Experience has taught me that the buying process involves common stages for all home buyers. To help you understand that process and make the most of every day and dollar you spend, I have prepared this Home Buyers Guide to provide an overview from the planning table to the closing. After all, helping you fulfill your dream of home ownership is my business.
How Much House?
The first step toward buying a house is to "pre-qualify." Simply, it will help you determine how much house you can afford to buy. Knowing your affordable price range will bring your house-hunting into focus. Many lenders, for a small "upfront" fee, will send out all required verification and pre-approve you for a mortgage, allowing you the opportunity to negotiate as a cash buyer.
How much house you can afford to buy depends on two things; how much you can afford for the monthly housing payment, and how much you can invest in the down payment. Monthly payments include principal and interest on the mortgage loan, and property taxes and insurance against fire and other hazards. These four costs are often abbreviated "P.I.T.I." (For some buyers and lenders, monthly housing costs may also include homeowner association dues, condominium fees and mortgage insurance.)
In today's market an "affordable" home is not so much determined by sales price as it is by the financing which translates that price into a monthly payment. A house hunter's first step is to set a housing budget, then go shopping for the house (price) and payments (P.I.T I.) that fit that budget.
Even though there are many ways to qualify to buy a home, make sure the monthly payment makes sense for you. A current rule of thumb is that the monthly payment should not be more than 25-33% of gross monthly income. Restrictions will apply for smaller down payments.
How Much House Can I Afford?
The key items are the size of the down payment, interest rate, APR and the amount of the mortgage. The down payment might be zero in the case of VA-backed mortgages. Or a buyer may invest 20 to 25 percent of the purchase with a conventional loan and not be required to buy mortgage insurance. I can help
you to determine just how much house you can afford.
Sources For Your Down Payment
The obvious source of money for your down payment is either your savings or the proceeds from the sale of a home you already own. But there are some other not so obvious sources. In recent years, for example, "parent power" has taken some new twists for first-time buyers.
Home Equity Loan
Parents often have considerable equity built up in their own homes-and many are tapping that asset through home equity loans to make a gift to the youngsters. Ask your tax advisor for current information. Often lenders will require a "gift letter" to verify that parents don't expect repayment.
In return for providing a part of the down payment, the parents (or another investor) share in the "profit" or net equity of the house when the home owners eventually sell it.
If you have built up a cash value on your life insurance policy over the years, you may be able to borrow from your insurance company up to the amount of this accumulated cash value. Often they will even ask a more favorable interest rate than would be asked for other types of loans.
Stocks and Bonds
If you feel the market doesn't favor selling your stocks or bonds now, you may be able to secure a bank loan using your portfolio as security.
Company Profit Sharing or Savings Plan
Look into the possibility of withdrawing what you have in your profit sharing or savings plan account or borrowing against it, if your company has these programs.
Mortgage Insurance Can Reduce Down Payment
If you need a conventional loan, there is a way to put down only 5 or 10 percent. Through the lender, you will be required to buy private mortgage insurance (PMI). This insurance provides protection for the lender in case of default, and allows the lender to approve a larger mortgage amount.
In a common approach, you'd pay an initial amount at closing (often one percent of the mortgage if your down payment is 5 percent, 1/2 of 1 percent if you put down 10 percent). Then, included in your monthly payments for your mortgage, you would pay an additional one-twelfth of 1/4 percent of the mortgage balance. This payment will usually continue until dropped at the discretion of the lender, unless a stop point is specifically written into the deed of trust, such as accumulating a 20% equity. Ask your lender for specific figures for any loan program you are considering, as the amount of mortgage insurance varies by the type of loan.
The larger the down payment, the less money you need to borrow, which means a lower monthly payment. However, remember that in addition to your down payment and monthly payments, you will need money to pay for closing costs, moving, appliances, household setup, a reserve for family emergencies and other miscellaneous items. So don't plan to put your last penny down on the closing table.
Figuring Your Housing Budget
Generally, lenders figure that the home buyer shouldn't pay more than 28-38 percent of gross income for P.I.T.I. payments, or 36-38 percent for both P.I.T I. and monthly debts combined. This might be a little more or a little less depending on other outstanding long term debts (more than 10 months), alimony/child support payments, number of children and their ages, and other household budget items.
The easiest way to make a quick estimate of the mortgage amount you may qualify for requires applying the two basic formulas for loan application that lenders use. Keep in mind the loan balance will vary over the term of the loan, although the monthly payment remains the same.
Two Lender Formulas
Most lenders will require that loan applicants meet both guidelines before approving a mortgage loan. The first formula compares income to housing costs without including long term debts, the second includes all debts.
Total Monthly Housing Costs
(P. I. T I.)
__________________ = 28% (or less)
Gross Monthly Income
P.I.T.I. + All Monthly Debts
__________________ = 36% (or less)
Gross Monthly Income
A variety of other formulas exist. VA and some lenders use a single ratio based on mortgage payment and all debts, which allows easier qualifying for a more expensive home for a borrower with little debt.
To figure your housing budget, simply multiply your gross monthly income (before taxes) by 28% and 36%. For example, a family with a monthly income of $3,500 might qualify for a mortgage with payments up to $980.
More Mortgage Help
New types of mortgages, such as graduated payment mortgages, flexible payment mortgages and deferred interest loans, feature monthly payments that start lower than usual in the early years - and thus help home buyers "afford" more house and buy sooner by qualifying on a lower mortgage payment.