Thinking of buying a home or refinancing your existing home, here are some things you should know about mortgage loans. I have outlined 10 items that you should keep in mind to help you get a mortgage loan that will work best for you.
1. It’s not just how much you can borrow, it is what you can really afford to spend
When you apply for a mortgage, your lender will consider two debt metrics. After reviewing both, the one that produces the lower monthly mortgage payment will determine the maximum amount of loan they will lend you.
The front-end ratio considers your new mortgage payment as a percentage of your pre-tax income. For example, if you earn $7,500 per month and your maximum mortgage payment allowed using this ratio would be $1,500. The front-end ratio is 20% of your gross income. The other ratio is the back-end ratio. This ratio considers your mortgage payment plus all of your other monthly debt obligations, such as auto loans, student loans, and credit cards. The total ratio for back end is 36%. To qualify for the $1500 payment with the $7500 income your total of all debts would have to be $1200 or less.
The mortgage industry has used this standard of a maximum of 28% for the front-end ratio and 36% for the back-end ratio for years. However, it is possible to qualify for a loan that produces a back-end ratio of up to 45% in some circumstance. More important than what the lender says you can afford is what you are emotionally comfortable paying. Most people find that they are comfortable using the lender ratio’s but if you are not then let the lender know what you consider correct.
2. The 30-year mortgage is not the only mortgage term available
The 30-year mortgage was the standard of the U.S. mortgage industry for years. Over the past decade home owners have opted to look for shorter loan programs. This is especially true of baby boomers looking to pay off their homes sooner.
When you apply for a loan, request your lender to run your numbers for a 10, 12 and 15 year mortgage as well. You may be surprised that the payment does not increase significantly for the shorter loan. Not only will you pay off your home in less time, but shorter loans normally have lower interest rates. The amount of money to pay back to the lender for the money you borrow will be much less.
3. If you can pay minimum of 20% down it will save you money
While it is possible to buy a home with 3% for FHA financing or 5% conventional financing if you pay less than 20% down you will have a monthly fee added to your mortgage payment. There is at least one exception, and that is a VA loan.
This additional payment is insurance payment to the lender and called “Private Mortgage Insurance” or PMI. This additional payment is not tax delectable, does not reduce your mortgage, nor does it decrease over time. It is strictly additional cost to you. If at all possible, you should try to pay at least 20% down. If obtaining a refinance get the mortgage for less than 80% of the appraised value of your home.
4. The better your credit score the more you save
We all have heard that good credit helps. Still, most people do not realize how much it can save you. One of the credit companies just released that average credit score is now over 700 for the first time since 2005. While lenders will lend to you even if your credit score is in the mid to low 600’s, if your credit score is in mid to high 700’s you can expect to save over $20,000 on a 30 year mortgage. That is a savings of almost $700 per year.
5. In addition to credit what else does a lender consider
Your lender will want to know your employment history, your income, and what assets and liabilities you have. Be prepared to document every one of these. Start by getting copies of your last few federal income tax statements. Include your W-2 or 1099 statements.
Let your employer know you are applying for a mortgage and have correct contact numbers for HR or the person who will verify your employment at work. You will need at least 3 months of bank statements for every account you have including retirement accounts. If you own real estate, mortgage payments and current mortgage balance statements. Verification of additional income sources like rent or child support.
6. Not all mortgage lenders have the same loan programs
You will most likely be surprised to learn that different lenders can offer slightly different mortgage rates. If you can reduce the rate even by just a slight amount the difference can mean thousands of dollars in savings over the long run.
It is not true that “rate-shopping” will hurt your FICO score. Credit score companies now say that no matter how many mortgage lenders you apply with, as long as they all occur within a two-week window, it won’t affect your credit any more than a single application.
7. Stop buying anything until your mortgage is in place
Don’t apply for any new credit or buy anything over time after you have made your mortgage loan application. Make sure you make all payments on time and that you do not run up your credit cards before your mortgage closes. The lender will “pull up” credit checks on you through the loan process. Any negative changes to your credit can ruin your loan of make significant changes in your mortgage payments.
8. First time home buyers with an IRA have another money source
The IRS allows first time home buyers a special provision in the IRA rules that allows you to “borrow” money from yourself. Specifically, you’re allowed to withdraw up to $10,000 from your IRA penalty-free (although you may have to pay taxes on the money) for the purpose of a first-time home purchase. You would want to talk with your tax accountant or tax advisor before using any money from your IRA.
9. Adjustable rate mortgage
In the 1970’s because interest rates were so high lenders created adjustable rate mortgages. Adjustable rate mortgages or ARM, have interest rates that increase or decrease on set time intervals depending on market interest rates. ARMs are generally better idea when interest rates are high and you expect rates to decrease over time. They can also be an option if you do not plan on owning your house for more than two or three years.
10. Tax benefits
While it is not a good idea to buy a home or refinance your home for tax benefits alone, it is important to understand there are tax implications that can reduce the cost of home ownership. Interest that you pay on your home mortgage is tax-deductible as an itemized deduction. Discount points you pay to obtain a loan and state property taxes are also tax deductible. If you consider that you will either pay Uncle Sam the money or pay it toward owning your home, this can make the cost of owning a home more favorable.
Related Article: 4 Steps to Buying a Home