There's no point wasting time and energy
house-hunting before you know what you
can afford. So your next step is to
assess your finances:
Interest Rates and How They Change
As you start shopping for a home loan,
your first question of each lender will
probably be "What's your interest rate?
How much are you charging?" Interest
rates are usually expressed as an annual
percentage of the amount borrowed. If
you borrowed $120,000 at 10% interest,
you'd owe interest of $12,000 for the
first year. With most mortgage plans
you'd pay it at the rate of $1,000 a
month. You would also send in something
each month to reduce the principal debt
you owe - and the next month you'd owe a
bit less interest.
When your grandparents bought their home
(putting at least half the purchase
price down, by the way), their interest
rate was probably around 4 or 5%. Rates
stayed the same for years at a time.
Then in the years following World War
II, things became more turbulent. As
economic changes speeded up, rates began
to change several times a year. By the
l980s, lenders were setting new rates on
mortgage loans as often as once a week -
and they still do today. When inflation
hit a high in the '80s, some mortgage
loans carried interest rates as high as
17% - and those who absolutely needed to
buy, paid that much. Rates dropped
gradually through the 1990s, and by 1998
had reached their lowest rates in
decades.
Closing Costs
On the day you actually buy your new
home, in addition to your down payment
and the prepaid property tax and
homeowners insurance premiums, you'll
need cash for various fees associated
with the purchase. These expenses are
known as closing costs and are paid by
both buyers and sellers. Some closing
costs you pay up-front when you apply
for a mortgage loan. That includes money
for a credit check on all applicants and
an appraisal on the property. Keep in
mind that even if you don't eventually
receive the loan, that money is not
refundable. Other closing costs are
possible and should be considered when
evaluating your financial situation.
These may include, but are not limited
to:
-
Title insurance fee
-
Appraisal charge; Loan origination fee
-
Attorney fees or escrow fees
-
Document preparation fee
-
Points - up-front interest paid in return for a
lower interest rate. Each point is
one percent of the loan amount.
Sometimes you can contract for the
seller to pay your points.
TIP:
Consider closing costs when choosing
one mortgage plan over another. The
good news is that if your cash is
limited, some mortgage plans allow the
seller to pay some or all of your
closing costs, such as title insurance,
escrow fees, and points. Certain closing
costs can sometimes be added to the
amount of mortgage loan you're
receiving.
Figuring Out Your Monthly Income
When you apply for a home loan (and even
long before that, when you first speak
to a REALTOR) the first question may
likely be "How much is your income?" In
making this determination, lenders
consider the income of all parties who
will be owners of the property. Be
prepared to provide a monthly accounting
of all sources of income.
Figuring Out Your Monthly Debt
Lenders are interested mainly in your
present monthly payments because they
want to be sure you can handle the
mortgage payment you'll be applying for.
Different mortgage plans consider
payments on any debt that won't be paid
off within, for example, six months,
nine months, or a year.
Amount of Your Down Payment
Your down payment is paid in cash and is
not included as part of the loan amount.
The bigger your initial down payment,
the smaller your loan, which reduces the
amount of your payments. How much you'll
put down depends on the cash you have
available and the amounts you'll need
for closing costs and prepaid property
taxes and homeowners' insurance.
Mortgage plans have various down payment
requirements and they can range from 0%
down on a VA (Veterans Administration)
loan to between 3 and 5% down on a FHA
(Federal Housing Administration) loans
to 20% down, the traditional amount for
a conventional loan. In addition,
special state programs for first-time
home buyers may set different sums,
which are usually lower than
conventional financing.
If you put less than 20% down on most
loans, you'll be asked to protect the
lender by carrying private mortgage
insurance (PMI). Carrying PMI ensures
that the debt is repaid if you default
on the loan. This adds approximately an
extra half a percent onto the loan. FHA
mortgages, in return for their
low-down-payment requirements, also
charge for mortgage insurance premiums
(MIP).
How Much House Can You Afford?
The amount of loan for which you qualify
is based on two different calculations.
Using what are known as qualification
ratios, lenders evaluate your income and
long-term debts to determine a "safe"
amount for your mortgage payments. A
fairly standard ratio is 28/33. Certain
mortgage plans sometimes use more
liberal ratios - for example, the FHA
currently uses 29/41. Here's how it
works: With a 28/33 ratio, you'd be
allowed to spend up to 28% of your gross
monthly income for mortgage payments.
The lender will then run a different
calculation. This one is your loan
payment and debt payments combined,
which may not exceed 33% of your gross
monthly income.
To calculate exactly how much you may
borrow, you also need an estimate of
current interest rates. For Example:
Suppose you had $1,000 a month for
mortgage payment; at 7% that would let
you borrow about $160,000 on a 30-year
loan. At 6% the loan amount would be
nearly $175,000. If your rate were 8%,
the loan amount would be a bit less than
$150,000. As part of this calculation,
you also need to estimate and include
the property taxes and homeowner's
insurance which are considered part of
your monthly expense.
Begin the home buying process by using our mortgage calculator to
determine how much you can afford, or
visit a mortgage lender and they can
analyze it for you.
Assess
Your Finances
