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How To Afford A Mortgage
ü Minimum Cash Requirement
The main deterrent in buying a home today is not income or credit requirements but not knowing enough about financing to make a reasonable decision on what type of mortgage is needed for one's personal finances. Traditionally a 20 percent downpayment is required and in many instances the related closing costs and escrow can run a added 10%. Funds for the purchase of a home can include obtaining a cash gift from a relative or cashing in an insurance policy or retirement account; fortunately, there are other more available methods to lower the initial costs of obtaining a mortgage.
100% Financing Programs - With 100% to 103% financing programs it is now possible to obtain a mortgage with no more than the closing cost, which if negotiated the seller can contribute up to 6% for non-recurring closing cost.
Conventional loans also offer low or no downpayments with PMI (Private Mortgage Insurance). PMI is not life or accident insurance, but rather insures the mortgage itself and covers the lender in the event of a foreclosure on the property. Generally, lenders will require PMI when there is less than a 20 percent downpayment. Many lenders offer conventional loans with as little as 5 percent down and a few offer loans with no downpayment at all. Generally conventional loans with PMI are subject to more restrictive credit and income guidelines than FHA or VA loans. Interest rates among most types of prime loans are roughly equal.
The key to using the minimum in up-front funds is to have the seller pay most or all of your closing costs. Depending on the down payment you make, the seller may be permitted to absorb all of your closing costs. Under the VA program, the seller can also pay the tax and insurance escrow allowing the buyer to get in the home with little or no funds. FHA and most conventional programs allow the seller to pay up to 6 percent of the sales price to the closing costs; conventional loans at 95 percent LTV (Loan-To-Value) allow the seller to pay only 3 percent of the sales price towards closing costs. You may have to make the seller a full price offer to have him absorb the closing costs, but any offer can be presented. If the seller does agree to pay the closing costs, ask your lender if you can obtain a loan without escrowing for taxes and insurance. This will mean that you will have to come up with hefty payments when the property taxes and insurance are due periodically throughout the year, but you will have avoided establishing a fat escrow fund at closing. Beware however, finding money to pay taxes and insurance in a lump sum can be difficult and most lenders won't allow it unless you have a large (20 percent) downpayment. Also, try to set up your closing to occur towards the end of the month, because you will have less pre-paid interest due at settlement for the month of closing.
Many times a 5 percent cushion is built into the sales price of a home to allow negotiation of a sales offer. Just remember that in a hot real estate market, the seller may not be anxious to accept a low offer and may reject the agreement on a home that you really want due to small differences. If you play the game, you must be prepared to lose and go on to the next property.
You should try to get pre-approved by a lender prior to shopping for a home. A pre-approval is a strong marketing tool when making an offer that may contain many a number of seller concessions. Telling a seller that you are already approved for a loan makes the acceptance of a low offer or one where he may be paying the closing costs much more palatable.
ü How to Maximize Your Income
Most lenders will require that you disclose your income from the previous two years and use this income to qualify you for a mortgage. They will ask for W-2 forms, tax returns, or bank statements to verify the income. The lender will then apply a formula to the income to determine your ability to repay the loan. A common requirement is that the mortgage payment cannot be greater than 28 percent of the borrower's gross monthly income, and the mortgage payment plus all other monthly obligations cannot exceed 36 but can go as high as 50% percent of the gross monthly income. FHA allows higher ratios, and there are always exceptions to the guidelines.
One way to expand your purchasing power is to obtain a low, low rate mortgage such as some adjustable rate mortgages. They may begin with an introductory rate 3 percent under the going rates. The disadvantage to these types of loans is that the rates are subject to change as frequently as every six months to one year. Payments are permitted at an artificially low rate but these may result in "reverse amortization;" that is, the mortgage balance may be higher at the end of the year than when you started! This may not always be bad, particularly if you are buying in an area of high appreciation or if you only intend to live in the home for a few years but know what you are getting in to. Not all adjustable rate mortgages are negative amortizing and lenders are required to give you a program description. Get it and review it until you are sure that you understand all of the terms. This type of loan can however add thousands to your purchasing power due to the low initial rate.
If you don't have the stomach for an adjustable rate mortgage, explore 5/1 or 7/1 type loans. The rate will stay the same for the first five or seven years, and then it changes to a one-year ARM for the remainder of the term. The initial rate is lower than a fixed 30-year mortgage, and by the time the rate is due to change in five years, you may be ready to move or refinance.
Take a look at your monthly installment payments. It can be advantageous to use some of your downpayment money to pay off high interest rate or short term debt to ease your
qualifying ratio. Paying off a car loan with a few years to run may erase a high dollar monthly
payment for only a few thousand dollars. The result may be a higher mortgage due to less downpayment, but monthly you will be spending less and mortgage payments only increase by only a few dollars per thousand due to longer amortization.
In general, look at your entire financial picture. Never pay up front points (fees for a lower rate) on a loan. Shorter-term loans do save interest over the long run but decrease buying power up front. You can always make extra payments later if you want to shorten the term of the mortgage. Forget about bi-weekly mortgages, they just force you to make extra payments whether you want to or not. It may be smarter to save money in a mutual fund or other vehicle that could offer a better return and easier access to funds when needed than a mortgage. Owning a home with a mortgage could allow you to itemize your taxes for the first time and save money on April 15th.
ü Finding a Bargain Home
One of the clichés of the real estate world is the most important thing to consider when buying a home is "location, location, location." That also applies when trying to find a bargain in a home. Generally it is better to buy a "fixer-upper" in a terrific neighborhood rather than a great but bargain-priced home in a less desirable neighborhood. There are always bargains in run down areas, but while these houses may offer a lot of house for the dollar, they will be difficult to sell and may have little or no appreciation despite the time, energy, and money you have poured into them.
Forget about buying a home from the newspaper foreclosure notices, they are difficult to purchase and better left to the pros. Instead foster a relationship with a real estate agent and remain loyal to that agent. You want to find a home that may need some cosmetic work but is basically sound. Estate sales are probably the best area you want to explore, and try to investigate listings that have been on the market for awhile. Keep in mind that the reason a property has been on the market for a long time is because it is less desirable for some reason. Remember, most every property has its price and will ultimately sell when the price/value ratio becomes attractive. Multi-family homes can offer some additional income if you are willing to put up with the headaches of being a landlord with tenants in close proximity. It can be financially profitable to live in the multi-family for a few years and then keep the property as an investment after you move to a single family home.
If financially able, look to buy a home during periods of high interest rates or economic recession. During those times home prices may drop or the seller will be more amenable to accepting low offers. High interest rate periods don't last forever, and when rates come down or the economy improves you can refinance for a lower rate and even take out some excess cash from appreciation.
ü Credit Scores and Sub-Prime Loans
Prior to the early 1990s home buyers had to have a very good credit history to qualify for a loan. Those who had foreclosures, repossessions, or bankruptcies in their history were told to wait seven years and to walk the straight and narrow credit path in the meantime. During the 1990s a new type of financing became available called "sub-prime" lending. Those who could not previously obtain a loan were eligible for a sub-prime loan where the interest rate charged may be 2 percent to 5 percent higher than the prevailing "prime" mortgage interest rates. Basically there is a trade off by the lender for receiving a higher interest rate in return for accepting a perceived higher risk loan. The good news is that now many more people are eligible to obtain a mortgage albeit at a higher than the prevailing rate and with this mortgage are frequently adjustable rate mortgages with a pre-payment penalty that makes it expensive to pay off during the pre-payment penalty period that may be three to five years.
During the 1990s credit scoring also came into effect. Credit scores, or FICO scores, attempt to classify a person's credit history into one three-digit number ranging from 300 to 900. A credit score of 650 or above is deemed to be a "good" credit risk by many lenders, the higher the better. In fact, a credit score of 700 or above can allow for a 100 percent LTV loan at only a little higher interest rate. A score of 625 may be acceptable, but scores from 525 to 625 usually fit into the sub-prime loan category. A score under 500 makes it very difficult or impossible to obtain financing of any sort. There are three credit repositories in the United States and their method of determining a person's credit score is somewhat a secret but mainly based on the past payment history and overall amount of debt.
ü Hidden Costs in a Mortgage
Most every loan is going to have associated with it fees for title insurance, appraisal, credit report, etc. Most of these fees are commonly required amongst all lenders and they must give you a list of their costs associated with a mortgage. Despite the fact that the costs are disclosed, some lenders may include extraordinary "junk" fees in their costs that an unwary buyer may not recognize as an extra fee. At the time of a loan application lenders are required to give you a written closing cost estimate and a HUD booklet explaining settlement costs. If you don't automatically receive it ask for it because this booklet does effectively explain most costs but unfortunately is often not read by home buyers.
First, don't pay up-front points to obtain a lower rate. Fees paid for a lower rate do result in a lower payment but it is not cost effective until about five years out. By that time you may have sold or refinanced the property. Beware of fees labeled "underwriting," "warehouse," "processing," "commitment," or other not commonly recognized fees. These fees may well be legitimate but always question why they are being charged. Some lenders advertise artificially low rates to attract customers but load up on fees to compensate for a lower rate. A tip off to a lender that charges hidden fees would be a lender who advertises interest rates that are appreciably lower than the competition. Interest rates are very competitive and shopping for the very best rate may in fact work to your disadvantage. Differences in rates of 1/8th or 1/4th of a percent result in very little difference in a payment and may be offset by poor service and added hidden fees.
ü Correcting Past Credit Problems
Contrary to what you may have heard, credit reports are for the most part accurate. Common last names and a "Jr." in the family does cause a few problems but credit reports identify people by social security number, address, and name. If you have an issue with your credit report, credit-reporting agencies are required to attempt to resolve the problem. Most of the information has to be provided by the individual and they should stay in touch for as long as it takes, frustrating or not. There are three main credit repositories in the United States: Equifax, Trans Union, and Experian. These companies each hold a database of information and provide it to a more local credit-reporting agency that may actually be issuing the report. If you have a dispute, you can go direct to the three repositories to attempt to clear the issue. Their addresses are listed below.
As mentioned before, credit scores in the 500 range can cause problems when attempting to obtain new credit. You can raise your score if the original information was incorrect, or you can over time improve your payment history, but it may take a few years of diligent pay history to appreciably raise your credit score.
If worse comes to worse declaring bankruptcy may be your only answer, but despite its growing popularity, I recommend it only as a very last resort. A bankruptcy will stay on your record for years and make obtaining credit difficult. There are two methods to declare bankruptcy: Chapter 13 and Chapter 7. Chapter 13 is where an individual attempts to restructure his debts and pay them off over time. Chapter 7 is when an individual is relieved of his obligations included in the bankruptcy petition.
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