There are several ways to gauge how much you can afford to spend on a house. But, before you go house-hunting, get pre-qualified for a mortgage so you'll know in what price range you can shop. It is not unusual for first-time buyers to be somewhat baffled about how to estimate what mortgage payment they will be able to handle each month, plus how much money they'll need for a down payment and closing costs.
That's why it is a good idea to get pre-qualified through a lender before you even start to look for a home. Pre-qualification lets a buyer know exactly how much a lender is willing to loan them. With pre-qualification in hand, the buyer can save a lot of time-and frustration.
Pre-qualification does not obligate buyers to take a loan from the lender, nor should it involve any fees (until later, when they actually apply for the loan).
At the same time, you must understand that pre-qualification is not pre-approval for a loan either which is a much more involved formalized process that results in an actual letter of credit from a lending institution for a specific loan. Depending on your unique circumstances, you may wish to consider pre-approval as an option, but it is not necessary-consult with your real estate professional to decide what's right for you.
The less formal process of pre-qualifying on the other hand is a tremendous tool for buyers to have when making an offer. Usually, pre-qualified buyers have an edge when making a purchase offer because the seller knows that the buyer is pre-qualified, and that there is at least one lender ready to make it happen.
In addition, it allows you the flexibility to choose the mortgage that is best for you at the time of actual purchase-which is sometimes months down the road. That can be important given the volatility of interest rates.
When a lender pre-qualifies, they are more concerned about the buyer's paying ability than the price of the property.
For this reason, lenders are interested in more than just a buyer's income. They also want to know how much existing debt a buyer has, what their on-going financial obligations happen to be, and what the buyer's monthly budget looks like.
Lenders use an established debt-to-income ratio, usually between .28 to 1 and .38 to 1, to calculate the amount of the loan they are willing to give to a buyer. For instance, a lender who uses a .3 to 1 debt-to-income ratio has determined that payments toward debt reduction-including existing debt plus new debt associated with buying a home-cannot be more than 30% of they buyer's gross monthly income.
An important factor that may influence a lender to authorize a loan with a higher debt-to-income ratio - (where debt payments take a higher percentage of a buyer's income) - is a larger down payment. Buyers who put a larger percentage of the purchase price down (5%, 10%, 15%, 20%, etc.) are considered better "risks," because the theory is that the more a person has actually invested in the purchase, the less likely they are to default on the loan.
Buyers usually discover that the pre-qualification process will produce a home purchase price that is roughly 2 1/2 to 3 times their gross annual income. The 2 1/2 -to-3 guideline is only a general rule of thumb, however, and it doesn't take a buyer's full financial situation into consideration. Since the lender's calculations will also consider a buyer's actual debts and ongoing expenses, the loan pre-qualification amount may be higher or lower.
Regardless of the price bracket a buyer targets, they should keep pre-qualification in mind.
How much should you budget to own your own home?
Aside from the down payment, the three largest expenditures involved with the purchase of a home are usually your monthly mortgage payment, insurance and taxes. Obviously, the amount of your mortgage payment depends upon your down payment, rate of interest and the price of the property.
Take, for example, a home that has a $200,000 mortgage. An 7% fixed mortgage for 30 years, will run approximately $1330 per month. What about taxes? The rate will often times vary from city-to-city, but generally you might expect your yearly tax bill to total around 1.25% of the purchase price.That means, for a home with a market value of $250,000, yearly taxes might run around $3125. A local real estate agent can help prospective homeowners refine these figures.
In addition, it is important to keep in mind that there are many additional expenses incurred with home ownership, some of the most obvious are utilities and trash collection. Smart homeowners should also budget for one other item, maintenance and upkeep of the home. If possible, a small amount should be set aside each month to pay for those "rainy day" repairs such as painting, plumbing (hot water heaters, garbage disposals), adding storm windows (to improve energy usage), insulation (in attics), etc.
But home ownership is not just a one way street-that is, aside from spending money on repairs and maintenance, homeowners can profit from their property. The most significant benefit is the tax deduction. It is no secret that among the last real income tax deductions available to consumers today are the interest paid on the home loan, and the property taxes. This can amount to thousands of dollars in deductions each year.
And, of course, the primary benefit of home ownership is appreciation-equity that builds every month. A home, aside from being a place that provides shelter, can be a profitable investment, and the rising value of the property oftentimes provides another "savings" account.
So, when it comes to buying a new home, remember one thing ... the purchase of a property requires budgeting and planning.
How do you go about finding a mortgage?
The commotion of house hunting is finally over. You found just the right house, and your offer has been accepted. It was a great buy. Now, just one more hurdle-getting a loan-and you're home free.
Often, buyers are so eager to get this "final detail" behind them, they rush through this portion of the transaction, and end up with less-than-ideal terms. Borrowers, however, have something lenders want-their business. This positions them to negotiate the best possible price (cost of loan), terms and service.
Let's look at price, or the cost of the loan. The first thing to do is find out what the current rates are, information readily available on the internet, in your newspaper or from your real estate agent. When comparing rates, figure the annual percentage rate (APR), which includes interest, extra fees and costs amortized over the life of the loan. Also determine the number of points, if any, that the lender will charge to make the loan.
(A point is equal to one percent of the loan amount.)
Next, consider what loan options the lender offers. There are six or seven basic types of loans, which vary in their duration. Check how rates are calculated (fixed versus variable), and whether charges are fully amortized over the life of the loan, or whether you'll have to pay points up front and/or balloon payments at the end.
Is there a prepayment penalty clause?
Which terms are best for you depends on such factors as what changes you expect in your income and what you predict will happen in loan rates in the years ahead.
For example, if you only plan to reside in the home for a year or two, starting with a lower Adjustable Rate Mortgage (ARM) might be the best choice. If you have no plans to move, and feel that inflation will rise rapidly, a fixed rate would obviously be better.
Finally, and perhaps most importantly, consider speed and service. Buyers shouldn't have to wait days for approval and weeks for closing just because the lender is slow.
Remember, qualified buyers are great prospects for lenders - so give your business to the lender who demonstrates they not only want it, they deserve it.
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