Financing

Figuring Out What You Can Affordmortgage_money_house_1_business_desk

In addition to your monthly mortgage payments, there are many things to factor in when determining how much you can afford, or even if you can afford to buy a home at all. There is a down payment for the loan, closing costs, moving expenses, plus purchases and maintenance for the new home.  Generally, your annual gross income multiplied by 2.5 will give you an approximate amount for the price of home you can afford.  It could vary depending on how much you have as a down payment, your debts, financial situation, and credit history/rating.  Your debts, including alimony and child support, should not be more than 30 to 40% of your gross income.

Monthly Mortgage Payment

Lenders want to make sure you have the ability to pay your loan.  As a general rule of thumb, you can figure that your monthly mortgage payment should be equal to or less than 25% of your gross monthly income.  This also will vary depending on circumstances.

Amount of Money Needed

You will need money for a down payment and closing costs, plus any move related expenses and maintenance or repair costs for your home.
  • Down Payment – Your down payment is a percentage of the property value and is usually from 3 to 20%, or more if you want a lower loan amount.  This can vary by the type of mortgage you obtain.  Also, if your down payment is less than 20%, you may be required to pay mortgage insurance (PMI or MI).
  • Closing Costs – these are settlement costs involved in purchasing your home.  They range from 2 to 7% of the property value and include such things as points (a percentage paid for securing a particular interest rate), financing fees, taxes, title insurance, pre-paid and escrow items, and your down payment.  You will receive an estimate of these costs prior to closing.
  • Move In and Initial Expenses – these are costs associated with moving in such as movers, utilities, electric, cable, internet, new appliances needed, initial updates or repairs such as flooring, paint, electrical work, or any other initial expense that “pops up”.  Nearly every home comes with a few surprises.  You should have a savings set aside for these new home “adventures”.

What To Know About Creditcreditscore3

There is nothing more important than your credit when it comes to buying a home.  The first thing a lender will do is review your credit report.  This is a history of money you have borrowed in the past and how you have repaid those debts.  It contains a list of debts such as credit cards, car loans, and other loans.  It shows any bills that have been referred to a collection agency.  It lists other public record information such as liens or bankruptcies.  And, it documents inquiries about your creditworthiness and whether you were extended credit or not.  Your credit report is constantly updated and most information is deleted after 7 years (10 years for bankruptcies).  This credit information then helps generate a computer-derived number that indicates your risk as a payer of debts.  This is called your credit score.  Your credit history and/or your credit score is used to decide whether your loan is approved and it could be used to determine your interest rate.

If You Don’t Have Credit

If you haven’t established credit, start now.  Perhaps apply for a credit card or two, then use them carefully and pay them off each month.  Once you’ve done this, you’ve started your credit history.  Next, apply for credit on a store purchase such as an appliance, or a TV.  Do this even if you have the cash to pay for it.  When the first bill comes, use your cash to pay it off in total.  You see, buying on credit and paying it off helps your credit better than buying something for cash.

If You Have Bad Credit

It can take awhile to improve bad credit, but it can be done.  Since credit scores reflect much of your most recent activity, the first thing you should do is to start paying on time.  Pay all of your bills, even if it’s just the minimum.  Never pay less than what is due, and never pay late.  And, don’t max out your credit cards because it indicates poor money management.  One of the best things you can do is to make a budget to help with your monthly expenditures and then live by it.  Also, start a savings account and make it part of your budget.  You will need money for a down payment, or it will help if you lose your job or source of income.

Often What You Qualify For Is Different Than What You Can Afford

Depending on your credit, you may qualify for more or less than you can afford.

If your lender qualifies you for a loan that was larger than you expected… The qualification process took into account your income and credit history, but there are other factors to consider to decide what you could actually afford.  You may want to spend less on a house, so your mortgage payments would be smaller and you have more money left over each month for other things, like eating out and home decor.   Being pre-qualified for a home is a like having a credit card.  You get a limit on what you can spend, but it doesn’t mean you can afford to max it out.  It’s important to take a look at all your monthly expenses, both mandatory and discretionary, to determine how much you really want to spend on your mortgage each month without giving up the things that matter to you.
If your lender qualifies you for less than what you thought you could afford then you know you need to work on your credit, pay off some bills, and save up.  You have two options, downsize your list of wants in a home or delay purchase for several months while you work on your credit.

You Don’t Always Need A Large Down Payment

Coming up with a 20% down payment is one of the biggest hurdles for many.  There may be other options.  Different lenders offer different programs.  Some have programs with government assistance for the down payment and closing costs, some offer programs with as little as 3% down.  It’s good to talk to several lenders and do some research into which program and type of loan will be the best for you so you an be in a home and building equity sooner.

Closing Costs  May Be More Than You Expected

Many people know they need a down payment, but don’t realize the money needed for closing costs on top of that.  Be sure when saving up you factor in closing costs.  This typically is 2% to 8% of the sale price of a home.  Your lender will provide you with a detailed estimate of these costs so you are prepared for the total amount required to close your purchase.  If you are planning to make a 20% down payment, that means you’d really need 22% – 28% of the home’s purchase price to cover all the costs, which can take a long time to save.  Luckily there are loan options available with as little as a 3% down payment, which means you’d only need 6% – 11% of the home’s purchase price to cover costs.

Save Some Money For Unexpected Expenses

“We were so excited to be in our new house, but when the dishwasher stopped working and the hot water heater ruptured within a few months of each other, we were worried about how we’d cover the expense.  We used all of our savings for the down payment and closing costs.  We should have kept something for emergencies.”

It’s no secret that there are many potentially expensive repairs that come with home ownership.  The seller is legally obligated to disclose any known problems with the home and the home inspection will give you a sense of what issues could arise, but there are always unexpected surprises.  Some not even related to the house – like losing your job, car problems, or getting ill.  That’s why even if you have enough money to make a sizeable down payment, it may be a good idea to put less money down if it means using all of your savings.  That way you have money available to handle the unexpected.

Types Of Mortgages

Fortunately for buyers, there are a variety of mortgages to choose from.  It is in your best interest to investigate each of them to determine which is the best for your situation. You probably won’t qualify for all of them.  In fact, you may only qualify for one.  But if you do qualify for more than one, you may save yourself money (and worry) in the long run if you do your homework before signing on the dotted line.

Fixed Rate Mortgages

Consider a fixed rate mortgage if either of the following describes you:

  • You plan on living in your new home for many years, and/or
  • You are not a risk-taker and prefer the stability of knowing how much your payment will be each month.

Since most home loans are for a period of 30 years, if you want a payment you can count on for that long of a period of time, a fixed rate mortgage may be what works best for you. Once your loan amount and interest rate are calculated and locked in, a fixed rate mortgage will guarantee that you will have the same payment over the life of the loan. Making extra payments to principal will allow you to pay your loan off sooner.

This may not always be the best choice, however. If interest rates are very high at the time you take out your loan, with a fixed rate mortgage you’ll be stuck with that high interest for the life of the loan (unless you choose to refinance). Conversely, if interest rates are very low, you’ll come out the winner with interest rates that will stay low no matter how high interest rates go in the future.
The following are the advantages and disadvantages of the varying lengths and terms of fixed-rate mortgages:

15-Year Fixed-Rate:

  • Pay off the loan in half the time of a 30-year loan
  • Equity builds up more quickly than in a 30-year loan
  • Payments are higher (which may be a problem if you lose your job or become unable to work)

20-Year Fixed-Rate:

  • Pay off the loan in 2/3 the time of a 30-year loan
  • The overall interest paid is considerably less than for a 30-year loan

30-Year Fixed-Rate

  • The most common choice, especially for first-time homebuyers, as it’s the easiest of the fixed-rate loans to qualify for
  • Monthly payments are lower than for 15-year and 20-year loans. This can prove especially helpful if you do not have a lot of “padding” between the amount you can afford to spend and the monthly payment for your desired property
  • More desirable if you plan on staying in the same home for years, since equity builds more slowly than for shorter-term loans
  • For income tax purposes, this term provides the maximum interest deduction

Adjustable-Rate Mortgages (ARMs)

If you are more comfortable in taking a risk with your money or if interest rates are very high at the time you take out your loan, an adjustable-rate mortgage (ARM) may be the solution for you. You might also choose this type of loan if your planned ownership of the property is short-term or if you expect your income to increase to cover any potential rise in the interest rate.
Generally, the interest rate when you take out your loan will be lower than a fixed-rate mortgage. Please note that this is true initially, not necessarily long-term.
Since an ARM rate rises and falls depending on the prevailing interest rate, your mortgage payment will rise and fall accordingly. If your income is not sufficient to cover the highest possible payments, then this option is not for you. On the positive side, the lower initial payments will allow you to qualify for a larger loan than if you choose a fixed-rate. The downside is that your payments will increase if/when the rates go up.
Typically, ARM interest rates are tied to a specific financial index (such as Certificate of Deposit index, Treasury or T-Bill rate, Cost of Funds-Indexed Arms or COFi, or LIBOR [London Interbank Offered Rate]) and your payment will be based on the index your lender uses plus a margin, generally of two to three points. Get the formula used by your lender in writing and make sure you understand what it means.
Fortunately, the amount an ARM can increase is limited. There are “caps” on how much your lender can increase your rate, both for a period of one year and for the life of the loan. Plan ahead, and have your lender calculate what the maximum payment would be if your rate went to the highest amount allowed by the cap for your particular mortgage. If you are not confident you’ll be able to pay that amount on a monthly basis, perhaps you should reconsider this type of loan.

Convertible ARMs

If neither the fixed-rate or the adjustable-rate mortgage seems like the best option, perhaps the convertible ARM will be right for you. This alternative combines the initial advantage of an ARM with a fixed rate after a predetermined number of years. Obviously, this type of mortgage has more advantages when the initial interest rate is low and the future rate is not guaranteed.

 Government Loans

Another mortgage option available to some people is a government loan, providing that you meet the qualifications for these loans.

  • VA Loans:Veterans may qualify for a loan from the Veterans Administration. There is a limit on the amount you can borrow, so this option works best for those buying a lower priced home.
  • FHA Loans: The Federal Housing Association offers loans to lower-income Americans. Look for the phrase “FHA approved” when looking at ads for homes.

Low Down Payment Loan Options

It can be shocking to realize how long it will take to save a 20% down payment, but there are several low down payment loan options that may help you achieve the dream of home ownership sooner.

Loans with Private Mortgage Insurance

With a loan backed by private mortgage insurance, buyers are able to purchase a home with a down payment as low as 3%.  There are several payment options available, and depending on the form of private mortgage insurance, your payments might automatically cancel when your mortgage balance reaches 78% of the home’s original value.  Some lenders will even allow cancellation with an 80% balance.  Private mortgage insurance premiums may also be tax deductible.

FHA Insured Loans

With an FHA insured loan, buyers are able to purchase a home with a down payment as low as 3.5% through a government program backed by taxpayers dollars.  The program offers only one payment option – an upfront fee due at closing and a monthly fee.  It’s important to note that while the FHA recently lowered their premiums for the loans they insure, making them more affordable, they removed a buyer’s ability to cancel the premium payments, meaning a buyer must make the payments for the life of the loan.  FHA premiums may also be tax deductible.

How are private mortgage insurance and FHA different?

Private mortgage insurance is the private sector alternative to FHA, which is a government program backed by taxpayers.  Another key difference is with cancellation.  Some forms of private mortgage insurance may be cancelled when a loan reaches 78% loan-to-value, unlike FHA that may be paid for the entire loan term.  And while both base the cost of their insurance premiums on a variety of factors, including your credit profile and other characteristics, their premiums are different, so it’s important to compare the cost of both options to see which makes the most sense for you.

Loans for Veterans

VA loans provide a benefit by offering a long term financing option to American veterans.  These programs are government insured loans and offer various down payment options.  To find out more about VA loans and whether or not you are eligible, go to the US Department of Veterans Affairs website or speak to a loan professional.

Down Payment Assistance

Down payment assistance provides additional options for families that qualify (typically low to moderate income).  These programs can provide assistance by giving favorable terms for second mortgages, grants, or gifts, but they can add steps to the home buying process.

Mortgage Application Document Checklist

It’s time to apply for your mortgage.  The amount of information lenders require to process your loan application can be overwhelming, but this handy checklist can help you prepare.  Gather all the documentation in a folder, and bring it with you when you speak with your mortgage lender.  Just remember that each lender is different, and may request additional documents from you.

Personal Information:

  • Social Security Number and Date of Birth. Required of you and any co-borrowers.
  • Current Housing Information. For renters: your address, the name and address of your landlord, proof of lease, and your current monthly rent.  If you’ve lived at your current address for less than 2 years, bring information for your previous addresses.  For existing homeowners: your address, current market value, mortgage lender, account number, current monthly payment, and outstanding balance due on the mortgage.

Employment Information:

  • Employer(s) Verification. Names, addresses, and telephone numbers of your employers for the past two years.
  • Income Verification. Your two most recent pay stubs with year-to-date earnings, and W-2s for the past two years.
  • Self-Employment Documents. If self-employed, bring your profit and loss statement and balance sheet for the past two years, and two years of tax returns.
  • Additional Income. Bring documentation to prove you receive any of these additional forms of income: social security or veteran’s benefits (provide copies of the award letter), overtime bonus, commissions, interest income, or alimony income from divorce/ separation agreements.

Financial Information:

  • Tax Information. W-2 tax forms and tax returns for the past two years.
  • Bank Account(s) Information. Account number(s) and current balance(s) of your checking, savings, or any other account(s).
  • Assets Information. Statements of current assets, such as Individual Retirement Accounts (IRAs), Certificates of Deposit (CDs), stocks, and bonds.  For individual investments, a current brokerage statement with the name of the stocks, the amount per share, and the number of shares owned.
  • Personal Property Information. Disclosure of the value of your personal property, including employee retirement accounts, furniture, cars (copy of titles to any vehicles owned), any valuable collections or other valuable property, and life insurance.
  • Credit Information. Credit card bills for the past few billing periods.
  • Rental Property Information. Federal tax returns and a schedule of all real estate property you own, plus account number and address of the mortgage company if any property you own is not paid for.  If the property is rented, provide a copy of the current lease and rent payments in the form of canceled checks.
  • Gift Funds. If money for down payment is a gift from a relative, supply a copy of the gift letter (which should state that the gift money does not have to be repaid) and copy of the gift check.
  • Divorce or Separation Information. A copy of the divorce decree or maintenance agreement, along with any amendments and a 12-month payment history of alimony and/or child support payments, as well as documents if the payments are needed to verify your income and qualify for the mortgage.

Top 5 Tips To Financing A Home

  • Get pre-approved – A pre-qualification letter is an important first step in successful home hunting, so real estate agents and sellers take you seriously.
  1. Get your documents in order – You’ll need to document two years’ worth of your gross income, down payment, and credit.
  2. Understand your credit score – Your credit score plays a key role in determining several factors of the mortgage you get, and there’s more to it than just paying your bills on time.
  3. Do not increase monthly debt – while you are going through the process of buying a home as it could negatively impact your ability to buy the property / qualify for a loan.
  4. Keep paying your bills on time