER declares a recession when most or all of these indicators fall for more than a couple of months. It dates the start of the recession at the peak of economic activity — the point when the economy first starts to decline. This means that by the time the NBER declares a recession, it’s already in progress. Short recessions may be officially over by the time they’re declared.

This also means recessions aren’t always terribly hard times for consumers. When the U.S. is coming off a high economic peak, it’s still pretty strong even if it’s in decline. A recession can be easier than an economic expansion when the economy is coming up from a deep low.

Types of Recessions

Economists further classify recessions based on their “shape” — the plot of economic growth over time. Recessions fit into several different types:

  • V-Shaped. A V-shaped recession is short and sharp. Economic activity declines suddenly, then just as quickly recovers. The recession of 1990 to 1991 was a V-shaped recession.
  • U-Shaped. A U-shaped recession is a prolonged slump. After declining, the economy takes a long time to recover. The slowdown of 1973 to 1975 was a U-shaped recession.
  • W-Shaped. This is sometimes called a “double dip recession.” Economic activity declines, starts to recover, then drops again. This kind of recession occurred in 2001. Shiskin’s definition of a recession as two quarters of falling GDP doesn’t account for W-shaped recessions, which is one reason the NBER doesn’t use it.
  • L-Shaped. An L-shaped recession is the worst kind. After the initial decline, economic growth stays nearly flat. The economy can take years to return to its previous level. The Great Recession of 2008 is an example.
  • K-Shaped. Recently, economists began talking about a new type of recession: K-shaped. In this kind of recession, the recovery is uneven. Parts of the economy recover quickly, as in a V-shaped recession. But other parts remain sluggish, as in an L-shaped recession, or even continue to decline. That’s what happened as the U.S. recovered from the COVID-19 recession of 2020.

What Causes a Recession?

It’s normal for a market economy to alternate between periods of growth and periods of decline. Economists call these ups and downs the business cycle. Recessions are a normal, expected part of that cycle.

However, they don’t just happen out of the blue. In most cases, there’s some specific event — or several — that sets them off. Common recession triggers include economic shocks, excessive consumer debt burdens, and stock market crashes.

Economic Shock

Economies can chug along smoothly for years as long as nothing changes much. They can even adjust to gradual changes, such as some industries slowly declining while others rise. But any sudden change in the way things work can send the economy off the rails. 

Economists call these sudden changes economic shocks. One example from U.S. history is the 1973 oil embargo that sent oil prices soaring. Drivers had to wait in long lines at gas stations, and the high prices they paid to fill the tank dampened their other spending. More recently, the lockdowns at the start of the COVID-19 pandemic slowed both production and spending. 

Excessive Consumer Debt

To a certain extent, borrowing is good for the economy. Companies need loans to help them expand their business. Consumers also rely on loans to fund home purchases and college education. All this spending is productive and helps the economy grow.

But when consumers and businesses take on too much debt, they have trouble paying their bills. Eventually, some default on their debt or go bankrupt. A major cause of the Great Recession was overstretched borrowers defaulting on home loans.

Stock Market Crash

The worst economic downturn in U.S. history, the Great Depression, began with a stock market crash. When stock values plummet, it makes investors understandably nervous. Many of them panic and withdraw from the market entirely.

This means there’s less money flowing to businesses. With less to spend, they respond by cutting back on production, worker pay, and funding for retirement plans. This can send the entire economy into a downward spiral.

Asset Bubbles

An asset bubble occurs when a particular asset, such as stocks or real estate, becomes highly overvalued. Sooner or later, the bubble bursts and prices drop rapidly. This leads investors to panic and sell, often resulting in a market crash that sends the economy into a recession. 

The drop in housing prices prior to the Great Recession is a classic example of an asset bubble bursting. Another case occurred in 2001 as the dot-com bubble of the late 1990s burst.

High Inflation

High inflation — a steady rise in prices — does not cause recessions directly. In fact, it’s almost the opposite. Inflation tends to be highest when the economy is booming and consumer spending is high. 

However, governments often respond to high inflation by raising interest rates. This encourages people to save rather than spend. But sometimes, the government overshoots and spending falls off too much. Businesses make less money and a recession results.


While high inflation can indirectly lead to a recession, deflation — a prolonged drop in prices — can create one directly. When prices fall, wages fall as well, leading people to spend less. Then businesses lose revenue, cut back, and lay people off. 

Deflation can occur for various reasons. New technology can make goods cheaper to produce, or government actions can tighten up the money supply. In the 1920s, an insufficient supply of gold — which, back then, was the world’s universal form of money — led to deflation that became one of the factors behind the Great Depression.

Technological Advances

In the long term, advances in technology help an economy grow and produce more. But in the short term, new technology disrupts the economy. It can make jobs and even whole industries obsolete, putting many people out of work.

This has happened several times throughout history. Two examples include the advances of the Industrial Revolution and Henry Ford’s assembly line in the early 20th century. Some economists fear artificial intelligence may cause similar job losses in the near future.

Effects of a Recession

Recessions cause ripples throughout the entire economy. They harm workers, companies, and pretty much everyone who uses money. The effects of a recession include higher unemployment, higher business failure rates, and lower spending by businesses and consumers.

Increased Unemployment

When sales fall off, businesses cut back spending. Often, this means laying off workers. Many people lose their jobs, and new jobs become harder to find. Even those who keep their jobs can face cuts to their wages and benefits.

Business Failures

Nearly all businesses make less money during a recession. But some companies can’t even make enough to stay in business. Many businesses close their doors during recessions, putting still more people out of work.

Lower Spending

When workers lose jobs or see their paychecks cut, they naturally spend less. But less consumer spending means less money flowing to businesses, which leads them to cut back still more. It becomes a vicious cycle in which business and workers both lose out.

Higher Government Debt

Governments often try to support a weak economy by spending more. They can funnel money to businesses or directly to consumers, as the U.S. did with the COVID-19 stimulus payments. This helps fight the recession, but it also increases the national debt.

Investment Losses

During a recession, businesses produce less and make less money. As a result, their stocks decline in value. If stock prices drop by at least 20% over a period of 2 months or more, it’s called a bear market. 

In a bad recession, real estate can lose value too. When people can’t make mortgage payments, foreclosures rise, driving home values down. Both stock and real estate investors lose money, and some go bankrupt. 


As noted above, deflation can cause or contribute to a recession. But it can also be an effect of one. When people are spending less, retailers respond by cutting their prices. The resulting deflation lowers wages, making the recession worse.

Lower Interest Rates

As noted above, governments often respond to inflation by raising interest rates. In a recession, they do just the opposite. They cut interest rates to discourage saving and encourage spending, borrowing, and investment.

Historical Examples of Recessions

Few people alive today remember the Great Depression. But there have been several more recent recessions in the U.S. that many American adults can recall. Recessions of the past 50 years include:

1980’s Recessions

Technically, there were two recessions close together in the early 1980s. One was in early 1980, and the second ran from 1981 to 1982. However, some economists treat the two as a single double-dip recession, especially since unemployment remained fairly high in between.

There were two main factors behind this period of recession. One was the Fed raising interest rates to ultra-high levels to fight the inflation of the 1970s. The other was the 1979 energy crisis, which drove up oil prices.

1990 Recession

The recession of 1990 to 1991 is sometimes known as the Gulf War recession. Like the previous one, it was triggered by a combination of high interest rates and oil prices. Growing consumer debt was also a factor. But this recession was shorter, lasting only eight months.

2001 Recession

The long economic expansion of the 1990s ended with the bursting of the dot-com bubble in 2000. This set off a recession in early 2001 that was worsened by the economic shock of the 9/11 attacks. Officially, this recession lasted only eight months, from March through November. However, the job market did not fully recover until the middle of 2003.

The 2001 recession is an example of the flaws in Julius Shiskin’s definition of a recession. Instead of two consecutive quarters of decline, this W-shaped recession featured a decline, a brief rally, and another decline.

2008 Recession

As discussed above, the recession that started in 2008 was due mainly to a real estate bubble and unsustainable debt. Known as the Great Recession, it was the worst recession since the Great Depression, lasting 18 months. Many large financial institutions failed, and the auto industry suffered a crisis as well. 

2020 Recession

In late 2019, the economy went into a decline that was worsened by the COVID-19 pandemic. The 2020 recession was intense but brief. It lasted only two months, making it the shortest recession in U.S. history. But during those two months, the unemployment rate rose to nearly 15%, its highest level since the Great Depression.

Signs a Recession May Be Coming

It’s not always possible to predict a recession. For instance, no one knew a global pandemic would turn the slowdown of late 2019 into a severe recession. But often there are warning signs a recession is on its way.

Economists watch the following economic indicators to predict future recessions. Some are early signs that a recession is coming, while others confirm that one has already started. 

Real GDP

A drop in real GDP doesn’t always mean a recession is brewing. Sometimes GDP dips down briefly but rebounds in the next quarter. But a six-month decline in GDP, combined with other indicators, always means a recession is in progress.

Inverted Yield Curve

The Treasury bond yield curve is a plot of the interest rates, or yields, of short-term and long-term Treasury securities. Normally, yields get higher the longer the term of the bond is. Investors demand a higher return for long-term bonds because they tie up their money longer.

But sometimes, the yield curve inverts. Short-term bonds start paying higher interest rates than long-term ones. This means more investors are putting more money into long-term bonds because they’re a low-risk investment. That’s typically a sign they’re worried about the economy.

A yield curve inversion is one of the earliest indicators of a recession. However, it matters which securities you’re looking at and how long they stay inverted. 

If the interest rate for ten-year Treasuries dips below the rate for three-month Treasuries and stays lower for three months, that’s a very accurate sign that a recession is coming. But a shorter-term inversion, or an inversion involving ten-year and two-year Treasuries, might not mean anything.

Stock Market

Stock market prices are extremely volatile. They can shoot up and down in ways that have little relationship to the state of the economy. Thus, a sudden drop in the stock market doesn’t always mean a recession is coming.

However, it’s still a cause for concern. When lots of investors sell off their stocks at once, it’s a sign they’re not feeling confident about the economy. And if stock prices stay low long enough, the bear market itself can trigger a recession by starving businesses of funds.

Low Consumer Confidence

The U.S. economy depends heavily on consumer spending. And in general, consumers spend more when they feel confident about where the economy is going. If they expect their wages to remain high, they’re more willing to spend.

That’s why economists look at surveys that measure consumer confidence. When levels of consumer confidence fall, that suggests consumers are becoming more cautious about spending. If they stay that way, a recession could result.

Declining Leading Economic Index (LEI)

The Leading Economic Index, or LEI, is a monthly indicator published by the Conference Board. The LEI combines a variety of economic factors into a single number. These include stock market performance, new orders for manufactured goods, and unemployment applications. 

This index serves as a broad measure of how the economy is doing. When it starts falling — especially if it drops below zero — that’s an early sign the economy is headed into a decline.

Increased Unemployment

When unemployment rates rise, that’s a sign the economy is already in a recession — even if the NBER hasn’t declared one yet. Rising unemployment means businesses are closing or cutting back spending. And it also means many consumers have less money to spend. 

Thus, unemployment rates are less a warning of a recession than a confirmation. However, a decline in manufacturing jobs specifically can be an early indicator. Factory jobs tend to drop off when orders for goods do — a sign of declining consumer demand.

According to Shiskin’s definition, a recession must involve an increase of at least two percentage points in the unemployment rate. In addition, total unemployment must hit a level of at least 6%. However, the NBER is less specific about exact numbers. It looks more at whether unemployment is rising along with other signs of a recession.

Recession vs. Depression

A severe recession that lasts for several years is called a depression. Economic texts sometimes define a depression as a recession that lasts at least 3 years or causes a significant decline in GDP. Significant, in this case, means a drop of 10% or more in a given year. 

But economists don’t stick very closely to this definition. For instance, the U.S. economy entered a recession in 1945 after World War II, and GDP declined by 11% in 1946. But economics texts don’t refer to this period as a depression. 

In fact, economists have not used this term to refer to any slowdown since the Great Depression. This downturn was both long and severe, lasting more than three and a half years. It saw a 33% decline in the production of goods and services, an 80% drop in stock market value, and unemployment rates as high as 25%.

The deepest prolonged slump since then, the Great Recession, was both shorter and milder by comparison. Although it lasted 18 months and saw unemployment as high as 10%, it didn’t meet the standards for economists to call it a depression.

Recession FAQs

There’s lots more to learn about how recessions happen, their effects, and how to prepare for one. Here are some common questions and their answers.

How Long Do Recessions Last?

A recession can last anywhere from two months to three years. Once it passes the three-year mark, it’s considered a depression. Since the Great Depression, recessions in the U.S. have lasted anywhere from two to 18 months, averaging 11 months. 

But from 1854 through 2019, the average was nearly twice as long, and several recessions lasted two years or longer. The lessons of the Great Depression helped the U.S. government learn to react to recessions early and minimize the damage.

How Can You Prepare for a Recession?

Recessions aren’t good for anyone, but they’re worse for some than others. 

For instance, people in some professions are less likely to lose their jobs. These include many of the people labeled as “essential workers” during the pandemic: medical professionals, firefighters, police, utility workers, and grocery store workers. Having one of these jobs can protect you when a recession hits. 

While you may not be able to change your career, you can protect yourself financially. One of the most important steps you can take is to have an emergency fund. Those savings can help you get through a job loss or a cut in wages.

It also helps to pay down debt. Debt payments weigh down your budget. Reducing them makes it possible to get by on less if you have to.

Finally, you can protect your investments by diversifying your portfolio. Don’t put all your money in stocks that can lose their value in a slump. Keep some in safer investments like Treasuries. Other good investments in a downturn include dividend-paying stocks and rental properties.

What Should You Do in a Recession?

Even if you didn’t prepare ahead of time, there are a few steps you can take once a recession starts to help you get through it. First, avoid taking on new debt if possible. Especially avoid adjustable-rate debt, as interest rates on these debts will rise when the recession ends. 

If you have a steady job, do all you can to hold on to it. Be conscientious about coming to work on time and meeting your deadlines. If you lose your job in a recession, it’s hard to find another.

If you own stocks, don’t panic and sell them at a loss. Hold on to them, and they’ll recover when the recession ends. In fact, if you have extra money, you can profit from a recession by buying more stocks while they’re cheap. If you use dollar-cost averaging, you will do this automatically.

What Happens to Interest Rates During a Recession?

During a recession, the government typically cuts interest rates. This discourages saving and encourages spending, which can help get the economy going. It also helps businesses borrow money to finance their operations.

What Happens to Unemployment During a Recession?

Unemployment rates rise during a recession. Cash-strapped businesses look for ways to cut expenses, and laying off workers is one of them.

What Happens to GDP During a Recession?

By definition, a recession is a period when GDP is falling. According to Shiskin’s definition, a recession means real GDP has fallen at least two quarters in a row and lost at least 1.5% of its value.

Final Word

Like bad weather, recessions are an unfortunate fact of life. They’re not good for anyone, but there’s no way to avoid them entirely. The best you can do is try to keep from getting soaked when the storm hits. 

Take the appropriate steps to prepare for a recession ahead of time. That way, when it comes, you’ll be able to ride it out. You may have to tighten your belt for a while, but just like storms, recessions always come to an end. Eventually, the economic forecast will be sunny once again.

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Amy Livingston is a freelance writer who can actually answer yes to the question, “And from that you make a living?” She has written about personal finance and shopping strategies for a variety of publications, including,, and the Dollar Stretcher newsletter. She also maintains a personal blog, Ecofrugal Living, on ways to save money and live green at the same time.


Loan-to-Value (LTV) Ratio – What It Is & How It Affects Your Mortgage Rate

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In the fourth quarter of 2021, the median home sold for just over $408,000. 

Could you afford to pay that out of pocket? Probably not. That’s why most homebuyers wind up applying for mortgage loans.

Getting a mortgage can be a long process and lenders look at a lot of factors when deciding whether to approve your application. You also have to go through a similar process when refinancing.

One thing that lenders look for when making a lending decision is the loan-to-value (LTV) ratio of the loan.

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What Is a Loan-to-Value Ratio?

The loan-to-value ratio of a loan is how much money you’re borrowing compared to the value of the asset securing the loan. In the case of a mortgage, it compares the remaining balance of your loan to the value of your house. On an auto loan, it compares the balance of your loan to the value of your car.

Lenders use LTV as a way to measure the risk of a loan. The lower a loan’s LTV, the less risk the lender is taking. If you fail to make payments and the lender forecloses, a lower LTV ratio means the lender has a higher chance of fully recovering their losses by selling the foreclosed asset. A higher LTV means more risk the lender loses some money.

Lenders may have maximum LTVs that they’ll approve. For example, FHA loans require at least 96.5% LTV. Conventional loans require at least 97% LTV, but only for the best-qualified borrowers — most require 95% LTV or lower. Your loan’s LTV can have other important impacts on your borrowing experience, including your interest rate and monthly payment.

Calculating the Loan-to-Value Ratio

Because LTV plays a big role in the overall cost of your loan, it’s a good idea to calculate it before you apply. 

LTV Formula

To calculate the LTV ratio of a loan, you divide the balance of your loan by the value of your home.

The formula is:

(Loan balance / Home value) = LTV

LTV Calculation Example 

Imagine that you want to purchase a home that appraises for $300,000. You apply for a mortgage and get approved for a $270,000 loan.

The LTV of that loan is:

$270,000 / $300,000 = 90%

If you choose to make a larger down payment and only borrow $240,000, your mortgage’s LTV will be.

$240,000 / $300,000 = 80%

As you pay down your mortgage or as your home’s value changes, the loan’s LTV ratio moves away from this initial value. Typically, as you pay off your mortgage, the LTV ratio drops.

How LTV Affects Your Mortgage Rates

Lenders use LTV as a way to measure the risk of a loan. The higher the LTV of a loan, the higher its risk.

Lenders compensate for risk in a few ways. 

One is that they tend to charge higher interest rates for riskier loans. If you apply for a loan with a high LTV, expect to be quoted a higher interest rate than if you were willing to make a larger down payment. A higher rate raises your monthly payment and the overall cost of your loan.

Another is that lenders may charge additional fees to borrowers who apply for riskier loans. For example, you might have to pay more points to secure an affordable rate, or the lender might charge a higher origination fee. A larger down payment might mean lower upfront fees.

One of the most significant impacts of a mortgage’s LTV ratio is private mortgage insurance (PMI). While PMI does not affect the interest rate of your loan, it is an additional cost that you have to pay. Many lenders will make borrowers pay for PMI until their loan’s LTV reaches 80%. 

PMI can cost as much as 2% of the loan’s value each year. That can be a big cost to add to your loan, especially if you have a large mortgage.

LTV Ratio Rules for Different Mortgage Types

There are many different mortgage programs out there, each designed for a different type of homebuyer.

Different programs can have different rules and requirements when it comes to the LTV of a mortgage.

Conventional Mortgage

A conventional mortgage is one that meets requirements set by Fannie Mae and Freddie Mac. While these loans are not backed by a government entity, they must meet Fannie or Freddie’s minimum credit score and maximum loan amount thresholds, among other criteria. Otherwise, they can’t easily be repackaged and sold to investors — the fate of most mortgage loans after closing. 

Conventional mortgages have a maximum LTV of 97%. That means your down payment will need to equal at least 3% of the home’s value. If your LTV is higher than 80% to begin with, you’ll have to pay PMI until your LTV drops below 78%.

Refinancing Mortgage

Refinancing your mortgage lets you take your existing loan and replace it with a new one. This gives you a chance to adjust the interest rate or the length of your loan.

Most lenders aren’t willing to underwrite refinance loans above 80% LTV, but you might find lenders willing to make an exception.

FHA Loans

Federal Housing Administration (FHA) loans are popular with homebuyers because they allow low down payments and give people with poor credit the opportunity to qualify.

If you’re applying for an FHA loan, the maximum LTV is 96.5%, meaning you’ll need a down payment of at least 3.5%. If the LTV value of your mortgage starts above 90%, you’ll have to pay PMI for the life of the loan. If your LTV is less than that amount, you can stop paying PMI after 11 years.

VA Loans

VA loans are secured by the Department of Veterans Affairs. They’re only available to veterans, service members, members of the National Guard or Reserves, or an eligible surviving spouse.

These loans offer many benefits, including the option to get a loan with an LTV as high as 100%. That means that you can borrow the full amount needed to purchase your home. The only upfront costs you need to pay are the fees associated with getting the loan.

USDA Loans

USDA loans, guaranteed by the US Department of Agriculture, are designed to help people purchase homes in designated rural areas. Borrowers also have to meet certain maximum income requirements.

USDA loans can have LTV ratios of 100%, letting borrowers finance the entire cost of their home. The LTV of the loan can exceed 100% if the borrower chooses to finance certain upfront fees involved in the loan.

Fannie Mae & Freddie Mac

Fannie Mae and Freddie Mac are government-backed mortgage companies. Neither business offers loans directly to consumers. Instead, they buy and offer guarantees on loans offered by other lenders.

Together, the two companies control a major portion of the secondary market for mortgages, meaning that lenders look to offer loans that meet their requirements.

For a single-family home, Freddie Mac has a maximum LTV of 95% while Fannie Mae sets the maximum at 97% for fixed-rate loans and 95% for adjustable-rate mortgages (ARMs).

Limitations of LTV

There are multiple drawbacks to the use of LTV ratios in mortgage lending, both for borrowers and lenders.

One disadvantage is that LTV looks only at the mortgage and not the borrower’s other obligations. A mortgage with a low LTV might seem like it has very little risk to the lender. However, if the borrower has other debts, they may struggle to pay the loan despite its low LTV.

Another drawback of LTV is that it doesn’t consider the income of the borrower, which is an essential part of their ability to repay loans.

LTV ratios also depend on accurate assessments of a home’s value. Typically, homeowners or lenders order an appraisal as part of the mortgage process. However, if a home’s value increases over time, it can be difficult to know the home’s actual worth without ordering another appraisal.

That means that you might be paying PMI on a loan without realizing that your home’s value has increased enough to reduce the LTV to the point that PMI is no longer necessary. You can always order another appraisal, but you’ll have to bear the cost — typically around $500 out of pocket.

LTV vs. Combined LTV (CLTV)

When looking at a property, lenders often use combined loan-to-value (CLTV) ratios alongside LTV ratios to assess risk.

While an LTV ratio compares the balance of a single loan to the value of a property, CLTV looks at all of the loans secured by a property and compares them to the home’s value. It’s a more complete way of assessing the risk of lending to someone based on the value of the collateral they’ve offered.

For example, if you have a mortgage and later get a home equity loan, CLTV compares the combined balance of both the initial mortgage and the home equity loan against your home’s appraised value.

LTV Ratio FAQs

Loan-to-value ratios aren’t easy to understand. If you still have questions, we have answers. 

What Is a Good LTV?

What qualifies as a good LTV ratio depends on the situation, the loan you’re applying for, and your goals.

An LTV over 100% is pretty universally seen as bad because you wouldn’t be able to repay your loan even if you sold the collateral asset.

In general, a lower LTV ratio is better than a high LTV ratio, especially if you want to avoid paying for PMI on top of your mortgage loan payment.

The 80% threshold is a particularly important breakpoint, especially for conventional loans. If you have an LTV of 80% or lower, you can avoid PMI on conventional mortgages, saving hundreds of dollars per month early in the life of your loan. At 80% LTV, you’ll qualify for a good interest rate, though dropping to 70% or even 60% could drop your rate further.  

How Can I Lower My LTV?

There are two ways to lower the LTV of your mortgage: pay down your mortgage balance or increase the value of the property.

Your loan’s LTV will naturally decrease as you make your mortgage payments. You can speed up the process by making additional payments to reduce your balance more quickly.

If you make improvements to your home, it can increase your home’s value. Real estate prices may also rise in your area, bringing your home’s value up too. However, to formally update the value of your home, you’ll need to pay a few hundred dollars to get it appraised again.

What Does a 50% LTV Ratio Mean?

A 50% LTV ratio means that you have 50% equity in your home. In other words, the total loan balance secured by the home — whether it’s a first mortgage, home equity line of credit (HELOC), home equity loan, or some combination of the three — is half the appraised value of the property.

As an example, your loan-to-value ratio is 50% if your home is worth $200,000 and you still owe $100,000 on your mortgage.

What Does a 75% LTV Ratio Mean?

A 75% LTV means that your loan balance is three-quarters of your home’s value. For example, if your home is worth $200,000 and your remaining mortgage balance is $150,000, your LTV is 75%.

Final Word

LTV ratio is one way that lenders look at the risk of making a loan based on the value of the collateral securing it. In the real estate world, LTV is a very important measure because it impacts things like private mortgage insurance and mortgage interest rates.

If you’re looking to avoid paying PMI or trying to get out of paying PMI on your loan, you’ll want to take steps to lower your mortgage’s LTV ratio. You can do this by investing in home improvements that increase the value of your home, then ordering a professional appraisal, or by paying extra principal each month to reduce your mortgage balance faster.

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GME is so 2021. Fine art is forever. And its 5-year returns are a heck of a lot better than this week’s meme stock. Invest in something real. Invest with Masterworks.

TJ is a Boston-based writer who focuses on credit cards, credit, and bank accounts. When he’s not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties.


Conventional Mortgage Loan – What It Is & Different Types for Your Home

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Dig Deeper

Additional Resources

The mortgage industry is rife with jargon and acronyms, from LTV to DTI ratios. One term you’ll hear sooner or later is “conventional mortgage loan.”

It sounds boring, but it couldn’t be more important. Unless you’re a veteran, live in a rural area, or have poor credit, there’s a good chance you’ll need to apply for a conventional mortgage loan when buying your next house.

Which means you should know how conventional mortgages differ from other loan types.

What Is a Conventional Mortgage Loan?

A conventional loan is any mortgage loan not issued or guaranteed by the Federal Housing Administration (FHA), Department of Veterans’ Affairs (VA), or U.S. Department of Agriculture (USDA). 

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Most conventional loans are backed by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac). These government-sponsored enterprises guarantee the loans against default, which lowers the cost for borrowers by lowering the risk for lenders.

As a general rule, stronger borrowers tend to use these private conventional loans rather than FHA loans. The exception concerns well-qualified borrowers who qualify for subsidized VA or USDA loans due to prior military service or rural location.

How a Conventional Mortgage Loan Works

In a typical conventional loan scenario, you call up your local bank or credit union to take out a mortgage. After asking you some basic questions, the loan officer proposes a few different loan programs that fit your credit history, income, loan amount, and other borrowing needs. 

These loan programs come from Fannie Mae or Freddie Mac. Each has specific underwriting requirements.

After choosing a loan option, you provide the lender with a filing cabinet’s worth of documents. Your file gets passed from the loan officer to a loan processor and then on to an underwriter who reviews the file. 

After many additional requests for information and documents, the underwriter signs off on the file and clears it to close. You then spend hours signing a mountain of paperwork at closing. When you’re finished, you own a new home and a massive hand cramp.  

But just because the quasi-governmental entities Fannie Mae and Freddie Mac back the loans doesn’t mean they issue them. Private lenders issue conventional loans, and usually sell them on the secondary market right after the loan closes. So even though you borrowed your loan from Friendly Neighborhood Bank, it immediately transfers to a giant corporation like Wells Fargo or Chase. You pay them for the next 15 to 30 years, not your neighborhood bank. 

Most banks aren’t in the business of holding loans long-term because they don’t have the money to do so. They just want to earn the points and fees they charge for originating loans — then sell them off, rinse, and repeat. 

That’s why lenders all follow the same loan programs from Fannie and Freddie: so they can sell predictable, guaranteed loans on the secondary market. 

Conventional Loan Requirements

Conventional loans come in many loan programs, and each has its own specific requirements.

Still, all loan programs measure those requirements with a handful of the same criteria. You should understand these concepts before shopping around for a mortgage loan. 

Credit Score

Each loan program comes with a minimum credit score. Generally speaking, you need a credit score of at least 620 to qualify for a conventional loan. But even if your score exceeds the loan program minimum, weaker credit scores mean more scrutiny from underwriters and greater odds that they decline your loan. 

Mortgage lenders use the middle of the scores from the three main credit bureaus. The higher your credit score, the more — and better — loan programs you qualify for. That means lower interest rates, fees, down payments, and loan requirements. 

So as you save up a down payment and prepare to take out a mortgage, work on improving your credit rating too.  

Down Payment

If you have excellent credit, you can qualify for a conventional loan with a down payment as low as 3% of the purchase price. If you have weaker credit, or you’re buying a second home or investment property, plan on putting down 20% or more when buying a home.

In lender lingo, bankers talk about loan-to-value ratios (LTV) when describing loans and down payments. That’s the percentage of the property’s value that the lender approves you to borrow.

Each loan program comes with its own maximum LTV. For example, Fannie Mae’s HomeReady program offers up to 97% LTV for qualified borrowers. The remaining 3% comes from your down payment. 

Debt-to-Income Ratio (DTI)

Your income also determines how much you can borrow. 

Lenders allow you to borrow up to a maximum debt-to-income ratio: the percentage of your income that goes toward your mortgage payment and other debts. Specifically, they calculate two different DTI ratios: a front-end ratio and a back-end ratio.

The front-end ratio only features your housing-related costs. These include the principal and interest payment for your mortgage, property taxes, homeowners insurance, and condo- or homeowners association fees if applicable. To calculate the ratio, you take the sum of those housing expenses and divide them over your gross income. Conventional loans typically allow a maximum front-end ratio of 28%. 

Your back-end ratio includes not just your housing costs, but also all your other debt obligations. That includes car payments, student loans, credit card minimum payments, and any other debts you owe each month. Conventional loans typically allow a back-end ratio up to 36%. 

For example, if you earn $5,000 per month before taxes, expect your lender to cap your monthly payment at $1,400, including all housing expenses. Your monthly payment plus all your other debt payments couldn’t exceed $1,800. 

The lender then works backward from that value to determine the maximum loan amount you can borrow, based on the interest rate you qualify for. 

Loan Limits

In 2022, “conforming” loans allow up to $647,200 for single-family homes in most of the U.S. However, Fannie Mae and Freddie Mac allow up to $970,800 in areas with a high cost of living. 

Properties with two to four units come with higher conforming loan limits:

Units Standard Limit Limit in High CoL Areas
1 $647,200 $970,800
2 $828,700 $1,243,050
3 $1,001,650 $1,502,475
4 $1,244,850 $1,867,275

You can still borrow conventional mortgages above those amounts, but they count as “jumbo” loans — more on the distinction between conforming and non-conforming loans shortly.

Private Mortgage Insurance (PMI)

If you borrow more than 80% LTV, you have to pay extra each month for private mortgage insurance (PMI).

Private mortgage insurance covers the lender, not you. It protects them against losses due to you defaulting on your loan. For example, if you default on your payments and the lender forecloses, leaving them with a loss of $50,000, they file a PMI claim and the insurance company pays them to cover most or all of that loss. 

The good news is that you can apply to remove PMI from your monthly payment when you pay down your loan balance below 80% of the value of your home. 

Types of Conventional Loans

While there are many conventional loan programs, there are several broad categories that conventional loans fall into.

Conforming Loan

Conforming loans fit into Fannie Mae or Freddie Mac loan programs, and also fall within their loan limits outlined above.

All conforming loans are conventional loans. But conventional loans also include jumbo loans, which exceed the conforming loan size limits. 

Non-Conforming Loan

Not all conventional loans “conform” to Fannie or Freddie loan programs. The most common type of non-conforming — but still conventional — loan is jumbo loans.

Jumbo loans typically come with stricter requirements, especially for credit scores. They sometimes also charge higher interest rates. But lenders still buy and sell them on the secondary market.

Some banks do issue other types of conventional loans that don’t conform to Fannie or Freddie programs. In most cases, they keep these loans on their own books as portfolio loans, rather than selling them. 

That makes these loans unique to each bank, rather than conforming to a nationwide loan program. For example, the bank might offer its own “renovation-perm” loan for fixer-uppers. This type of loan allows for a draw schedule during an initial renovation period, then switches over to a longer-term “permanent” mortgage.

Fixed-Rate Loan

The name speaks for itself: loans with fixed interest rates are called fixed-rate mortgages.

Rather than fluctuating over time, the interest rate remains constant for the entire life of the loan. That leaves your monthly payments consistent for the whole loan term, not including any changes in property taxes or insurance premiums.

Adjustable-Rate Mortgages (ARMs)

As an alternative to fixed-interest loans, you can instead take out an adjustable-rate mortgage. After a tempting introductory period with a fixed low interest rate, the interest rate adjusts periodically based on some benchmark rate, such as the Fed funds rate.

When your adjustable rate goes up, you become an easy target for lenders to approach you later with offers to refinance your mortgage. When you refinance, you pay a second round of closing fees. Plus, because of the way mortgage loans are structured, you’ll pay a disproportionate amount of your loan’s total interest during the first few years after refinancing.

Pros & Cons of Conventional Home Loans

Like everything else in life, conventional loans have advantages and disadvantages. They offer lots of choice and relatively low interest, among other upsides, but can be less flexible in some important ways.

Pros of Conventional Home Loans

As you explore your options for taking out a mortgage loan, consider the following benefits to conventional loans.

  • Low Interest. Borrowers with strong credit can usually find the best deal among conventional loans.
  • Removable PMI. You can apply to remove PMI from your monthly mortgage payments as soon as you pay down your principal balance below 80% of your home’s value. In fact, it disappears automatically when you reach 78% of your original home valuation.
  • No Loan Limits. Higher-income borrowers can borrow money to buy expensive homes that exceed the limits on government-backed mortgages.
  • Second Homes & Investment Properties Allowed. You can borrow a conventional loan to buy a second home or an investment property. Those types of properties aren’t eligible for the FHA, VA, or USDA loan programs.
  • No Program-Specific Fees. Some government-backed loan programs charge fees, such as FHA’s up-front mortgage insurance premium fee.
  • More Loan Choices. Government-backed loan programs tend to be more restrictive. Conventional loans allow plenty of options among loan programs, at least for qualified borrowers with high credit scores.

Cons of Conventional Home Loans

Make sure you also understand the downsides of conventional loans however, before committing to one for the next few decades.

  • Less Flexibility on Credit. Conventional mortgages represent private markets at work, with no direct government subsidies. That makes them a great choice for people who qualify for loans on their own merits but infeasible for borrowers with bad credit. 
  • Less Flexibility on DTI. Likewise, conventional loans come with lower DTI limits than government loan programs. 
  • Less Flexibility on Bankruptcies & Foreclosures. Conventional lenders prohibit bankruptcies and foreclosures within a certain number of years. Government loan programs may allow them sooner. 

Conventional Mortgage vs. Government Loans

Government agency loans include FHA loans, VA loans, and USDA loans. All of these loans are taxpayer-subsidized and serve specific groups of people. 

If you fall into one of those groups, you should consider government-backed loans instead of conventional mortgages.

Conventional Loan vs. VA Loan

One of the perks of serving in the armed forces is that you qualify for a subsidized VA loan. If you qualify for a VA loan, it usually makes sense to take it. 

In particular, VA loans offer a famous 0% down payment option. They also come with no PMI, no prepayment penalty, and relatively lenient underwriting. Read more about the pros and cons of VA loans if you qualify for one. 

Conventional Loan vs. FHA Loan

The Federal Housing Administration created FHA loans to help lower-income, lower-credit Americans achieve homeownership. 

Most notably, FHA loans come with a generous 96.5% LTV for borrowers with credit scores as low as 580. That’s a 3.5% down payment. Even borrowers with credit scores between 500 to 579 qualify for just 10% down. 

However, even with taxpayer subsidies, FHA loans come with some downsides. The underwriting is stringent, and you can’t remove the mortgage insurance premium from your monthly payments, even after paying your loan balance below 80% of your home value.

Consider the pros and cons of FHA loans carefully before proceeding, but know that if you don’t qualify for conventional loans, you might not have any other borrowing options. 

Conventional Loan vs. USDA Loan

As you might have guessed, USDA loans are designed for rural communities. 

Like VA loans, USDA loans have a famous 0% down payment option. They also allow plenty of wiggle room for imperfect credit scores, and even borrowers with scores under 580 sometimes qualify. 

But they also come with geographical restrictions. You can only take out USDA loans in specific areas, generally far from big cities. Read up on USDA loans for more details.

Conventional Mortgage Loan FAQs

Mortgage loans are complex, and carry the weight of hundreds of thousands of dollars in getting your decision right. The most common questions about conventional loans include the following topics.

What Are the Interest Rates for Conventional Loan?

Interest rates change day to day based on both benchmark interest rates like the LIBOR and Fed funds rate. They can also change based on market conditions. 

Market fluctuations aside, your own qualifications also impact your quoted interest rate. If your credit score is 800, you pay far less in interest than an otherwise similar borrower with a credit score of 650. Your job stability and assets also impact your quoted rate. 

Finally, you can often secure a lower interest rate by negotiating. Shop around, find the best offers, and play lenders against one another to lock in the best rate.

What Documents Do You Need for a Conventional Loan?

At a minimum, you’ll need the following documents for a conventional loan:

  • Identification. This includes government-issued photo ID and possibly your Social Security card.
  • Proof of Income. For W2 employees, this typically means two months’ pay stubs and two years’ tax returns. Self-employed borrowers must submit detailed documentation from their business to prove their income. 
  • Proof of Assets. This includes your bank statements, brokerage account statements, retirement account statements, real estate ownership documents, and other documentation supporting your net worth.
  • Proof of Debt Balances. You may also need to provide statements from other creditors, such as credit cards or student loans.

This is just the start. Expect your underwriter to ask you for additional documentation before you close. 

What Credit Score Do You Need for a Conventional Loan?

At a bare minimum, you should have a credit score over 620. But expect more scrutiny if your score falls under 700 or if you have a previous bankruptcy or foreclosure on your record.

Improve your credit score as much as possible before applying for a mortgage loan.

How Much Is a Conventional Loan Down Payment?

Your down payment depends on the loan program. In turn, your options for loan programs depend on your credit history, income, and other factors such as the desired loan balance.

Expect to put down a minimum of 3%. More likely, you’ll need to put down 10 to 20%, and perhaps more still.

What Types of Property Can You Buy With a Conventional Loan?

You can use conventional loans to finance properties with up to four units. That includes not just primary residences but also second homes and investment properties. 

Do You Need an Appraisal for a Conventional Loan?

Yes, all conventional loans require an appraisal. The lender will order the appraisal report from an appraiser they know and trust, and the appraisal usually requires payment up front from you. 

Final Word

The higher your credit score, the more options you’ll have when you shop around for mortgages. 

If you qualify for a VA loan or USDA loan, they may offer a lower interest rate or fees. But when the choice comes down to FHA loans or conventional loans, you’ll likely find a better deal among the latter — if you qualify for them. 

Finally, price out both interest rates and closing costs when shopping around for the best mortgage. Don’t be afraid to negotiate on both. 

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GME is so 2021. Fine art is forever. And its 5-year returns are a heck of a lot better than this week’s meme stock. Invest in something real. Invest with Masterworks.

G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.


Plan Your Financial Future at Any Age

Long-term financial goals take five or more years to accomplish and generally apply to major life events. Some of the most important long term financial goals people have include saving for retirement and paying off their mortgage.

Save more, spend smarter, and make your money go further

It’s natural to feel overwhelmed when thinking about your finances several years down the road. Seeing your responsibility for a mortgage, credit card debt, or personal loan can often feel unmanageable when viewed as a whole. The key to overcoming this feeling is to prepare yourself long before the need arises. Setting long-term financial goals early in life can make the process more manageable.

Long-term financial goals take five or more years to accomplish and generally apply to major life events. To boot: You can set them anytime in your life. This guide breaks down how to set a long-term financial goal at any stage of your life and provides tangible financial goal examples to inspire your planning.

Why Are Long-Term Financial Goals Important?

If you only focus on financial goals relevant to your current situation, you may find yourself unprepared when you experience future life events. For example, saving an emergency fund is an incredibly useful short-term goal, but if you don’t save money outside of that fund, then you will be unprepared for retirement. Long-term financial goals bring awareness to events that may be decades away and help to ensure you’ll be prepared for when they arrive.

Long-Term vs Short-Term Financial Goals

While long-term financial goals focus on several years into the future, short-term goals are concerned with the present. Short-term goals can generally be accomplished within a year and are usually easy to achieve. Typical short-term financial goals include establishing a monthly budget and saving an emergency fund. Establishing key short-term goals can help investors achieve their long-term money goals by getting them on the right track early on.

A venn diagram defines short-term, mid-term, and long-term financial goals.

Long-Term vs Mid-Term Financial Goals

Mid-term financial goals are a gray area in financial planning. They often overlap with short and long-term goals—taking longer to achieve than short-term goals, while less difficult than long-term goals. Saving for a down payment can fall under either type of financial goal since the amount you need to save can vary based on the size of the purchase. It can take more than five years to save up for a house down payment depending on your income and the cost of the house.

Long-Term Financial Goals For Your 20s

Your 20s represent a unique time in your financial journey since many people start out with a blank page. Knowing where to begin can be a challenge, but this time in your life has the power to set the stage for decades to come. Setting financial goals now can improve your quality of life and answer the question, “Where should I be financially at 25?”

 A chart identifies the long-term financial goals a person should set for themselves in their 20s.

Identify Your Retirement Needs

Although your retirement is likely several decades away, identifying your future needs will increase your likelihood of meeting them when they arise.

Think about likely expenses you’ll have at this time in your life. How much might you receive from social security? Will you have rent or mortgage payments? How much will you need to receive from your retirement account to cover your estimated retirement budget?

You can build your current monthly savings plan around your expected future needs. Comparing these needs to your current income will help you determine if these goals are realistic and if you need to find new income streams.

Open a Retirement Account 

Saving money early on is the one of the greatest ways to secure your financial future. The interest you earn on your savings will compound, leading to exponential growth by the time you’re ready to withdraw it. The rule of thumb is to save 15 percent of your pre-tax income each year.

There are multiple options for where to invest your money. A couple of the most common include individual retirement accounts(IRA) and 401(k)s. It can be very beneficial to participate in your employer’s retirement program since they often include company contributions, which is like an addition to your salary.

Save For a House Down Payment

Most people dream of owning property. Building equity in an appreciating asset instead of spending money on rent can be a great way to eliminate future expenses after you pay off the mortgage.

The amount of money you need to save will be dependent upon the cost of your desired home. A down payment of 20 percent can lower your interest rate and eliminate the need for private mortgage insurance (PMI). If your desired first home costs $300,000, then you will need a down payment of $60,000 to meet this requirement. Smaller down payments are possible, but they will affect your interest rate and the likelihood of being approved for the loan.

Pay Off Credit Card Debt 

Credit cards can allow you quick access to funds when you need them most, but carrying credit card debt can quickly wipe out your financial progress. In a perfect world, you’ll be paying off your credit card monthly without accruing any interest.

In the event that you have accumulated credit card debt, it should be a top priority to pay it off. High interest rates, sometimes surpassing 15 percent, offset the gains you’d be making by investing that same money while holding the debt. Use a credit card payoff calculator to learn how long it will take to settle your debt.

Increase Your Earnings Potential 

Making more money is the simple answer to securing your financial future, but how do you go about making it happen? Evaluating where you want to be in five years is a great starting point. Does your career path require a higher level of education than you currently have? Does your current job have a glass ceiling preventing growth?

Talk to your boss about your aspirations. There may be training they can recommend to put you on the ladder of success. If your current employer is unable or unwilling to help, consider upskilling on your own. Get certifications independently or enter a graduate program. Proactively finding ways to increase your earnings is better than wasting years at a dead-end job.

Long-Term Financial Goals For Your 30s

Entering your 30s often brings a new degree of stability to your finances. Ideally, you will be on a career path that allows you to meet most of the long-term financial goals you set for yourself in your 20s. However, with age comes life changes that may require you to shift your priorities.

A chart identifies the long-term financial goals a person should set for themselves in their 30s.

Pay Off Student Loans

The sooner you pay off your debts, the more money you can put toward other financial goals. If you have no higher commitments, it can be better to aggressively pay off your student loans early. Variable loans may be manageable for you at the moment, but if interest rates rise, your loan could quickly increase by more than 5 percent.

Large payments are not a possibility for every investor’s goals. Putting just 10 percent of your gross income toward your student loans can still be enough to whittle away your outstanding debt. As your income increases, aim to pay a larger monthly amount until the loan is eliminated. Using a student loan calculator can help make your goal attainable.

Improve Your Credit Score

A good credit score makes it easier to meet a number of personal financial goals. You can get approved for a better apartment or receive a better interest rate on your car loan and mortgage payments. Although it depends on the scoring system, aiming for a credit score above 700 will generally give you more favorable terms.

Ways to improve your credit score include:

  • Paying your rent on time and not breaking the lease early
  • Using 30 percent (or less) of your total credit limit
  • Paying your credit cards in full each month
  • Keeping old lines of credit open
  • Limiting the number of hard inquiries into your credit
  • Settling any delinquencies

Set a Retirement Date

In your 20s, you might have had a general idea of when you wanted to retire. In your 30s, it’s time to think about a precise date that you can plan around. Your potential retirement year will vary based on your income, debts, and personal commitments.

If you were unable to stick to the goals you made in your 20s, then you may need to adjust your financial planning for retirement to something more attainable. If you are committed to retiring in a specific year, you may need to ramp up your savings and cut unnecessary purchases. Identifying when your mortgage will be paid off and when your kids will be finished with school can also affect your retirement date.

Create a Last Will and Testament

A last will and testament is the legal document used to allocate your property after you die. It also identifies the executor of your estate—the person responsible for settling your outstanding debts and seeing that your will is honored.

Without a will, your assets will be distributed by the government after you die. This can be a costly process with no guarantee that your wishes will be honored. If you have plans for who inherits your belongings, meeting with an estate planning attorney should be made a priority.

Long-Term Financial Goals For Your 40s

Life in your 40s is full of responsibilities. You likely own more assets now than at any other time in your life, your family is growing, and your goals are changing. Now it’s time to reorient your long-term financial goals to your current situation.

A chart identifies the long-term financial goals a person should set for themselves in their 40s.

Pay Off Non-Mortgage Debt 

Aside from your mortgage, which can follow you into your 50s and 60s, all other debt elimination should be prioritized. Just because you eliminated some debts in your 20s and 30s does not mean new debts haven’t appeared.

You may have new credit card debt or student loans from returning to school. Automobile purchases can happen at any point in life. Regardless of the reason for the debt, you won’t want high APR payments lingering when you are approaching retirement age.

Evaluate Life Insurance Policies

Life insurance is what your dependents will use to bolster their lifestyle in the event of your death. Having a comprehensive policy can ensure their needs are met even if your savings at that time are not enough.

Due to the financial obligations the average 40-year-old has, it is often recommended to purchase more life insurance than you initially thought you’d need. You’ll want to make sure your family can cover their living expenses and settle any debts without your income.

Invest in Your Child’s College Fund

Saving for your children’s education is one of the best ways to set them up for financial success. If they can avoid the early debt of student loans, then they can focus on other financial goals earlier.

A college fund is a large investment and it will take a long time to accomplish. Depending on when you have kids, you may want to start their college fund before your 40s to ensure it is adequate by the time they graduate high school.

Maximize Your Earnings Potential 

Most people reach their peak earning potential at some point in their 40s. Putting yourself in a position to maximize this number will set the stage for your quality of life in retirement. A larger income will enable you to max out your retirement contributions.

This is another time to analyze if your current job aligns with your long-term financial plans or if you need to make a change. Look for ways to make more money by negotiating for a raise, earning a promotion, starting a side hustle, or changing employers.

Long-Term Financial Goals For Your 50s and 60s

These two decades in a person’s life often have a large degree of overlap. Your personal commitments are simplified, and your set retirement date is finally within view. All that is left for you to do is tie up loose ends.

A chart identifies the long-term financial goals a person should set for themselves in their 50s and 60s.

Become Entirely Debt-Free

Paying off your mortgage is a major financial goal and getting it done before you retire is a huge accomplishment. Knocking it out while you’re still working full-time enables you to put more money into your retirement portfolio. The same goes for any other outstanding debts that are persisting. These monthly expenses can prolong your time in the workforce past what you originally intended.

Plan Long-Term Care Options

There may come a time in your life when you are no longer able to take care of yourself. You’ll want a plan in place before that happens so your finances will be enough to meet your needs. Make sure your family is aware of your wishes so they can prepare as well. Some things to consider include:

  • Who will be your guardian?
  • Will you receive in-home care or move to a live-in facility?
  • If you require a live-in facility, which one will it be?

Long-term care services are a costly addition to your retirement budget. Setting up funding for such an event years before the need arises can make it more manageable.

Re-evaluate Your Estate

Many changes may have occurred in your life since you first drafted your will. Re-evaluating what assets are currently in your possession will make the process of managing your estate go much smoother. This is another opportunity to discuss your financial affairs and wishes with your family. Avoid unexpected revelations after your death, so there isn’t fighting amongst your loved ones.

Downsize Your Living Expenses

Implementing cost-cutting measures in your life before retirement can help put your future lifestyle into perspective. You may realize that your initial retirement budget can’t meet your needs and you need more time to save.

The house you raised a family in may no longer be necessary once your kids are out of the house. Selling it for a smaller property can add to your savings while reducing expenses. The same can be said for owning multiple vehicles or vacation properties.

Everyone has unique needs and obligations that influence their financial journey. Budgeting and saving can keep you on track to meet your long-term financial goals. Regardless of where your finances stand today, it’s always a great time to prepare for many of life’s important events.

An infographic overviews how to set long-term financial goals, no matter your age or stage of life.

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loanDepot May be the Easiest Way to Refinance and Save Money on Your Mortgage

Luckily, a company called loanDepot helps you refinance without all the unnecessary stress.
They have lots of different kinds of loans you can choose from, including conventional mortgages, VA loans and FHA loans. But the company’s loan officers follow a “no steering” policy. In other words, there’s no bias or push for you to choose a certain type of loan.
**Results may vary. Conditions apply
Since it was founded in 2010, the company has loaned out over 5 billion worth of home loans. It’s now the fifth-largest mortgage lender in the country, working with 27,000 clients a month.

How to Refinance Your Home and Save Money — the Easy Way

And loanDepot makes it easier to upload all your necessary documents into its online portal. You’ll also get help from one of the company’s loan officers, who can guide you through the process. Even better: loanDepot is accredited by the Better Business Bureau with an A+ rating, is licensed to do business in all 50 states and has more than 200 branches across the country.
Interest rates and fees vary by customer, but you can talk to a loan officer to get a rate estimate and ask about any fees.
Maybe you’ve considered refinancing before, but the whole thing felt overwhelming. But still, you know it’s something that could save you a lot of money over the course of your mortgage.
Get the Penny Hoarder Daily
Your home means everything to you. It’s where you spend time with the people you love most. Getting a mortgage and purchasing it was one of the biggest moments in your life. But things might’ve changed since then, which means you might be spending more than you need to on your mortgage payments.

How to Get Started

Privacy Policy
It takes just a few minutes to get started and see how much money you could save on your mortgage.
Mike Brassfield ([email protected]) is a senior writer at The Penny Hoarder. He has refinanced so many times.
To get started, you’ll upload the basic personal and financial documentation that any lender needs. Basically, they need to know who you are and other qualifying elements.
Although the documentation part is entirely digital**, you’ll also speak with one of loanDepot’s 3,000 licensed loan officers, who will help you get your final loan approval and schedule your loan closing.
Ready to stop worrying about money? <!–


*By refinancing the existing loan, the total finance charges may be higher over the life of the loan.

Chapter 7 vs. Chapter 13 Bankruptcy Differences – Which Is Better to File?

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It’s easy to be in denial about debt. But when anxiety and fear take over, it can affect more than just your financial life. If you feel paralyzed by crushing debt, know that there’s a way out: bankruptcy.

Whether you opt for Chapter 7 or Chapter 13 bankruptcy, it won’t be an easy road. But it can help you regain control of your life and get back on solid financial footing.

How it works depends on which one you choose. And that may depend on your individual circumstances. So it pays to understand the ins and outs of both before deciding which one’s right for you.

Chapter 7 vs. Chapter 13 Bankruptcy

Before you file bankruptcy, it’s vital to understand that some debts are treated differently in bankruptcy. Priority debts will stick around afterward, whether you choose Chapter 7 or Chapter 13. If you owe child support or alimony or have tax debt or federal student loans, you can’t use bankruptcy to eliminate them. 

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Bankruptcy also might not eliminate any secured debts you have. Secured debts are anything that’s backed by collateral, usually the thing you’re buying with the loan, such as your mortgage payments or car loans.

That doesn’t mean you have to surrender your home or car when you file bankruptcy. Instead, you can continue making payments on those debts, though how that happens depends on which type of bankruptcy you choose. If you still owe on them, you continue to pay your secured loans after the bankruptcy is over too. 

In both cases, when you file for bankruptcy, the court issues an automatic stay, which prevents your creditors or collection agencies from attempting to collect your debts. Both types of bankruptcy can help you keep certain types of property and give you a bit of breathing room. Both also require credit counseling no more than 180 days before filing. 

But there are some crucial differences between Chapter 7 and 13 bankruptcy. 

Chapter 7 Bankruptcy – The Quick and Easy Option

Chapter 7 is generally the quicker and easier option, as it’s usually over within a few months and entirely discharges any qualifying debt. It’s a liquidation bankruptcy, meaning the trustee might sell (liquidate) your assets to pay down your debts. If you only have unsecured, nonpriority debts and don’t have a lot of assets, Chapter 7 is usually the better option.

During Chapter 7, the bankruptcy trustee, an individual the court assigns to represent your estate in bankruptcy, can sell your belongings, whether they’re high-value items like a boat or motorcycle or lower-value items like furniture or designer clothing. 

Chapter 7 does have income limits, so you might not qualify if you earn too much or if your debt-to-income ratio, the amount of debt you owe versus how much you make expressed as a percentage of how much of your income goes toward debts, isn’t high enough. That in addition to your family size is what the government calls a “means test.” 

Debts you can discharge in Chapter 7 bankruptcy include:

  • Credit card debt
  • Medical debt
  • Past-due rent
  • Personal loans
  • Past-due federal and state income taxes (at least three years old)
  • Past-due utility bills
  • Past-due attorney’s fees
  • Civil court judgments

Secured debts, which are backed by property, such as a car or house, get treated differently in Chapter 7. You can discharge any back debt on them, provided you give up the collateral. If you want to keep the property connected to secured debts, you must reaffirm the debt and continue making payments. You need to be up-to-date on payments to do so.

If you’re behind on secured debts, there’s a risk of losing the collateral (such as your home). Even if you don’t discharge it, the trustee can sell it if there’s enough equity built up. 

But you might qualify for an exemption, depending on the property type. An exemption protects your property from creditors. But if you owe a lot, the exemption might not be enough to fully protect you.

There are several advantages to Chapter 7 bankruptcy.

  • You can wipe out unsecured debts (and potentially secured debts), giving you a fresh start.
  • It happens quickly, in as little as a few months.
  • It gets creditors and collection agencies off your back.

But there are some significant disadvantages you should consider:

  • The bankruptcy trustee can sell certain possessions.
  • You’re at the risk of a foreclosure on your home or repossession of your car, as it doesn’t give you the option to catch up if you’ve fallen behind on payments.
  • The bankruptcy can stay on your credit report for a decade.
  • Your credit score will drop, though it may not be that much and might be preferable to debt.

Chapter 13 Bankruptcy – Debt Reorganization and Payment Plan

If you don’t qualify for Chapter 7, Chapter 13 is the way to go. Unlike Chapter 7, Chapter 13 requires you to pay off your debts through a payment plan created by the bankruptcy trustee. Chapter 13 is a reorganization bankruptcy since the payment plan rearranges your debts. 

Note that there is a limit to how much debt you can have to qualify for Chapter 13. You need to have less than $465,275 in unsecured debts and less than $1,395,875 in secured debts. 

The trustee will rank your debts under the payment plan to ensure priority debts (such as alimony) get paid in full by the time the plan is complete (in three to five years). The plan will also account for secured debts you have and, if you can afford to pay them, unsecured debts. The amount you pay under the payment plan is based on your monthly income.

Chapter 13 takes longer than Chapter 7, in some cases up to five years. How long depends on the repayment plan. If your income is below the state’s median monthly income, your plan lasts three years. If you earn more than the state median income, it lasts five years.

Chapter 13 bankruptcy lets you discharge a few more debts than Chapter 7. The additional debt types you can discharge in Chapter 13 include: 

  • Debts for malicious and willful injury to property (but not to a person)
  • Debts to pay for nondischargeable tax obligations
  • Debts connected to property settlements in a divorce or separation (other than support obligations like alimony and child support)
  • Outstanding debts from a previous bankruptcy in which the court denied your discharge 
  • Retirement account loans 
  • Any homeowners association or condominium fees due after your filing date
  • Certain noncriminal government fines and penalties

You must continue making payments on secured debts if you want to keep the property associated with them. The benefit of Chapter 13 is that it allows you to reschedule the debt and potentially reduce the value of some property types, such as a car. 

With Chapter 13, you can continue to make payments on secured debts once the payment plan is complete. You don’t have to pay them in full within three to five years. 

While Chapter 13 doesn’t entirely erase your debt, there are several reasons people often view it more favorably than Chapter 7.

  • It creates a payment plan to make your debt more manageable.
  • It impacts your credit score less than Chapter 7.
  • You can keep your house and other assets as long as you pay the debts connected to them.
  • It gets creditors and collection agencies off of your back.

But there are still some significant disadvantages.

  • The process takes much longer than Chapter 7.
  • You might have difficulty making payments under your payment plan unless you make and stick to a budget.
  • The bankruptcy will stay on your credit report for seven years.
  • Your credit score will drop, though it may not be that much and it may be preferable to staying in debt.

Which Is Right for You: Chapter 7 or Chapter 13 Bankruptcy?

Whether it’s best to file Chapter 7 or 13 largely depends on your income and what types of debt you have. 

You Should File Chapter 7 Bankruptcy If…

Overall, Chapter 7 bankruptcy is best for lower-income Americans who are in way over their heads. Chapter 7 bankruptcy is a better fit if:

  • Your Income Is Below the Median in Your State. You need to pass a means test to be eligible for Chapter 7. You automatically pass the test if you earn less than the median monthly income in your state.
  • You Don’t Have a Lot of Assets. Your bankruptcy trustee can sell your stuff to pay off creditors during Chapter 7. While there are exemptions, it’s usually better for a debtor not to have a lot of assets or possessions when they file for Chapter 7 bankruptcy.
  • You Mainly Have Unsecured Debts. If you owe back taxes, alimony, child support, or student loans, bankruptcy won’t help. You’re still on the hook if you have secured debts and want to keep the collateral. Chapter 7 isn’t a magical get-out-of-debt-free pass. But if you have credit card debt, medical bills, or unsecured personal loans, Chapter 7 can give you a fresh start.  
  • You Don’t Have Enough Disposable Income to Repay Your Debts. You can pass the means test even if your income is above the state median, provided your disposable income (what’s left over after you pay for all your necessary expenses) isn’t enough to cover your monthly debt payments. 

You Should File Chapter 13 Bankruptcy If…

If you have ample income but still struggle to make your payments, Chapter 13 might be a better fit. Chapter 13 bankruptcy is a better fit if:

  • Your Income Is Above the State Median. To qualify for Chapter 13, you need to have a regular income. If you don’t pass the means test for Chapter 7, Chapter 13 might be your better option.
  • You Own Your Home or Car. Filing Chapter 13 can keep your home out of foreclosure, as you have the option of catching up on your mortgage payments. You can also catch up on other types of secured debt, such as your car loan. 
  • You Don’t Have Too Much Debt. Chapter 13 has an unsecured debt limit of $465,275

and a limit of $1,395,875 for secured debt. If you owe more, Chapter 11, which is usually reserved for businesses, might be the better choice for you.

  • You Can Afford the Monthly Payment. To get a discharge from Chapter 13, meaning you’re free of all your unsecured debts, you need to complete your payment plan. That means you need to be able to afford the monthly payment. If you believe your income will remain steady in the future, you can feel pretty good about filing Chapter 13.

Final Word

Whether you end up filing for Chapter 7 or Chapter 13, bankruptcy isn’t something to rush into. The bankruptcy courts seem to recognize that, as all filers need to complete a credit counseling course during which they learn about their debt repayment options and carefully evaluate whether bankruptcy is the best choice before they file.

But ensure you speak with a bankruptcy attorney to get a better sense of what your bankruptcy options are first. It’s very difficult to successfully file bankruptcy without one. 

Speaking with a fiduciary financial advisor can also help you decide if Chapter 7 or 13 will provide the relief you need or if another debt relief option, such as negotiating with your lenders or getting on a debt management plan, is the right choice.

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Amy Freeman is a freelance writer living in Philadelphia, PA. Her interest in personal finance and budgeting began when she was earning an MFA in theater, living in one of the most expensive cities in the country (Brooklyn, NY) on a student’s budget. You can read more of her work on her website, Amy E. Freeman.