Buying a home is a significant long-term investment, the foundation of our lives, providing financial and emotional security. It is also more than likely the largest single transaction that you'll ever make. We believe it's so important to choose a home and mortgage that are well suited to your needs. We want to be there for you every step of the way, starting with this guide.
It is a good idea for you to understand your mortgage options and costs incured so you can make an educated decision about the home financing that best fits your needs. We search over 200 lenders, tailoring a home financing package which best fits your unique financial picture. We find programs to help you realize your home, even if you have past credit issues.
Why Buy Instead of Rent?
I have no idea of who first coined the phrase "the American dream" but home ownership is still a meaningful goal for the majority of both individuals and families. Owning a home is thought of as a wise investment as homes have increased in value over the past decades and it appears they will continue to do so. Additionally, as time goes by you will gain equity, like a bank account you can borrow against it, should the need arise.
Unlike renting, home ownership allows for significant tax breaks, because interest paid on a home mortgage is almost always tax deductible. The personal satisfaction of owning your own home a home to share with friends and family is immense, you can hang a picture, paint, garden, without the need of someones permission.
Key Points:
- What is a mortgage?
- What does my mortgage payment include?
- How do I qualify for a mortgage?
- How much home can I afford?
- How large of a loan can I be approved for?
- How important is my credit history?
- How much do I need for a down payment?
- What about closing costs?
- What kinds of mortgages are available?
- What are my possible financing choices?
- Which loan is best for me?
- Are there any tips to consider when loan shopping?
- How important is pre--approval?
- Who will approve my application?
- What happens after I apply?
We hope to answer many of your questions and make you more comfortable with the home buying process. This reference tool also includes a glossary to take some of the mystery out of the process, you'll allows have a check list to help you with your home shopping.
Home Financing 101
What is a mortgage? A mortgage is a loan secured by your real estate (your home). You guarantee to pay back the this loan plus interest to the lender over a certain period of time. You back up this guarantee by pledging your home as collateral. Should you default you will allow the bank to take over ownership of the property, this is known as a foreclosure. Your mortgage will be paid back in monthly installments set by your mortgage note.
What does this monthly payment include?
The common practice is for your mortgage payment to include four parts:
- Principal
- Interest
- Taxes
- Insurance
Depending on your situation it might also include association dues, pre planed building maintenance, mortgage insurance and assessments. Principal is the amount of your monthly payment that reduces the original amount borrowed. Over the life of a standard mortgage loan, the entire mortgage is fully paid off, this is known as fully amortized. The interest rate is the fee charged to borrow the outstanding balance for the PAST MONTH. Additionally, a monthly amount may be collected and held in a separate ESCROW account to cover property taxes, homeowners insurance (known as "Hazard Insurance"), and mortgage insurance. The lender will pay your real estate taxes and home owners insurance when they come due.
How Do I Qualify For a Mortgage?
All lenders use the same "4 C's" Capacity, Character, Capital and Collateral as the standards to approve or deny an applicants application.
Should your situation require any one of these to be "over looked" the risk of default increases and so does the interest charged.
1) Income (Capacity)
You need to be able to verify sufficient, steady, ongoing income to make the monthly payments and allow for normal living expenses. Your lender will divide your Gross Mmonthly Income by your monthly debt (including current obligations, new home expenses) the result is a percentage called your Debt to Income Ratio (DIR). Each lender and certain mortgage programs have DIR maximums they will accept.
Sources of income may come from:
- Employment, including self employment, overtime, commissions, retirement benefits
- Investments annuities
- Veterans benefits
- Disability payments
- Alimony & Child Support
- Rental income
While most mortgage programs require verification of income. However, there are special programs which do not.
2) Credit History (Character)
Although this is based mainly on how you make your payments, it also takes the length of time you have had credit and the types of credit you have. If you have limited or no credit history, "nontraditional" credit history may be the answer (including utility payments, telephone, cable tv, rent, storage shed, etc..). Did you file bankruptcy have judgments or a foreclosure special financing programs may help you still get the home of your dreams.
3) Savings (Capital)
Do you adequate funds to cover; earnest money, down payment, cash to close, and escrow account set up and reserves (if required)? Not only do you need funds to cover your new home purchase and its expenses but you also need funds to cover current obligations as well. These funds can come from savings, 401k, gifts.
4) Property (Collateral)
An appraisal on your new home will be required. This appraisal will determine its market value, using recent sales in the area. Additionally, if you are looking at a town house or condominium there will be home owner's association dues which increases your Debt to Income Ratio. This increase may force the underwriters to re-evaluate your application. Should you wish to prepare your lender for a possible increase in DIR inform your lender you are looking town houses and condominiums they can then plan for it.
Most Realtors® will require you to be FULLY pre-approved for a mortgage loan prior to showing you homes. This FULL pre-approval should be conditional only as far as appraisal and title work. However, should you decide to make credit purchases after being pre-approved you must realize those purchases will change you DIR. This change just as association dues may be enough to disqualify your application.
How large of a loan and how much can I spend on a home?
Your Mortgage Broker will look at your financial profile, credit history, available cash, existing debt and financial obligations. Your Mortgage Broker will then search the market for a mortgage that fits your risk factor and wishes. Using the current interest rate for that mortgage program your Mortgage Broker then can predict the maximum loan amount you might qualify for. To that maximum you will add the funds you have set aside for down payment this is the maximum purchase price you should look at.
Two general guidelines are used by lenders to determine to loan amount for which you may qualify. These guidelines (based on your individual financial profile) ensure that your housing expenses and debt payments don't take up too much of your income. These guidelines can help you remain inside your financial comfort zone after you buy a home.
The first guideline, known as the housing expense - to - income ratio (or front - end ratio), compares your gross monthly house payment (PTTI) to your total household gross monthly income. The second guideline, known as the debt - to - income ratio (or back end ratio), compares your anticipated monthly housing payment to your gross (pre - taxed) monthly earnings and your monthly debt requirements. Monthly debt includes expenses such as credit cards, car loans, student loans, consumer loans plus other financial obligations such as child support and alimony.
At one time maximum rations were 28/36, this meant you could devote up to 28% of your gross monthly income to housing expenses (the front end ratio) and your monthly total living expense could be as high as 36% (the back end ratio).
Currently, these ratios have been so expanded that some mortgage programs don't use ratios. However, the majority use ratios of 30/43. Although this allows the buyer to purchase more home it may stretch the limits to a point where there isn't money for emergencies or entertainment.
Depending on your financial profile and the mortgage program you choose, your mortgage broker may use standard or flexible ratios as part of the qualifying process. Once you have this maximum figure, it's up to you to decide if this is the right amount for you. You may feel more comfortable with a smaller mortgage and a lower monthly payment. Perhaps you can't find a home of lessor price yet you want lower monthly payments. Your mortgage broker may have additional programs that will help.
The Credit Report How Important Is It?
Your credit report is an important consideration to lenders reviewing your financial profile. If you have a history of paying your monthly obligations on time, your lender will assume there is a good chance of receiving payments on time as well. So your credit report is looked upon as a major factor in your qualification and the amount you may qualify for. However, keep in mind even if you have no credit history or challenged credit including bankruptcy and or foreclosure, your mortgage broker has access to programs that can help you buy a home.
A few steps to improve or establish credit ratings
1) If you've always paid by cash or checks to make purchases, you haven't established a credit record. You can use credit to purchase low - priced items, make prompt payments and pay off the balances as they occur.
2) Some loan program guidelines allow for "alternative" credit. If you have limited credit history, your paid receipts and canceled checks for rent, utility payments, storage shed, car insurance, items paid on a monthly and ongoing basis may be used to document a pattern of paying on time.
3) If you already have outstanding loans or credit card debts, try to pay off as many as possible (remember doing so will reduce your back end ratio and increase your maximum loan amount). Do not cancel any card or other revolving debt that you've had a long time as they are your history, canceling them elimenates your history.
4) If on the other hand you have credit cards you do not use and have not had for a long period of time it may be best to cancel them.
The Down Payment
In the past, saving money for a down payment on a home was often the largest barrier to home ownership. Most lenders required 20% down while some required even larger percentages down. However, with todays flexible loan programs the issue is less of a challenge. You may qualify for zero down and seller paid closing costs.
One thing of great importance you must consider; should you desire to have less than 20% down you would normally be required to pay Private Mortgage Insurance (PMI). To avoid PMI you might consider a combination of loans, such as a 80/10/10, 80/15/5 or a 80/20. The first number (80) would be yor first mortgage 80% of the purchase price. While the second number is a second mortgage 10 or 15 or 20 of the purchase price. You will note the first two combinations have a third number this is the percentage of the purchase price you would use as a down payment. Notice the third combination equals 100% of the purchase price, menaing nothing down. An additional inovation is the 75/20/5, used with some lenders to attain approval not received by the 80/XX programs ro to avoid jumbo mortgage rates.
Closing Costs
Closing costs cover the amount you pay to closie a mortgage loan aside fro the downpayment. The amount you pay in closing costs varies among lenders, mortgage products and localities. The closing cost fees generally fall into one of three categories:
- out of pocket expenses
- pre-paid items
- points
Out - of - pocket expenses usually cover third party services that are directly charged to you, such fees for appraisals, attorneys, credit reports, title work or tax xervices. Which services you must pay for varies on the property location and home financing program. If you don't understand what the fee covers, or why you must pay it, ask your mortgage broker to explain it.
Pre-paid items can varie based on the type of propery and the time of the closing, but they generally include home owners insurance, mortgage insurance, and fees associated with establising an escrow account. Escrow accounts are set up by lenders to pay property tax and insurance premiums. Instead of paying the entire premium every six or 12 months, the borrower pays a portion of the cost along with every mortgage payment. This helps the borrower avoid the hassle of planning for the large payments, while reassuring the lender that tax and insurance paymetns are always up to date. Using an escrow account is an option and NOT a requirement.Points are fees, each point representing 1% of your loan amount, that cover the cost of your mortgage loan. Generally, points can be split into two categories:
- Origination Points: This is an amount by the lender for making the loan.
- Discount points: As discussed elswhere in the article, this is a fee that allows you to buy down the interest rate. In other words, in return paying more discount points upfront, you can lower yor interest rate and thus your monthly payment. This is common practice if yor debt to income ratio is very close to or exceeds the maximum approval guidlines.
To make the best apples - to - apples comparison on lendes and home financing packages, be sure all have the same number of total points and that you factor in the total amount you will be paying at closing. While one may offer a lower rate, it may also require you to pay a higher number of points at closing, thus more out of pocket for you. Also, don't forget to consider the loan features in addition to rate, APR, and points when you compare different loan programs.
The Annual Percentage Rate (APR) adds in other costs required to make the loan to determine your loan's total finance charge, expressed as a percentage over the life of your loan. After you apply for a mortgage, you will receive a Truth - in - lending Statement (commoningly refered to as the Till). Homebuyers often find this document confusing because it states the APR only, and not the interest rate.
Lock or Float
A lock gives you a specified period of time - from 15 to 120 days - of protection from financial market fluctions in interest rates by setting the range of pricing available to you. Your rate may still be affected by changes in the loans's characteristics (for example, if you choose to pay fewer points or make a smaller down payment) or in your credit profile or employment.
If you choose to float your pricing, then your rate will fluctuate with the market. The benefit to floating is that you would have the optionof locking at a lower level if rates should decrease. The risk, of course, is that you would face a higher rate should interest rates rise before you lock. It is sort of like riding a roller coaster hoping you lock at a low point but due to closing date you may find your self at a peak, it is a gamble. Certain banks and certain types of mortgages do not have a lock feature until all paper work has been completed and a closing date has been set. However, there are a few "lock and look" programs, where you may lock a rate then start looking for a home. This type of a lock puts presure on finding, buying and closing on the buyer.
Remember, no one can predicte the future nor can they predicte if interest rates will rise or fall. It is up to you the home buyer to decide to lock or float, the decision is yours.
Additional Questions?
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