ABC’s of Real Estate Finance
When you are starting a home search, the first subject you must become familiar with is how to finance your purchase. In this author’s opinion, the best way to go is with a lender or broker who was referred to you by someone you trust. When you decide on someone, the next step is to find out if you really qualify for a loan.
Credit Score, Income, and Debt
The first question a mortgage lender will want to know is “what is your credit score?” (Tip: Most first time home buyers don’t realize that they do not have to give every possible lender their social security number to get an estimate of their rates. If you know your credit score, you can just tell them what it is and let them give you the rates they have, then you can come back and give them your social to process the loan.) Most lenders will not even look further into an application with a credit score lower than 580, while others will try to take advantage of bad credit customers with high priced products. Generally, customers with credit scores over 700 will have an easy time getting a fair mortgage loan. If your credit score is less than desirable, you may want to reconsider your decision to purchase a home at this time.
How Much Home Can I Afford?
So one of your first questions to tackle is “how much home can I afford?” The general rule is that your total monthly home costs should be no more than 28% of your gross monthly income. Monthly home costs include mortgage payment, taxes, insurance and any home repairs and upkeep. (Tip: You can find many mortgage payment calculators by doing a simple Internet search.) You also need to find local information about your tax and insurance rates.
Another important formula that most lenders will consider is your debt-to-income ratio. You generally do not want your total monthly debt to exceed 36% of your gross monthly income, or you may be in a trouble zone as far as trying to get your home purchase financed at a reasonable rate.
In the previous market, down payments were not always necessary. Mortgage brokers had many products that provided 100% financed loans to cover the entire loan. Nowadays, these types of loans are a thing of the past. You need a down payment of at least 10% of the purchase price of the home to receive financing, along with the closing costs which can be as high as $5,000. (Tip: Most sellers will provide what is called a “seller’s assist,” which is a percentage of the home purchase price, usually about 3% that will be put forth to help the buyer pay his or her closing costs. This “seller’s assistance” is applied at the closing table.)
What Kind of Mortgage Product is Best for My Situation?
Once it is determined that your credit score, income, home price, and debt load is appropriate for your situation, you then have to make the decision with your lender on what kind of mortgage you will take. The 30-year fixed loan is the most common and preferred-basically you will make a fixed payment every month for the next 360 months at a set rate. Some people vie for a 10, 15, or 20-year fixed loan at a higher monthly payment, the benefit being that you will be finished paying for your house in much less time compared to a 30-year, and save thousands in interest. (Tip: Most people also make biweekly-instead of monthly-payments on their 30 year fixed mortgages which allows them to pay off their loan quicker and with much less interest cost.)
Stated income and stated assets loans are available to people who are self-employed and have good credit. With these products you do not have to prove or verify income or assets, and the lender is only considering your payment and credit history. The negative side of a stated income or asset loan is a slightly higher interest rate which could cost you thousands over time.
Mortgage Loans to Avoid
– Balloon Payment mortgages (large payment at the end of the loan)
– Interest-only mortgages (only useful for real estate investors)
– Adjustable rate mortgages (ARMS) (not as bad as the others, but the rate is fixed for a certain number of years, then varies, sometimes to the detriment of the home buyer.)
Do Your Research
Use the Internet for all it’s worth. Search, research, and search again to gather as much information as possible before making a final decision on your real estate financing. Information is power, and ignorance is costly. With the proper research, questions, and parties involved in your transaction, financing your home can be a breeze.