Affording a Home & Legal Issues Involving Loans
Financial considerations will play an important role in your decision of whether to buy a home and which homes you can afford. You should be familiar with the costs of buying and owning a home so that you can make a knowledgeable assessment of whether you can bear them. While you can consult a mortgage broker for advice on your options, looking for a mortgage usually comes after making an offer on a home. If you cannot qualify for the amount that you need or borrow more than you can handle, the consequences can be severe and long-lasting.
Types of Costs Related to Buying a Home
The most immediate cost is the down payment, which is a percentage of the purchase price that you will pay at the outset. If you make a relatively substantial down payment, you will have smaller monthly mortgage payments, less interest, and a lower interest rate. You also will have no need to get private mortgage insurance if you pay 20 percent of the purchase price as your down payment.
In addition to the purchase price, there are certain types of expenses that you will need to undertake. Some of them are grouped together as principal, interest, taxes, and insurance (PITI). The principal consists of the size of your loan, and the interest is a percentage of the principal, which is a fee charged by the lender. Property taxes are collected on an annual basis and usually fall in a range of around one to two percent of the home’s purchase price. Insurance covers many types of events that can cause damage or injuries on your property, such as fire, theft, or accidents in which other people are injured. You will need to pay some of the PITI costs at closing, and you may need to pay them into an escrow account managed by the lender.
Buyers also need to account for certain miscellaneous types of costs that are generally not very substantial individually but can add up. For example, you will need to pay the cost of the home inspection, the appraisal by the lender, closing costs, and moving costs. If you want certain services like cable TV or high-speed internet, you must pay to install those. People who choose a home that requires substantial renovations should be aware that many unexpected costs may arise. Once you become a homeowner, moreover, you will need to handle the recurring costs of maintenance, repairs to appliances, repainting, and more.
Debt to Income Ratio
To determine the level of risk involved in a loan, lenders compare your income to your debt load. They want to make sure that your debt does not consume so much of your gross monthly income that you cannot pay your mortgage payment. The general rule is that the debt should not exceed 43 percent of a borrower’s monthly income. This can limit the range of mortgages for which you may be eligible. Calculating your ratio in advance can give you a sense of your options.
Credit History
Lenders will review your credit report and score to determine which loans to offer you. The three major reporting companies, which are Equifax, Experian, and TransUnion, are required under federal law to give consumers a free copy of their credit report each year. You may need to pay to get your credit score, although you can get it for free in some states. You should take a look at your report and score to find out whether you should work on improving your credit or find more creative ways of financing your home. People who are buying a home as a group should be aware that a poor credit score for any of them can affect the eligibility of all of them.
A credit score will be between 300 and 850, but most people fall between 600 and 800. A good target is 720. When you are reviewing your report, you should check for any errors that may be affecting your score. For example, you should verify that any records of debts and creditors, credit lines, collection actions, and late payments are accurate. If you find an error, you should report it to the agency to get it fixed. If you have a debt outstanding, you might be able to work with your creditor to get it resolved and get it off your credit history.
Preapproval for a Loan
This process consists of receiving a letter from a bank or lender stating that it will lend you a certain amount, subject to certain conditions. You should make sure to get preapproval in writing so that you can show it to a seller as assurance that you can pay for their house. Preapproval is a bigger step than prequalification, which simply is an estimate by a lender of what you will be able to borrow. Prequalification does not involve a commitment.
Getting preapproval involves checking your credit history and may cost some money. You can go through preapproval on your own or with the help of a mortgage broker. You will need to fill out an application and provide the lender with pay stubs, tax returns, proof of other income or assets, bank records, the contact information of your recent employers and landlords, and a summary of your current debts, among other things. You also will need to explain how you plan to make the down payment. If you eventually select a certain property, you will need to give the lender proof of homeowners’ insurance and arrange a property appraisal at your cost.
