Owning a home is the American dream. It is a comfort to know that something is yours. A person develops a sense of pride by creating a home that reflects who you are. You will face many decisions when buying a home.
Is buying a home the right thing for you to do? There are many advantages to homeownership:
You enjoy being part of a community and a neighborhood.
Houses can increase in value over time, which means you increase your net worth.
As your home appreciates in value, you build equity in your home. This equity works for you if you decide to take out a home improvement loan or home equity loan. Increasing equity also increases the amount of cash you may receive if you sell your home in the future.
Real estate is an important part of a diversified financial portfolio.
The interest you pay on your home mortgage is often tax deductible.
Homeownership offers more flexibility to make changes to your living space, such as painting your walls or putting in new carpeting.
Owning a home builds your credit history.
There are added responsibilities that come with homeownership:
You are responsible for fixing and maintaining the exterior, such as roofing, windows, and landscaping; and the interior, such as carpeting, plumbing, and painting.
You may need to purchase basic household items such as a lawn mower, garden tools, and major appliances.
Upkeep on a house can be time consuming and costly.
Down-Payment Options:
Buying a home doesn’t necessarily mean that you have to have large amounts of money on hand. Most mortgage lenders offer some type of low or no-down payment options. It is important to remember that there are costs associated with buying a house no matter how good the offer may seem.
Your Credit:
Responsible credit use is an important part of obtaining a mortgage. Your credit history will play an important role in determining if you get a mortgage. Often, the mortgage rate you pay is based on the quality of your credit. Individuals with a poor credit history may pay a higher mortgage rate. Before you apply for a mortgage check your credit report. Report any incorrect or outdated entries. If you don’t have a credit history then it will be important to buy something on credit and successfully make the payments.
Income and Debt:
Your lender will compare income to your outstanding debt to determine how much you can borrow. It will be important to have a consistent work history. If you are self employed you can expect to be asked for thorough documentation of income over a period of time. Guidelines vary, but lenders usually prefer that the amount you spend on monthly debt and housing expenses be no more than 36% of your gross monthly income.
The Basics
The basic premise behind a mortgage is simple: a loan made to help you finance a home. Your lender advances you a certain amount of money which you repay over a set period of time.
Rates, Points and Loan Fees
There are several factors that determine the cost of your mortgage: interest rate, discount points and loan fees. The expenses that contribute to the cost of your loan can be expressed as the annual percentage rate [APR].
Interest Rate refers to the percentage of your outstanding loan balance that you pay the lender each month as a part of the cost of borrowing the money. Your individual interest rate will be based on the current overall rate environment, as well as your financial profile and specific features of your loan.
Discount Points let you "buy down" your interest rate at closing. One point equals one percent of your loan amount. The more points you have the lower your monthly interest rate will be, and the less you will have to pay each month.
Loan Fees are up-front charges that cover the cost of originating, processing, and closing your loan. An origination point is a loan fee that equals one percent of your loan amount.
Your Monthly Mortgage Payment
Mortgage payments can generally be divided into four parts: principal, interest, taxes, and insurance.
Principal refers to the amount of money you borrow to buy a home and to the outstanding loan balance at any point during the mortgage term.
Interest is the cost of borrowing money. The amount of interest you pay each month is determined by the interest rate structure agreed to when getting the loan.
Taxes assessed by your local government will often be collected by your lender as part of your monthly payments and then paid on your behalf. This process is known as escrow.
Insurance is often collected by the lender in an escrow account. There are typically two components:
Homeowner’s insurance which protects you against damage to your property caused by fire, wind, water, etc.
Mortgage insurance which protects your lender in the event that you fail to repay your mortgage. Whether you have to pay mortgage insurance usually depends on the loan program and the size of the down payment.
Loan Types
Most home loans fall into two categories: fixed rate and adjustable rate mortgages.
Fixed rate mortgages have interest rates that stay the same for the entire life of the loan. With a fixed rate mortgage you will have predictable monthly payments throughout the life of the loan. Because it is a fixed rate you will not have to worry about rising interest rates.
Adjustable rate mortgages have interest rates that adjust periodically based on market conditions. The initial rate is fixed for a predetermined amount of time [usually one to ten years] and is typically lower than rates for a fixed rate mortgage. After the initial period of time the rate adjusts annually based on a market index. The rate will also have a predetermined cap that it can never rise above. Because the interest rate is lower some borrowers may be eligible for a larger loan amount with an ARM than with a fixed rate mortgage.
Loan Terms: The loan "term" is the period of time you will spend repaying it. The most common term is 30 years but you have other options as well including twenty, fifteen or ten years. Longer mortgage terms offer lower monthly payments. Shorter mortgage terms mean higher monthly payments, but allow you to repay the loan faster and save money on interest.
Preapproval vs. Prequalification
Preapproval is when a lender has taken a detailed look into your financial background and has committed to lend you a certain amount of money, pending certain property details. Because preapproval includes a credit check, it’s more powerful than a prequalification letter, which generally only estimates what you can afford based on information you have provided.
Preapproval is advantageous for anyone buying a home but it is especially useful for first time home buyers and those who are self-employed or who work on commission. Work with your lender to complete a mortgage application. If you qualify the lender will give you a written preapproval for a certain mortgage amount, down payment, and interest rate.