| Many people often start
with the wrong foot forward when thinking about
buying a home. They start by looking at newspaper ads and listings on the
Internet. They drive the neighborhoods they like, and they go to open houses.
Although it can be fun and
interesting, this kind of "window shopping" can lead to disappointment for many buyers. After having created a list of homes to
pursue, these buyers talk to a loan officer, who is unable to answer many of
their questions about the price of home they can afford. The buyers haven't done
their homework; they haven't yet calculated their income, savings and debts.
The first thing everyone thinking about buying real estate should
do—before talking to a mortgage broker, or even a Realtor®—is
assess how much savings and
assets they can use for a down payment and for paying the fees associated with
closing a real estate purchase. Determining how much money is available
affects almost every aspect of a purchase—including what loan
programs are available, what interest rates are offered, and what terms to
include in a purchase contract.
When a buyer has only enough for a minimum down payment, his choices of loan program
are limited to a few kinds of mortgages. Using gifted funds for some of the
down payment may also limit a buyer's options. When a buyer has enough for a down
payment, but needs help with purchase closing costs, lender rules will also
limit his options. A buyer planning to borrow money from a retirement plan
will have certain rules to meet, not only to make sure he can qualify for the best possible
loan, but also to avoid tax problems.
The trick is to calculate how much
you have, not how much you'll need to get. It's important to keep purchase
goals realistically
grounded by shopping based on current savings and income, not based on
striving for some future ideal that may be out of reach.
Buyers should calculate savings,
income, debts and desired down payment first, then talk to a loan officer to
determine what loan programs, interest rates and loan terms are available based on
the buyers' financial calculations. Adjustments to desired down payment and
loan terms can be made by the loan officer, if circumstances allow. The
important thing is that a loan officer will not be able to give any specific
answers regarding available loan programs, interest rates, or costs without
having a specific picture of a buyer's current finances.
In general terms, the down payment a
buyer needs is no longer the standard 20 percent that was required throughout
much of the 20th century. Loan programs are available today that provide
attractive interest rates and costs with down payments of as little as 3
percent. Even conventional loans are available that require no down payment at
all.
The amount of excess savings required
varies by lender and loan program. However, most buyers will need, at a
minimum, enough savings in addition to their down payment to be able to pay
their loan and purchase closing costs. These costs can vary from several
hundred dollars to more than $10,000, depending on the price of the home, the
amount borrowed and the type of loan obtained.
Closing costs for a purchase are
generally higher than those for a refinance transaction. For most purchases in
NW Oregon, closing costs are generally between $5,000 and $15,000. In addition
to this amount, some lenders will want to see additional savings or assets equal to
several months' worth of mortgage payments.
Speaking of assets, money for savings
or a down payment doesn't have to come from cash in the bank. When a borrower
doesn't have cash but has valuable personal property, such as stocks, bonds, a
boat, a valuable antique or collection of rare coins, etc., that
property can be sold to raise the needed funds. All that's needed is careful
documentation of the sale to show that the property legally belonged to the
borrower, and was legally transferred.
Money also can sometimes come from a
gift. Some lenders allow buyers with little savings, especially first-time
buyers, to receive help in getting together their funds. When this happens,
the lender will require documentation from the giver that the gifted funds do
not have to be repaid.
Some buyers also are able to turn to
their employers for help. Some employers have down-payment assistance
programs, while others allow employees to borrow against the value of a 401k
or other retirement plan.
Another avenue for raising money for
closing costs is seller assistance. Buyers who can show good employment and a
good credit history, but who have little or no savings and assets, may qualify
for a loan program that allows the seller to pay some or all buyer closing
costs. Many sellers are willing to provide closing cost assistance, especially
when buyers are willing to negotiate reasonably over the terms of a sale.
(Closing cost assistance programs have strict lender limitations, so it's
important to discuss these programs in detail with a loan officer after
calculating what other savings are available, but well before making a
purchase offer.)
Lenders also will look at income and
debts. They are looking for several main factors that tend to indicate a
buyer's ability to repay a home loan: (1) the percentage of the borrower's
total debts compared to his gross income; (2) the percentage of the borrower's
housing expense compared to his gross income; (3) the stability of the
borrower's income; and (4) the regularity of the borrower's income.
The percentage of a borrower's debts
to gross income is usually referred to as a "debt-to-income ratio."
For this figure, most lenders will want to see no more than about 36 percent for a
conforming, conventional loan. The figure is calculated by dividing the total
of all personal, monthly installment debt (including housing expense, charge
cards, credit accounts, car loans, etc.) by the borrower's total monthly
income before taxes.
The percentage of a borrower's
housing expense to gross income is referred to as "housing-to-income
ratio." For this amount, lenders generally want to see no more than about 26 percent
for a conforming, conventional loan. This ratio is calculated by dividing the
total monthly housing expense (including mortgage or rent, plus homeowners
insurance and real property taxes) by the borrower's total monthly income
before taxes.
For non-conventional loans, like
VA-guaranteed loans and FHA loans, housing-to-income and debt-to-income ratios
are often allowed to be as much as 5 percentage points higher. This is because
the federal government provides protection to lenders in the event of default.
Though the default risk to lenders may tend to be somewhat higher with these
higher-ratio loans, the government pays the lender a specified minimum amount
if the borrower defaults and has to have his property foreclosed.
Although a lender cannot
legally deny a loan based on the source of an applicant's income, a lender can
consider the stability and regularity of the applicant's income. Basically, this means
that lenders look at how long an applicant has
been receiving his income, how long into the future the applicant is likely to
receive this income, and how often he receives it.
Denying a loan because an applicant's
primary income is from child support or alimony violates federal fair lending
laws. However, a lender could deny a loan, for example, if alimony payments
were the primary source of income and were scheduled to stop a couple of
months after the loan was made.
For applicants with income from
employment, lenders usually will want to see a history with the same employer
or in the same type of field. If employment income is from some kind of
non-traditional career, especially sales careers, lenders usually will want to
see that the income comes at a fairly regular frequency, or will want to see
records to back up that the applicant has a history of financial success plus
sufficient savings to protect in the event of an unexpected slowdown.
There are so many financial variables
that affect every aspect of buying a home. Taking time in the beginning to
carefully calculate these financial variables will pay off in the end by saving time in
the loan application process and, potentially, saving a great deal of
frustration and heartache.
Buyers should look at ads, familiarize
themselves with neighborhoods, learn about prices, and read as much as
possible about the local home market. However, the first thing they should do
is do the math—calculate the value of their savings and assets, calculate the
amounts of their debts and income, and think about what down payment amount
they feel comfortable with.
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