What should I know before buying a home?
Here are some tips that could save you time, money, and trouble.
Plan ahead. Establish good credit and save as much as possible for the down payment and closing costs.
Get pre-approved online before you start looking. Real estate agents prefer working with pre-qualified buyers, but you will also have more negotiating power and an edge over homebuyers who are not pre-approved.
Set a budget and stick to it.
Know what you want in a home. How long will you live there? Is your family growing? What are the schools like? How long is your commute? Consider every angle before diving in.
Make a reasonable offer. To determine a fair value on the home, ask your real estate agent for a comparative market analysis listing all the sales prices of other houses in the neighborhood.
Choose your loan (and your lender) carefully. For some tips, see the question in this section about comparing loans.
Consult with your lender before paying off debts. You may qualify even with your existing debt, especially if it frees up more cash for a down payment.
Keep your day job. If there is a career move in your future, make a move after your loan is approved. Lenders tend to favor a stable employment history.
Do not shift money around. A lender needs to verify all sources of funds. By leaving everything where it is, the process is a lot easier for everyone involved.
Do not add to your debt. Increasing your debt by financing a new car, boat, furniture, or other large purchase could prevent you from qualifying.
Timing is everything. If you already own a home, you may need to sell your current home to qualify for a new one. If you are renting, time the move to the end of the lease.
How many houses Can I Afford?
How much house you can afford depends on how much cash you can put down and how much a creditor will lend you. There are two rules of thumb:
You can afford a home up to 2 1/2 times your annual gross income.
Your monthly payments (principal and interest) should be 1/4 of your gross pay or 1/3 of your take-home pay.
The down payment and closing costs – how much cash will you need? Generally, the more money you put down, the lower your mortgage. Depending on the loan, you can put as little as 3% down, but you’ll have a higher interest rate. Furthermore, anything less than 20% down will require you to pay Private Mortgage Insurance (PMI), which protects the lender if you can’t make the payments. Also, expect to pay 3% to 6% of the loan in closing costs. These are fees required to close the loan, including points, insurance, inspections, and title fees. To save on closing costs, you may ask the seller to pay some of them, in which case the lender adds that amount to the price of the house, and you finance them with the mortgage. A lender may also ask you to have two months’ mortgage payments in savings when applying for a loan. The mortgage – how much can you borrow? When evaluating your loan application, a lender will look at your income and your existing debt. They use two ratios as guidelines:
Housing expense ratio. Your monthly PITI payment (Principal, Interest, Taxes, and Insurance) should not exceed 28% of your monthly gross income.
Debt-to-income ratio. Your long-term debt (any debt that will take over ten months to pay off – mortgages, car loans, student loans, alimony, child support, credit cards) shouldn’t exceed 36% of your monthly gross income.
Lenders aren’t inflexible, however. These are just guidelines. If you can make a sizeable down payment or if you’ve been paying rent that’s close to the same amount as your proposed mortgage, the lender may bend a little. Use our calculator to see how you fit into these guidelines and find out how much home you can afford.
Why Should I Refinance?
You’re in good shape if you have a low 30-year fixed interest rate. But if any of these Five Reasons applies to your situation, you may want to look into refinancing.
1. Decrease monthly payments.
If you get a fixed-rate lower than the current one, you can lower your monthly payments.
2. Get cash out of your equity.
If you have enough equity, you can get cash out by refinancing. Just decide how much you want to take out and increase the new loan by that amount. It’s one way to release money for major expenditures like home improvements and college tuition.
3. Switch from an adjustable to a fixed rate.
If interest rates are increasing and you want the security of a fixed rate, or if interest rates have fallen below your current rate, you can refinance your adjustable loan to get the fixed rate you’re looking for.
4. Consolidate debt.
You can refinance your mortgage to pay off debt, too. Increase the new loan amount by the amount you need, and the lender will give you that cash to pay off creditors. You’ll still owe the lender but at a much lower interest rate – and that interest is tax-deductible.
5. Pay off your mortgage sooner.
If you switch to a short-term or bi-weekly payment plan, you can pay off your home earlier and save in interest. And if your current interest rate is higher than the new rate, the difference in monthly payments may not be as big as you’d expect.
Is refinancing worth it?
Refinancing costs money. Like buying a new home, there are points and fees to consider. Usually, it takes at least three years to recoup the costs of refinancing your loan, so if you don’t plan to stay that long, it isn’t worth the money. But if your interest rate is high, it may be wise to refinance to a lower interest rate, even if it is for the short term. If your mortgage has a prepayment penalty, this is another cost you will incur if you refinance.
Use the reasons above as a guideline and determine whether or not refinancing is the right thing to do. You can also use our refinance analysis calculator to help you decide.
What Are the Costs of Refinancing?
Here’s what you can expect to pay when you refinance:
The 3-6 Percent Rule
Plan to pay between 3% and 6% of the new loan amount (if you want cash-out, the loan amount will be more significant). Yet some lenders offer no-cost refinancing in exchange for a higher rate.
Getting to the Points
Points play a big part in how much it’ll cost to refinance – the more points you pay, the lower your interest rate. Points are a good idea if you’re planning to stay in your home for a while, but if you are moving soon, you should try to avoid paying points altogether.
Negotiate the Fees
Be aggressive and investigate the fees your lender is asking you to pay. You may not need an appraisal, or your loan-to-value may be such that you no longer need Private Mortgage Insurance. If you refinance with your current lender, they won’t need a credit report. With some research, it’s incredible how much you can save.
Here, we’ve explained the different loan refinancing fees.
Application Fee: This covers the initial costs of processing your loan application and checking your credit.
Appraisal Fee: An appraisal provides an estimate or opinion of your property’s value.
Title Search and Title Insurance: A Title Search examines the public record to discover if any other party claims property ownership. Title Insurance covers you if any discrepancies arise in the right. (A reissue of the title can save 70% over the cost of a new policy.)
Lender’s Attorney’s Review Fees: In any financial transaction of this scope, a lawyer’s participation ensures that the lender isn’t legally vulnerable. This fee is passed on to you.
Loan Origination Fees: This is the cost of evaluating and preparing a mortgage loan.
Points: These are basic finance charges you pay the lender. One point equals 1% of the loan amount (for example, one point on a $75,000 loan is $750). The total number of points a lender charge depends on market conditions and the loan’s interest rate.
Prepayment Penalty: Some mortgages require the borrower to pay the penalty if the mortgage is paid off before a specific time. FHA and VA loans issued by the government are forbidden to charge prepayment penalties.
Miscellaneous: Other fees may include costs for a VA loan guarantee, FHA mortgage insurance, private mortgage insurance, credit checks, inspections, and other fees and taxes.
How to Save Money Refinancing:
Research all costs and fees.
Don’t be afraid to negotiate with your lender.
Shop around for the lowest rates.
Check with your current lender for lower rates with reduced or waived costs.
What Kinds of Mortgages Are Available?
Fixed-Rate Mortgage – interest rates and monthly payments remain unchanged for the life of the loan.
Adjustable-Rate Mortgage – interest rates and monthly payments can go up or down, depending on the market.
Hybrid Loans – a combination of fixed and adjustable mortgages
· How do you decide which loan is best? These questions may help.
How much cash do you have for a down payment?
What can you afford in monthly payments?
How might your financial situation change shortly and beyond?
How long do you intend to keep this house?
How comfortable would you be with the possibility of your monthly payments increasing?
What is a Fixed Rate Mortgage?
This is the most common loan arrangement in the U.S. With a fixed-rate mortgage, the loan’s principal and interest are amortized or spread out evenly over the life of the loan, giving you a predictable monthly payment.
The upside is that if rates are low, you can lock in for as long as 30 years and protect yourself against rising rates. However, if rates fall, you can’t change your rate without refinancing the loan, which could cost money.
The 30-year Fixed-Rate Mortgage, the most popular and easiest to qualify for, will give you the lowest payment. But you can also get a 20-, 15- and even a 10-year fixed-rate mortgage if you wish to save interest and pay your home off sooner.
What is an Adjustable Rate Mortgage?
With Adjustable-Rate Mortgages (ARMs), interest rates are tied directly to the economy, so your monthly payment could rise or fall. Because you’re essentially sharing the market risks with the lender, you are compensated with an introductory rate lower than the going fixed rate.
How often does the interest rate change?
That depends on the loan. Changes can occur every six months, annually, once every three years, or whenever the mortgage dictates.
How much can my rate change?
Your ARM will stipulate a percentage cap for each adjustment period, which means your interest may not increase beyond that percentage point. If the market holds steady, there may be no increase at all. You may even see your payment decrease if interest rates fall.
How are the changes determined?
Every ARM loan is tied to a financial market index, such as CDs, T-Bills, or LIBOR rates. Your rate is determined by adding a percentage (known as a margin) to that index’s rate. When the index rises or falls, your rate rises or falls.
Is there a limit to how much interest I’ll be charged?
Yes. It’s called a ceiling or lifetime cap. This guarantees that your interest rate will never exceed a designated percentage. For instance, if your introductory rate was 5% and you have a lifetime rate cap of 6% (meaning that your interest rate can never increase more than 6% during the life of the loan), then your ceiling would be 11%.
What are the benefits of an ARM?
‘ With a lower initial interest rate (usually 2% to 3% lower than fixed-rate mortgages), qualifying is more straightforward, and the payments are more manageable at first.
‘ You may qualify for a larger loan than you would with a fixed-rate mortgage.
‘ If you’re only planning to stay a short time, the interest rate is likely to remain lower than that of a fixed-rate mortgage.
‘ If you expect regular pay increases that would cover the increase in your interest, or if you believe interest rates will fall, an ARM might be the wiser choice.
· A few words of caution:
Negative Amortization happens when a lender allows you to make a payment that doesn’t cover the cost of principal and interest. Watch for this; it may be used as a lure to get you into a home with the promise of low initial payments. Or, a lender may give you a payment cap instead of a rate cap. In this mortgage arrangement, if interest rates increase, your monthly payments could stay the same – but the higher interest will still be charged to your loan, adding to it instead of reducing it. Either way, if you find an opposing amortization ARM, you’ll be adding to your debt.
Discounted interest rates – Sometimes, a lender will advertise a meager initial rate. This is a discounted rate, and it’s essentially a marketing tool. If your ARM offers a discounted interest rate, you will see an increase at your next adjustment period, even if interest rates don’t change.
What is a VA Loan?
Administered by the Department of Veterans Affairs, these particular loans make housing affordable for U.S. veterans. To qualify, you must be a veteran, reservist, active duty, or a surviving veteran with 100% entitlement.
A VA loan is a fixed-rate mortgage with a competitive interest rate. Qualified buyers can also use a VA loan to purchase a home with no money down, no cash reserves, no application fee, and reduced closing costs. Some states allow a VA loan for refinancing as well.
Many lenders are approved to handle VA loans. Your VA regional office can tell you if you’re qualified.
What is an FHA Loan?
FHA loans are designed to make housing more affordable for first-time home buyers and those with low to moderate incomes.
Both fixed- and adjustable-rate FHA loans are available, and in most states, an FHA loan can be used for refinancing. The difference is that they’re insured by the U.S. Department of Housing and Urban Development (HUD). With FHA insurance, eligible buyers can put down as little as 3% of the FHA appraisal value or the purchase price, whichever is lower. Qualifying standards are not as strict, and the rates are slightly better than conventional loans.
Some adjustable-rate mortgages allow you to convert to a fixed rate at specified times. This mitigates some of the risks of fluctuating interest rates, but there will be a substantial fee to do it. And your new fixed rate may be higher than the going fixed rate.
This ARM only adjusts once at five or seven years, then remains fixed for the duration of the loan. Not only will you benefit from a lower rate for the first few years, but the new fixed rate cannot increase by more than 6%. It may even be lower, depending on market conditions. Then again, you also risk adjusting to a much higher rate.
Another ARM choice, the convertible loan, offers a fixed rate for the first three, five, or seven years and then switches to a traditional ARM that fluctuates with the market. A convertible loan might be a smart move if you strongly believe that interest rates will fall.
These short-term loans begin with low, fixed payments. Then, a single large payment (balloon) for all remaining principal is due in five, seven, or ten years. While this saves money up front, coming up with a large payment at the end of the loan may be difficult. Some lenders will allow you to refinance that payment, but some won’t so be sure you know what you’re getting into.
Graduated Payment Mortgage (GPM)
With a GPM, you pay smaller payments that gradually increase and level off after about five years. Lower payments can make it possible for you to afford a bigger home, but they’ll be interest-only payments, adding nothing to the principal. This could put you in a negative amortization situation.
How Can I save on a Fixed Rate Mortgage?
Short Term Mortgages
You don’t have to finance your home for 30 years. Granted, the payments will be lower, but you’ll be paying them longer. You could, instead, opt for a period of 20, 15, or even ten years, pay your home off sooner, and save in interest.
Furthermore, lenders offer much more attractive interest rates with short-term loans, so your payments may not be as much as you’d think.
The table below shows you the interest savings on a $100,000 loan at 8.5% interest:
By paying $215.83 more monthly on a 15-year mortgage, you’d save $99,555.83 in interest over a 30-year loan – and own the house in half the time.
What Determines the Cost of a Mortgage?
Five factors determine the ultimate cost of a mortgage.
The principal, or loan amount, is the total amount you borrow (the purchase price minus your down payment).
The interest rate adds significantly to the cost of your mortgage. Fixed or adjustable, the interest paid at the loan’s end can exceed the home’s original price. For instance, a $100,000 loan balance at 8.5% for 30 years will cost you $277,000 by the time the loan is retired.
The term of the loan is the time until the loan is paid off. A longer-term means more interest and higher cost.
Points are interest paid on loan, and they’re purely optional. You spend points at closing if you want to reduce the interest rate and make your monthly payments smaller. One point equals one percent of the loan amount.
Fees are paid to the lender at closing to cover the costs of preparing the mortgage. They can vary depending on where you live and what type of loan you secure.
While points and fees are not financed, they still contribute to the cost of the mortgage.
What is Private Mortgage Insurance?
Private Mortgage Insurance, or PMI, is insurance purchased by the buyer to protect the lender if the buyer defaults on the loan. PMI is generally applied when you put down less than 20% of the home’s purchase price. The reason is this:
With 20% down, you are considered low risk. Even if you default, the lender will probably come out ahead because they’ve only loaned 80% of the home’s value, and they can probably recoup at least that amount when they sell the foreclosed property.
But with 5% or 10% down, the lender has a lot more invested in the loan, and if you default, they will almost surely lose money. This is why lenders require buyers to purchase PMI if they put down less than 20%. It’s insurance that, no matter what happens, the lender will recoup its investment.
How does PMI increase your buying power?
In simplest terms, PMI allows you to put less money down, and the benefits are as follows:
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