Buying a Home
Buying Your First Home And Getting Your First Mortgage
Owning a home is one of the main ways that many Americans build wealth. Instead of renting each month, and having nothing to show for it, you can buy a home and build equity.
Equity is the difference between what a home is worth and what is owed on it. There are two ways to create equity in your home. First, your home’s value may rise just because housing values in your area are rising. Secondly, as you pay off the loan, the difference between what the house is worth and what you owe gets larger.
Building equity can give you flexibility. You may be able to borrow against it, take it out as cash when you sell the home, or even leave the home to your heirs as an inheritance.
In addition, a good portion of your home mortgage payment each month will go toward paying interest — especially in the early years. That interest is usually tax-deductible, which may mean more money in your pocket each month than if you were making a similar rent payment before.
Buying your first home can be intimidating, but you shouldn’t let it be! Today, there are thousands of different loan programs designed to allow people to get a loan that fits their needs. Whether your challenge is saving money for a downpayment, or a damaged credit rating, there are loans that can help. At the same time, you want to be financially prepared to own your own home – so you’ll be able to afford to keep it!
How Much Can I Afford?
The most general rule of thumb is that you can afford a home of about 2 – 3 times your annual income. So if you earn $30,000 a year, you can “afford” a home of about $60,000 -- $90,000. Lenders, however, have much more specific guidelines which we’ll describe next.
Tip: Be very careful about stretching yourself too thin and buying the most expensive house you can afford. Unexpected repairs, a spouse who decides to stay home to take care of children or aging parents, a lay off, or any other financial challenge can make it difficult to keep up the house payments.
Qualifying Ratios
Lenders use something called “qualifying ratios” to decide how much house you can afford. There are two ratios used here: the housing ratio (or “front end” ratio) and the debt ratio (or “back end” ratio).
Housing Ratio
Your housing ratio shows how much of your income will go toward making your house payment. Your house payment includes the payment required on the loan, which is made up of principal and interest. It also includes your property taxes and homeowner’s insurance. Together, these are called “PITI” – for principal, interest, taxes and insurance. If you have to pay Private Mortgage Insurance (PMI) because you put too little down on your house, it will be included in your PITI.
The rule of thumb is that your monthly PITI should not be more than 28% of your total monthly income. To calculate how much monthly payment you can afford take your total monthly income (before taxes, health insurance or retirement plan contributions are taken out).
Multiply that by .28 you will get the total monthly payment you can afford.
$_______ X .28 = _________
Example: Monthly income of $2500 x .28 = $700.
Keep in mind, however, that there are programs that will allow you to carry a higher monthly housing payment. This is only a guideline.
What price house will that payment buy? That depends upon what current interest rate you’ll qualify for, and how much your taxes and insurance on the property will be. Ask a loan officer to calculate this for you, based on current interest rates and typical taxes and insurance rates in your area.
Debt Ratio
Your debt ratio tells how much of your monthly income is going toward all your debts, including your housing payment. To figure your debt ratio, list your monthly debt payments. Don’t include any debts that will be paid off in the next 6 months.
Expected PITI: ______________
Credit cards (minimum payments only): ______________
Auto loans or leases: ______________
Student loans: ______________
Other personal loans: ______________
Child support or alimony (you pay): ______________
Total monthly payments on all loans: =______________
Now take your total monthly income and multiply it by .36.
$_________ X .36 = ___________
Example: Total monthly income of $2500 x .36 = $900
The figure you get is the maximum total monthly debt payment you’ll be allowed under many conventional loan programs. Ideally, your monthly debts should be lower than that amount. But again, it’s not a hard and fast rule – consumers do sometimes get mortgages even though they have higher debt ratios.
Cosigners
If a spouse, relative or anyone else will be purchasing the home with you, then you can include their income and debts in the calculations. If you qualify, however, you can buy the house yourself. Generally you cannot have someone cosign for the home loan unless they will be living in it as an owner with you.
What if your debts are too high? First, talk with your loan officer or mortgage broker to see if there are other programs that can help. But if you are still having trouble qualifying because you have too much debt, contact Consolidated Credit Counseling Services, Inc. for help in working out a repayment plan to pay back your debts.
Plan For Other Expenses
Owning your own home can be expensive! All the repairs you previously left for your landlord to worry about now become yours.
For a Free Consultation with a Certified Credit Counselor call 1-800-210-3481
Plus most people want to fix up their new home to suit their tastes. Keep a cushion for all those expenses that may crop up. Here are some examples:
Coming Up With A Down Payment
When you buy a home, you’ll need money for the down payment and for closing costs. While it used to be that you had to have 20% of the price of a home for a down payment, those days are long gone. Now you can get loans for 90 to 100% of the home’s price!
Those loans, however, may be more expensive because you may have to pay Private Mortgage Insurance (PMI). PMI protects the lender, not you, if you can’t make your house payment and go into foreclosure. It can add anywhere from $25 -- $150 or more to your monthly payment. It’s important to know that PMI is purchased by the lender, the cost may be influenced by your credit rating, and it is not tax deductible.
Piggyback loans can help you avoid PMI. With a piggyback loan you borrow 80% of the home’s value from one mortgage lender, while at the same time getting a loan from another lender for 10 – 15% of the home’s value. There is no PMI on a piggyback loan. Ask your loan professional for details. In addition, VA and FHA loans have very low and no down payment options.
Down payment assistance organizations can help as well. These nonprofit organizations offer programs that allow you to buy a home with no money down. The seller of the house you’re buying must participate and some will when they learn how this can help them sell their home faster. For more information, including links to companies that provide these services, visit www.downpaymentalliance.org. You don’t have to be a first-time buyer to take advantage of one of these programs.
American Dream Downpayment Program
A law went into effect in early 2004, authorizing $200 million in grants to help homebuyers with downpayments and closing costs, the biggest hurdles to homeownership. The average grant is expected to be $7500. The focus is on low-income families who are also first-time homebuyers. To participate, recipients must have annual incomes that do not exceed 80 percent of the area median income. For more information, visit www.HUD.gov.
Closing Costs
If you’ve never obtained a mortgage, the variety of closing costs that may be charged may seem bewildering! Closing costs, also called “settlement costs” can usually account for about 4% of the loan amount, sometimes more. If you don’t have a lot of cash, it can be helpful to negotiate to have the seller pay part of your closing costs. Depending on the loan program, they may be able to contribute 3 – 6% of closing costs. Again, ask your loan professional.
Three days after you apply for a mortgage, you’ll get what’s called a Good Faith Estimate of these closing costs. Review it carefully and ask your loan professional about any fees you don’t understand. You can also keep a copy to compare with your closing statement. Some estimated items will change.
When your loan goes to closing, you’ll get a copy of what’s called the HUD-1 Settlement Statement. These costs may be listed on that statement.
The numbers listed below refer to the section of the statement where you’ll see them appear:
800. Items Payable in Connection with Loan: These are the fees that lenders charge to process, approve and make the mortgage loan.
801. Loan Origination: This fee is usually known as a loan origination fee but sometimes is called a "point" or "points." It covers the lender's administrative costs in processing the loan. Often expressed as a percentage of the loan, the fee will vary among lenders.
802. Loan Discount: Also often called "points" or "discount points," a loan discount is a one-time charge imposed by the lender or broker to lower the rate at which the lender or broker would otherwise offer the loan to you. Each "point" is equal to one percent of the mortgage amount. For example, if a lender charges two points on an $80,000 loan this amounts to a charge of $1,600.
803. Appraisal Fee: This charge pays for an appraisal report made by an appraiser. The lender will require that the appraiser be on its approved list. An appraisal is not a substitute for a good home inspection.
804. Credit Report Fee: This fee covers the cost of a credit report, which shows your credit history. In some states, lenders are not allowed to charge more than the actual cost they pay for a credit report. In others, it may be marked up.
805. Lender's Inspection Fee: Lenders usually require inspections of newly constructed housing. (Pest or other inspections made by companies other than the lender are discussed later.) It is still however, a good idea for you to pay for your own inspection.
806. Mortgage Insurance Application Fee: This fee covers the processing of an application for mortgage insurance.
807. Assumption Fee: This is a fee which is charged when a buyer "assumes" or takes over the duty to pay the seller’s existing mortgage loan. Most conventional loans these days are not assumable, while VA and FHA loans are.
808. Mortgage Broker Fee: Fees paid to mortgage brokers would be listed here. You may see additional fees listed in this section, such as courier fees, loan-processing fees, underwriting fees, etc. Some fees may be negotiable, and the seller may pay some.
Section 900. Items Required by Lender to Be Paid in Advance:
