Mortgage Basics
When you want to buy a home, you will be faced with many decisions. The first is whether you are actually ready to buy. Finding the right home is not always easy, and getting a mortgage loan can be time-consuming and complicated. To help you decide if you're ready to buy, we'll take you through the steps a mortgage lending institution uses to decide if you qualify for a mortgage loan. When you take out a loan, you sign documents that say you promise to pay back the loan. When a mortgage lending institution makes your loan, it has determined that there is a good likelihood that you can keep that promise. The mortgage lenders knows that it does not help you or the lending institution if you are given a loan, but then, for any reason, are unable to make the payments each month. To decide if you will be able to repay the loan, the lender will look at many different pieces of information about you. This process is called "underwriting." These pieces of information show how well you have repaid your debts in the past, whether you are likely to repay your debts in the future, and your ability to repay the mortgage and your current debts. There are some general guidelines that help a lender in looking at these pieces of information about you. But you should also remember that there is some flexibility in these guidelines, because everyone's financial situation is different. If you are very strong in one area, it may help balance out another in which you aren't quite as strong. Go through the questions below and test yourself. If you aren't ready to buy a new home now, you'll find we've included information that may you qualify in the future. When you get to the end, you will have a better idea of whether this is the right time for you to buy a home, or whether you need to work on improving your credit history, paying off existing debts, or saving more money. This is important. Having a steady job helps you to keep your promise to pay back a mortgage loan. If you have been working continuously for two years or more, you are considered to have steady employment. A lender will need to know your job history, and it will be a major factor in whether you qualify for a loan. However, you do not have to have held the same job for two years in order to be approved for the loan. Job moves that result in equal or more pay and continue to use proven skills are a plus to you. If you have been working continuously for less than two years, the mortgage lender will look for an explanation. There may be a good reason: You may have been discharged recently from the military or just finished school. Your work may be seasonal, and you might have work gaps between seasons. There may be other acceptable reasons why you have not been employed continuously for two years too. For example, you may have been laid off because of a plant closing or an illness. Or you may be in line of work in which frequent job turnover can be customary but you have been consistently employed and have maintained a regular, consistent level of income. If you have been fired for cause such as excessive absences, have long haps in your employment record, or have dips in your income level that are difficult to explain, you should probably delay buying a home until you can demonstrate that you have a stable work history. How you paid you bills in the past gives a lender some indication of how you can be expected to pay them in the future. When you apply for a mortgage, you will be asked too list all your debts, the amount of your monthly payments, and the number of months or years left to pay on your debts. Your lender will order a credit report to verify the information that you give and to check on how well you have kept your promises to repay your debts. Credit reports are provided by credit reporting companies that make inquires through a wide range of available sources of information: banks that may have given you a car loan, credit card companies, even gasoline companies and department stores that offer credit cards. It's important to disclose all debts and any difficulty you may have had in the past in repaying those loans. It's also not to leave out any information about money you owe. Credit reporting companies have access to a great deal of financial information about you, and they make it available to lenders who will be reviewing your loan application. If you have previously owner a home, and your mortgage has been foreclosed upon within the last seven years, the foreclosure will be revealed on your credit report. Having a foreclosure on your records doesn't mean you can never buy another home. Your lender will want to know the reason for the foreclosure, and most prefer that three years go by before you apply for a new mortgage. If you have declared bankruptcy within the past ten years that also will be revealed on your credit report and it will be helpful for you to explain the circumstances surround it. Lenders usually prefer that you wait two years after discharge of the bankruptcy before assuming a new large debt like a mortgage loan. This gives you time to reestablish credit and show that you are again able to manage your financial affairs. Sometimes credit reports are inaccurate, or they give a misleading picture of past credit problems that have since been resolved. To check the accuracy of yours, you can obtain a copy of your credit report. For a small fee or sometimes for free, you can request a copy from a "credit-reporting agency" listed in your local yellow pages. If you find any errors, you can take steps to have the report corrected. If your credit report shows that you do not have a good credit history and the information reflected is correct, you should probably delay trying to buy a home and take steps to improve your credit profile. For example, you may have too many debts, or you may pay some debts late each month. If so, you should work to bring your payments up to date and to pay off some of your debts. Even if yours are current, you may not be considered a good candidate for a loan if you have paid your monthly payment after the due date each month. After you have decreased the amount you owe and are able to show a two-year history of making payments on time, you may be ready to begin looking for a home to buy. If you have never had any credit cards or taken out a loan through a financial institution, the various credit-reporting firms may not be able to issue a credit report on you. In that case, you may be able to a "nontraditional" credit history. For example, you may be able to document that you pay your rent, telephone bills, or utility bills on time each month. You can put these records together yourself by making copies of canceled checks or showing copies monthly bills that you do not have any late charges. A mortgage lender may be able to help you put this information together. When you buy a home, you will need money that you have saved for a down payment and "closing costs." The amount of the down payment may vary, but generally you must make a down payment that equals at least 5% of the purchase price. You will also need money for closing costs. These costs can be expensive, depending upon where you live. Sometimes the property seller is willing to pay part of your closing costs. The mortgage lender will want proof that you have saved the funds that you will use for a down payment and part or all of the closing costs. If the funds are in a savings account, the lender will ask the financial institution to verify the amount and the length of time that the funds have been in your account. The lender wants to make sure that you are not borrowing all the money you will use for the down payment and closing costs. Some communities have program to help first-time buyers. With some of these programs, you may be able to accept a gift from a relative or to borrow a portion of the money you will need for the down payment and closing costs from a local nonprofit organization or government agency. With others, you may be able to get a grant or other funds you will not have to repay and can use to cover some of these costs. If you do not now have at least a portion of the money saved, this probably is not the right time for you to try and buy a home. Instead, it would be a good idea to open a savings account and begin putting away some funds from every paycheck. The longer you have account and the longer and more consistently you have been able to save money, the better you will to the lenders when you are ready to apply for a mortgage in the future. If you pay rent each month, you may be prepared to make monthly mortgage payments. The amount of your monthly payment depends upon the amount you borrow, the interest rate and the repayment period or "term"." The shorter the term, the higher your monthly payment. For that reason, most homebuyers repay their mortgage over the longest term possible, usually 30 years. The amount of your mortgage payment will depend on how much you borrow the term (repayment period) of the loan, and the interest rate. If you know how much you need to borrow (the purchase price minus your down payment), and what the interest rate will be, you can use Chart 1 to find out what your monthly payment will be with a standard 30-year fixed-rate mortgage. Note that this chart below includes only principal and interest payments, not property taxes and insurance.
Use Chart 1 to calculate how much your monthly mortgage payment might be for a 30-year, fixed-rate mortgage. Let's supposed that you want to purchase a house that costs %50,000. If you make a $5,000 down payment, you would need a $45,000 mortgage. As you can see on the chart above, the monthly payment on a $45,000 mortgage at 7 percent interest is $2999. The $2999 monthly payment only covers the principal, or a portion of the amount you borrowed, and interest on the mortgage loan. There are other expenses that will be added to your monthly payment. These include taxes and homeowner's insurance. If your down payment is less than 20% , you may need to pay private mortgage insurance. These costs vary depneding upon where you live and the cost of your home, but they can add a hundred dollars or more to your montly payment. In addittion, if you are thinking about buying a unit in a condo or cooperative building, or a hose in a planned unit development, you may also need to pay monthly homeowner's fees to cover maintenace expenses or special assessments related to the common areas. When you first approach lenders about financing a mortgage for you, they will use two commonly accepted guidelines to help determine your ability to make mortgage payments. These guidelines are a starting point for evaluating your ability to make payments n the proposed loan. So your lender will look closely at your financial situation to determine if more flexible guidelines are appropriate for you. 1. Your monthly housing costs (including mortgage payments, property taxes, homeowner and mortgage insurance, and homeowner's fees) should total no more than 28 percent of your monthly gross (before taxes) income. In addition to your regular income, your income can include funds you receive from overtime work, a part-time job or second job; retirement, VA, and Social Security benefits; disability; welfare and unemployment benefits; alimony; and child support. 2. Your monthly housing costs plus other long-term debts such as payments on car loans, student loans, or other installment debt (debts with more than ten months left to repay) should total no more than 36 percent of your monthly gross income. Depending upon your household income, you may be eligible for special assistance programs. These programs may make it easier for you to get a larger mortgage loan than you would normally be able to using the above qualifying rules. Now to get an idea of the mortgage amount that you might be able to qualify for based on your annual income, look at Chart 2. You will need to know the approximate interest rate that lenders currently are charging for a 30-year fixed rate mortgage. Check the real estate section of your local newspaper or call a mortgage lender to get the current rates for your area. Find this interest rate (or the one closest) in your column on the left. Then follow that line to the right until you reach your approximate income level. This is the amount you could potentially borrow. Only you can decide whether you feel comfortable carrying the maximum amount of financing that you qualify for. And this chart can only help you with the first qualifying rule - the amount of your home payment. The chart does not take into account the amount for your other debts. If they are high, that could reduce the amount of the loan for which you can qualify. This chart below can help you find how large a mortgage you might qualify for based on your annual income and the interest rate currently quoted for 30-year fixed-rate mortgages. Rather than using the normal 28 percent ratio, this chart below uses a 25 percent ratio and assumes that the amount you need to set aside to pay for taxes and insurance would amount to approximately 3 percent difference. This simplifies approach should give you a fairly accurate answer.
Remember you do not have to estimate the amount of taxes and insurance. To account for those costs and make it easier to calculate, this chart assumes that you can devote 25 percent of your monthly income to housing costs. The home mortgage qualifying examples show how different families figured out whether they were ready to buy a home on their own. In the first example, the borrow should not have a difficult time qualifying because the proposed monthly housing cost and the proposed total monthly debts are lower than the maximum guidelines. If the borrower has a good credit history and money saved for a down payment, most lenders would consider this borrower a good potential customer. The borrower is not attempting to buy a house that would strap him or her financial. This individual gives every indication for being able to follow through on the commitment to repay his mortgage. The family in the second example, however, would probably not be able to qualify for a mortgage loan at this time - even if thewy have good credit history. Even if the lender is very flexible and willing to use more generous guidelines, the monthly debts are well above the range most lenders ocnsider reasonable. In this case, the family should concentrate of paying off some of their credit cards and getting their monthly expenses to a lower level for a period of time before looking to buy a home.
If you have tried to buy a home, but were unable to get approved for a mortgage, you should try to find out why the lender did not want to make the loan. Based on the information above, you may already have figured out why you did not get a loan. Maybe you did not have a steady work history, or you tried to buy a house that was too expensive for your income, or your debt level is too high. If you are unable to figure out why you were turned down, you should ask the lending institution for an explanation. You should also ask what steps you can take so that you can qualify in the future. If you have read all the information above, and have received a copy of your credit report, you may be ready to begin the process of buying a home. You may want to call a local real estate agent to show you homes in your area. You may also want to make an appointment with a mortgage lender. You can find the names of lenders in the yellow pages of the telephone book. It will take some time working with a real estate agent to find the right home in the price range that you can afford. It will also take time to apply for the mortgage, have the lending institution evaluate your application, and have your loan approved. Still more time is required to do all the necessary paperwork and close on your loan. But in the end, you will have a home for you and your family, and you will have achieved an important part of the American dream. |
