You don’t need to worry about applying for a loan until the time comes, right? Of course not. That credit report that follows you around like life’s scorecard can cost you big time, if it’s bad, or really big time, if it’s awful.
Nowadays, if you have bad credit, don’t even think about buying a house. You probably won’t even be able to buy a trailer. Stay with your parents or rent until you can repair your credit. Don’t even bother reading this section, because it will be a long time before you need it. Go right to page repair your credit.
If your credit is fair to excellent (we’ll describe that later), you can not only buy a home, but as of this writing you can get an amazing home at a cheap price. The real estate market crashed back in 09, which means your average home is worth 30 to 60 percent of what it was worth in 08. What this means is that if you buy a home at this time, most of your neighbors will hate you. They probably paid $450,000 for the exact same house you are buying for $300,000. Don’t let that stop you. Get right out there and get ready to find yourself a home.
Find out your Credit Score. Get your credit reports from all three major credit bureaus. They are free. If you haven’t seen them before, it might make you uneasy to see how much they know about you. It should. These reports are like a lens through which much of the world sees you.
Review it carefully. There are almost certain to be errors. Perhaps they show that you owe money on a credit card you cancelled a long time ago. These types of things happen a lot. When we talk about credit we’ll show you how to correct any errors.
Here is what you need to know about buying a house.
Application fees are usually a few hundred dollars. This covers the lender’s cost of processing your application, get your credit reports, verifying for information, etc. Often they are charged simply to keep you from applying to a bunch of lenders and taking the best deal. During special promotions, they may be waived, or, they may be added to the cost of the loan, so you don’t pay them upfront. One thing you will get from your application fees is what is called a “good faith estimate.” This will show the amount of the loan, all fees, points, charges, and so on, and the monthly cost of the loan.
The more you can put down up front, the lower the loan, the lower the monthly payment, and the more likely you are to be approved. If you have excellent credit, you will be approved regardless of how much money you put down, but if your credit is less than perfect, the amount of your down payment may mean the difference between rejection and approval.
A $300,000 house at 10% down will cost you $30,000 in cash. Does that sound like a lot? Assume you plan to buy a house in five years. That’s $6,000 a year, or $500 a month,or $125 week, or $17.00 a day. If there are two of you, stop buying lunch out and in five years you afford to the down payment for a house.
You will need to show a steady source of income, preferably for a few years. The lender needs to believe that you will keep working after you buy the house, so don't quit or change jobs right before applying for a mortgage. And don’t make up a job you don’t have, because you will have to supply the lender with copies of you tax forms.
One of the things the bankers look for is how much other debt you have. They figure that if you have too much debt and not enough income, you will eventually have to stop paying your debt. What nerve! Nevertheless, you are well advised to pay off any outstanding credit cards or bills. Don’t apply for new credit cards, or a car loan, or do anything to change or close your current accounts. A lot of last minute activity will look like you are trying to hide your plans to acquire more debt than you told them about in the application. You probably are. After all, a new house needs new furniture, right? And you can’t park your old clunker in front of your new house. But don’t do anything until after you have been approved for the mortgage. These guys and gals know more tricks than you can dream up in a lifetime.
Keep in mind that your lender won’t give you a mortgage they don’t think you can't afford. Since they don’t know you, they reduce you to a magic number, the debt to income ratio. This is what it looks like
Debt to Income Ratio: 7%
Then they add the mortgage: 300,000
Debt to Income Ratio: 23%
Go ahead and calculate this yourself and find out what your ratio is. If it is more than 20%, buy a cheaper house, come up with a higher down payment, rent for a while longer, or find a loan with lower interest rates.
Every lender has their own set of rules about how strict they will be about making a loan. If they are too strict, they will turn away too many good people and won’t make enough loans, particularly at higher rates of interest. If they are too loose with their rules, they will make too many loans to people who won’t pay, and will loose a lot of money. So what they do is tweek their rules on a regular basis, sometimes loosening, sometimes tightening, based on the amount of business they get and how much money they write off.
Write Off means they have decided they will never get paid back the money they loaned you. This can vary from a hundreds of thousands of dollars per month to millions, depending on the size of the lender. Ultimately, it is the cost of doing business, and besides, they will take back the house and sell it, so it’s not a total loss. But it is a loss. That’s why they charge a much higher interest rate to people with bad credit. They expect to write off a higher percentage of those loans, so they need to make more money on them, overall, to cover the losses. That is what bankers do. It’s what you would do, if you owned a bank. In fact, banks make more money from bad credit loans than they do from good credit loans, which carry a much lower interest rate.
Here’s the hard part. While you are in the process of applying for your mortgage loan, the interest rate will continue to fluctuate. It can happy virtually day by day. 5% becomes 5.4% becomes 5.2% becomes 4.9% and so on. At some point in the application process, you need to “Lock In” your rate. That means you tell the lender – in writing – that you want their current rate. You can normally lock in a rate for 30 to 90 days. If rates go up by the time of the closing, you’re in great shape. If they go down, it will probably be fractional. At least you know that the rate you are getting is one you can afford.
Some lenders charge a fee to lock in a rate. Most, if all, credit unions do not. Unless the lenders rate is way below what anyone else is charging, don’t pay for a lock in. Go to your credit union. They want to make money on you, like any other financial institution, but are way less likely to screw you to get it.
So far we’ve been talking about fixed rate mortgages. But there is also such a thing as an Adjustable rate mortgage. Like it sounds, your loan’s interest rate can change from year to year. It can go up, or it can go down. Lenders like this product because it keeps them from getting stuck with a low interest rate in the event interest rates rise significantly. Borrowers like this product because the interest rate usually starts off low, so they can buy more house than they normally would with a fixed rate loan. But you are taking a risk. The rate can go up over time and make your monthly payments skyrocket.
In addition to the hundreds of thousands of dollars a lender will make on your mortgage over the life of the loan, they want to reach into your pocket and retrieve several thousand extra dollars right up front. They can’t call it a fee, because that would screw up their APY calculations, so they call this little money grab POINTS. One POINT is equal to 1% of the loan. So if they charge you 2 POINTS for a 300,000 loan, you have to give the lender another $6,000 for the privilege of getting a loan. Seriously.
Some lenders charge more than two points, some charge less, and some don’t charge any points at all. But you might notice that the less points a lender charges, the higher the interest rate. And the more points a lender charges, the lower the interest rate. Most lenders will even give you the choice to “buy down” your interest rate by paying additional POINTS. For example:
6% @ 1 point ($3000) cost you 1200 per month
5% @ 2 points ($6000) cost you 1100 per month
So you the question you need to ask yourself is: am I better off paying more money up front and getting a lower monthly payment, or am I better off holding onto my cash and paying a higher monthly payment? There is no right answer. Look at all of your options and make a decision.
The term is another biggie, since you will probably have a choice of a 30 year or a 15 year mortgage.
The term is the final item that will affect your monthly payment amount for a mortgage. The longer the term, the less you have to pay each month. However, the longer the loan term, the more you will ultimately pay for the mortgage. For example, on a 300,000 loan, at 5%.
30 years – 1500 per month – total interest after 30 years: 180,000
15 years – 2200 per month – total interest after 15 years: 120,000
You save 60 grand on a 15 year mortgage, but you pay an additional 800 per month to do it.
Again, there is no right answer. You need to determine what works for you.
However, there is another point to consider: The Bi-Weekly Mortgage.
A biweekly mortgage means that instead of paying each month, you pay every four weeks. But didn’t they tell us in school that every month has four weeks? Isn’t it the same thing? No, it is not. Because there are 52 weeks in a year. 12 months times 4 weeks is only 48 weeks, leaving an additional 4 weeks unaccounted for. A biweekly mortgage, since it is based on weeks, not months, makes an additional 4 payments a year. Doesn’t sound like a lot, but let’s take a look.
30 years – 1500 per month x 4 extra payments = 6000 a year x 30 years = 180,000 in additional payments. Unbelievable, right. The fact is that when you take into account amortization (we’ll talk about that), your mortgage will actually be paid off in 23 years, at a savings of 120,000.
How about on a 15 year mortgage.
15 years – 2200 per month x 4 extra payments = 6000 a year x 30 years = 180,000 in additional payments. Unbelievable, right. The fact is that when you take into account amortization (we’ll talk about that), your mortgage will actually be paid off 11 years, at a savings of 120,000.
Your combination of down payment, interest rate, term and points will determine the cost of your loan.
First Time Home Buyers
If you're a first-time home buyer, you may qualify for a special mortgage, meaning a lower down payment, lower interest rates, less fees, no points or some other benefits. Sometimes these are extremely valuable. Check with your bank or credit union to determine if you want to apply for a first time homebuyer loan.
Before you go jumping into a mortgage, you need to consider another monthly cost that can add another 20 to 30 percent. When you borrow money for a house, that creates two additional costs:
Taxes and Insurance.
You have no choice but to pay both.
Taxes run from about 1% per year to 3% per year. Let’s see, that’s $9000 on a $30000 house, divided by 12, equal 250 per month. Plus insurance, which can run from 5000 per year, or 300 per month. That’s an additional $600 per month. Add that to the 1200 per month and you are talking 1800 per month to own a home.
The number you need to keep in mind is the PITI – Principle, Interest, taxes and Insurance. That is the base cost of owning a home, plus any maintenance fees, home repair, gardening, electric, cable, water, internet, etc.
You may also get some significant tax deductions,but that's another story.
There are some government sponsored programs to help individuals and families buy homes.
The Expanding American Homeownership Act
Buy a HUD Home and Save
Once you understand the basics of getting a mortgage, you can research of each of these programs to determine if you quality.
What is a Second Mortgage, or Home Equity Loans?
You may have heard about home equity loans. First you need to understand equity.
Say you buy a home or 300000 and that home is worth 300000. You hold onto it for ten years. Now your home is worth 350,000. Plus, you have paid down 25,000 in monthly payments, so your mortgage stands at 275,000. Let’s take a look.
Home Value: 350,000
Essentially, your home has an extra 75000 of value just sitting there. That’s fine. You can leave it alone and watch it grow over the years, or shrink, if the market collapses. But many people want to use that money, or some part of it, for various and assorted things, such as paying off credit card bills, adding a room or a pool, financing their education, or whatever. The way to get hold of that money is to get a second mortgage, or a home equity loan. Normally the rate is pretty good, since the lender knows that if you don’t pay, they can come after your home, evict you, and sell your house to recover their money. You need to know that. But if you can afford to pay another monthly cost, a home equity loan is good way to use the resources of your house to your financial benefit. Plus, under most circumstances, you can deduct the interest costs from your taxes. Be aware, however, than many people have borrowed money to pay off their high rate credit cards, then ran their cards right back up, leaving them with more debt than ever before. Don’t be one of those people.