There are many financing options available to homebuyers today. There are conventional loans, government backed loans, fixed rate vs. adjustable rate mortgages, hybrid mortgages, and many different programs designed to meet the individual needs of each buyer. We highly recommend that if you are considering buying a home in the near future that you begin to search for a lender and a loan program that suits your current financial needs, as well as your future goals.
If you do not have a bank or mortgage company that you already do business with, we would be happy to refer a lender for you to interview, or you can find many on-line. The key is to find a lender that you are comfortable with and that has a wide variety of loan packages available for you to choose from. You need to consider how long you plan to keep the home, if you are eligible for any government backed loans, how much down payment money you have, and what your credit rating and debt ratio is. Many mortgage companies and banks are competitive when it comes to interest rates and the various fees that they charge. It pays to shop for a mortgage!
Most loans fall into the following three major categories:
- Fixed-rate mortgages
A fixed rate mortgage has the same interest rate for the life of the loan. These types of mortgages are the most popular simply because they are easy to budget for and guard against inflation. Fixed-rate mortgages are usually for terms of 15 or 30 years.
- Adjustable-rate mortgages
An adjustable-rate mortgage (ARM) is based on an interest rate that changes over the life of the loan. The interest rate is tied to an index, such as Treasury Securities, that rise and fall over time. ARM's usually have caps to protect against dramatic increases in the rate. The rate may still increase, but will not be able to increase more than a certain percentage per year, and never go over a preset amount for the life of the loan. ARM's often have low introductory rates and are a very popular alternative to fixed-rate mortgages. Make sure that you understand the caps and ceilings for any ARM you are considering.
- Hybrid mortgages
Hybrid mortgages are a combination of fixed-rate and adjustable-rate loans. The loan could start with a fixed rate and then convert to an ARM after a certain period of time. Other loans may start with a fixed rate and then convert to a higher fixed rate for the remainder of the loan term. Usually the introductory rates for a hybrid loan are lower than a fixed rate, which may be attractive to a buyer that is planning on selling the home after a short period of time (5 years or less).
Get Your Finances in Order
If you are considering buying a home, the most important first step is to determine what your financial situation is and how this will affect your buying power. You need to know how much money you have available for a down payment and have a clear handle on your debts, expenses and income. A lender will need to verify all of your financial information and credit history. They will expect you to provide them with the following documentation on everyone who will be an owner of the home:
- Paycheck stubs to verify employment history and average income.
- Bank statements to see your history of saving and to verify funds.
- Tax records, especially if you are self-employed, to verify your annual income.
- Dividends & Investments that can strengthen your financial situation.
- Alimony/Child Support payments that can count toward your income.
- Credit Report that will list all of your long term debts as well as your payment history.
We highly recommend that if you have any doubts as to your credit history, that you obtain a copy of your own credit report ( US federal law requires that consumers have access to their credit reports available through local credit bureaus or national firms that specialize in credit reports ). This way, if there are any discrepancies or issues you have time to resolve them before your bank or lender sees the report. Credit bureaus are required to assist people in clearing mistakes on their credit reports, but it could take up to a month. Once you have a clean copy of your credit report, you can make copies for your lenders and avoid the fee they charge to pull your report themselves. From this report, you and your lender can begin to discuss the different loan options available to you.
How Much Home Can You Afford?
Determining how much home you can afford is crucial before you go out and begin looking at homes to purchase. Many sellers require that buyers submit a prequalification letter with an offer to purchase. Thus it is important to visit a lender and have them prequalify or preapprove you. Prequalification is simply an estimate of what a lender thinks you can afford based on the information provided by you. Preapproval is a step further where the lender has verified the information provided by you and agrees to lend you a specified amount of money.
Important criteria for lenders and bankers
- Your gross monthly income
- Your debt-to-income ratio ( monthly debt should not be more than 36% of monthly gross income )
- Your housing expense ratio ( monthly mortgage payment should be less than 28% of monthly income )
- Your credit history
- Amount of your debts
- Savings available for down payment and closing costs
- Your choice of mortgage
- Current interest rates
Down Payment Money
Most lenders expect buyers to make a down payment of 5% - 20% of the value of the home. The more you can afford toward the down payment, the less your monthly mortgage payments will be. The lender will need to know the amount of your down payment as well as the source of those funds.
Here are some other important factors to be aware of with regard to out of pocket expenses for buying a home:
- Private Mortgage Insurance:
Typically if your down payment is less than 20% of the purchase price, you will be required to pay Private Mortgage Insurance (PMI). This insurance is to protect the lender in the event of a default on the loan and carries a monthly premium paid by the buyer on top of the mortgage payment. Once 20% of the loan is paid off, the policy can be cancelled. Be aware that most lenders require you to request in writing to have the policy cancelled, as opposed to simply canceling it.
It is not permitted to borrow funds for the down payment or closing costs when buying a home. However, it is permitted to receive a gift of these funds from a family member, friend, or other source. The lender will require that you produce a gift letter stating that the money does not have to be repaid. Be sure to discuss this in advance with your lender to make sure that no other requirements need to be met regarding a gift.
- Earnest Money:
When writing an offer to purchase on a home, you will be expected to submit a check for earnest money, which, when the offer is accepted, is credited to the buyer at the time of closing. This money is a show of faith regarding the offer and should be kept in a trust account until the time of closing or is dispersed according to written instructions from both parties or a judge. The amounts differ greatly, but anticipate this cash outlay up front.
It is customary for all required or optional inspections to be paid for by the buyer. Although some inspectors will allow for their payment to be paid at the time of closing, many expect payment at the time of the inspection. Again this amount varies depending on the inspector and type of inspection.
- Closing Costs:
You will also need to set aside additional funds for closing costs. These are fees associated with the loan and the property, such as origination fees, title insurance, survey, appraisal, attorney's fees, property taxes, home owner association dues, etc. Often times, the closing costs can run into thousands of dollars. Sometimes these are negotiable with the seller. As your agent, we can help you determine this amount up front so that you are prepared.