Mortgage Information

If you’re like most buyers, a home is the most expensive purchase you’ll ever make, and you’ll probably need some form of financing. There are many lending institutions that offer a variety of mortgage products. Financing options and rates can vary widely, so it is important to do your research and shop around to ensure you get the mortgage that best meets your needs at the best price. I would be happy to refer you to some very good mortgage contacts I have in the metro Denver area or to help you in any other way I can to secure the best possible rate for your home purchase.

WHAT IS A MORTGAGE?

A mortgage is a loan to finance the purchase of a home, and it is probably the largest debt you’ll ever take on.

Your home is the collateral for the loan, which is also a legal contract you sign to promise that you’ll pay the debt, with interest and other costs, typically over 15 to 30 years.

If you don’t pay the debt, the lender has the right to take back the property and sell it to cover the debt; this is called repossession.

To repay the mortgage debt, you make monthly installments or payments that typically include the principal, interest, taxes and insurance, together known as PITI.

Principal and Interest

Principal: The principal is the sum of money you borrowed to buy your home. Before the principal is financed you can give the lender a sum of cash called a down payment to reduce the amount of money that you borrow.

Interest: Usually expressed as a percentage called the interest rate, interest is what the lender charges you to use the money you borrowed. In addition to the given rate, the lender could also charge you points and additional loan costs. Each point is charged at the rate of one percent of the financed amount and points are financed along with the principal.

Principal and interest comprise the bulk of your monthly payments in a process called amortization, which reduces your debt over a fixed period of time. Each payment includes both an interest payment portion and a principal payment portion. With amortization, the interest payment portion is higher in early years and principal payment portion is higher in later years.

Taxes and Insurance

In addition to your principal and interest, your mortgage payment could include money that’s deposited in an escrow or trust account to pay certain taxes and insurance.

Generally, if your down payment is less than 20 percent of the loan, your lender considers your loan riskier than those with larger down payments. (Note that the percent amount varies from place to place – in some places it could be 25 percent in others 20 percent – check with local lenders.) To offset that risk, the lender sets up the escrow account to collect those additional expenses, which are rolled into your monthly mortgage payment.

Taxes: The taxes are property taxes your community levies based on a percentage of the value of your home. The tax is generally used to help finance the cost of running your community, e.g., to build schools, roads, infrastructure and other needs. You must pay property taxes even if you don’t need an escrow account and even after your mortgage is paid off.

Insurance: Lenders won’t let you close the deal on your home purchase if you don’t have home insurance (also calledhazard insurance), which covers your home and your personal property against losses from fire, theft, bad weather and other causes. Even if you pay cash for your home, you should buy home insurance unless you can afford to repair or rebuild your home if it’s damaged or destroyed.

If your home is in a federally designated high flood risk zone within a flood plain and you are signing for a federally insured loan, federal law mandates that you must buy flood insurance. If you are not in a high flood risk zone, you can still buy the coverage.

If your down payment is less than 20 percent (or the percent amount accepted by lenders) of your home purchase most lenders will also charge you private mortgage insurance (PMI) premiums. The coverage doesn’t protect you, it protects the lender from you defaulting on the mortgage. Without the coverage, many buyers could not otherwise afford to buy a home.

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HOW MUCH CAN YOU AFFORD FOR A HOME LOAN?

As you think about applying for a home loan, you need to consider your personal finances. How much you earn versus how much you owe will likely determine how much a lender will allow you to borrow.

Estimate Your Available Finances

Income: First, determine your gross monthly income. This will include any regular and recurring income that you can document. Unfortunately, if you can’t document the income or it doesn’t show up on your tax return, then you can’t use it to qualify for a loan. However, you can use unearned sources of income such as alimony or lottery payoffs. If you own income-producing assets such as real estate or stocks, the income from those sources can be estimated and used in this calculation. If you have questions about your specific situation, any good loan officer can review the rules with you.

Debt: Next, calculate your monthly debt load. This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other ongoing monthly obligations, like alimony or child support. If it is revolving debt like a credit card, use the average monthly payment for this calculation. If it is installment debt, use the current monthly payment to calculate your debt load. And you don’t have to consider a debt at all if it is scheduled to be paid off in less than six months. Add all this up to get a figure that we’ll call your monthly debt service.

Housing costs: Calculate your monthly housing costs, including house payments, property taxes and insurance.

Factors Lenders Consider for Loan Qualification

In a nutshell, most lenders don’t want you to take out a loan that will overload your ability to repay everybody you owe. Although every lender has slightly different formulas, here is a rough idea of how they look at the numbers.

Note that actual percentage amounts will depend on several factors such as a FICO score as well as each lenders suggested GDSR (Gross Debt Service Ratio) for the type of mortgage.

Housing costs versus gross income: Typically, your monthly housing expense, including monthly payments for taxes and insurance, should not exceed about 28 percent of your gross monthly income. This can be expressed in the formula below:

HC < or = I x .28

or, written another way

I x .28 > or = HC

where:

I = gross monthly Income

HC = monthly Housing Cost including tax and insurance

If you don’t know what your tax and insurance expense will be, you can estimate that about 15 percent of your payment will go toward this expense. The remainder can be used for principal and interest repayment.

Housing and debt costs versus gross income: This is sometimes referred to as Gross Debt Service Ratio or GDSR. In addition to having housing costs be no more than a certain percent of your gross income, your proposed monthly housing expense and your total monthly debt service combined cannot exceed about 36 percent of your gross monthly income. If it does, your application may exceed the lender’s underwriting guidelines and your loan may not be approved. This can be expressed in the formula below:

HC + D < or = I x .36

or, written another way

I x .36 > or = HC + D

where:

I = gross monthly Income

HC = monthly Housing Cost including tax and insurance

D = gross monthly Debt

Example Calculations

The percentage amounts used below are given for example only.Note that actual percentage amounts will depend on several factors such as a FICO score as well as each lenders suggested GDSR for the type of mortgage.

Calculating maximum monthly allowable housing cost: for a monthly income I = $4000, housing costs should not exceed $1120

I x .28 > or = HC

$4000 x .28 = $1120

Calculating maximum monthly allowable housing and debt load: for a monthly income = $4000, monthly housing costs + monthly debt load should not exceed $1440

I x .36 > or = HC + D

$4000 x .36 = $1440

Calculating maximum monthly allowable housing cost based on income and debt load: for a monthly income = $4000 and a monthly debt of $400, monthly housing costs should not exceed $1040

In the example above, we calculated above that the maximum monthly housing and debt load should not exceed $1440

now we subtract the known monthly debt

$1440– $400 = $1040

Exceptions

Depending on your personal situation, there may be more or less flexibility in the percent ratio guidelines. For example, if you are able to buy the home while borrowing less than 80 percent of the home’s value by making a large cash down payment, the qualifying ratios become less critical. Likewise, if a rich relative is willing to co-sign on the loan with you, lenders will be much less focused on the guidelines discussed here.

Loan Options

Remember that there are hundreds of loan programs available in today’s lending market and every one of them has different guidelines. So don’t be discouraged if your dream home seems out of reach. Since there are so many different lenders and loan programs, it pays to shop around.

There are a number of factors within your control which affect your monthly payment. For example, you might choose to apply for an adjustable-rate mortgage (ARM) which has a lower initial payment than a fixed-rate program. Likewise, a larger down payment will lower your projected monthly payment.

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3 EASY STEPS TO GETTING A MORTGAGE

Examine your finances and shop around before you apply for a mortgage. Shopping for a mortgage is the first step toward owning a home and perhaps the most daunting, especially if you are not prepared.

Once a simple task that meant comparing fixed rates from among perhaps a dozen or fewer savings and loan companies, the mortgage hunt today is like finding your way through a maze.

There are dozens of loan types and hundreds of loan programs available through thousands of mortgage brokers, bankers, lenders, finance companies, credit unions and even stock brokerage firms.

Contrary to popular belief, finding a mortgage doesn’t begin with an application.

Education is a better first choice. Mortgage information sources are as vast as the number of mortgages available: Web sites, topical newspaper articles, mortgage books, consumer seminars and workshops, financial planners, real estate agents, mortgage brokers and lenders are all available to assist you along the way.

First and foremost, you must determine how your mortgage payment will fit your current budget and, to some extent, your future obligations 15 to 30 years down the road.

If you discover too late that you can’t afford your mortgage, you’ll not only face the possibility of losing the roof over your head, but you could also damage your ability to purchase a home in the future.

Step 1: Examine Your Finances

If you can afford to buy a home, you must then determine how much mortgage you can afford. Lenders are apt to put your loan application in the best light and qualify you for as much as they are willing to lend, which can be more than you can afford.

It’s up to you to take stock of your income and expenses, both current and projected, to determine what you can comfortably manage each month. Along with your mortgage payment, don’t forget related insurance, taxes, homeowner association dues and any other costs rolled into the mortgage payment.

Step 2: Shop for a Loan

When you are ready to shop for a loan you have two basic types of mortgage stores to shop from: direct lenders and mortgage brokers.

Direct lenders have money to lend. They make the final decision on your application. Lenders have a limited number of in-house loans available.

Mortgage brokers are intermediaries who, like you, have many lenders from which to choose. Brokers shop from many lenders, each with their own offering of loans.

If you have special financing needs and can’t find a lender to suit them, an experienced broker may be able to ferret out the loan you need. Mortgage brokers, however, are paid with a slice of the amount you borrow – some more than others, so it pays to compare rates. Internet brokers today perhaps receive the smallest cut, sometimes none at all, and can prove to be a real bargain.

Along with shopping the source, you’ll also have to shop for loan costs, including the interest rate, broker fees, points (a point is an amount paid to the lender and is charged at one percent of the amount you borrow), prepayment penalties, loan term, application fees, credit report fee, appraisal and a host of others.

Step 3: Apply for a Loan

The application process is the easy part – provided you’ve gathered the documents necessary to prove claims you make on the application.

The application will ask for information about your job tenure, employment stability, income, your assets (property, cars, bank accounts and investments) and your liabilities (auto loans, installment loans, mortgages, credit-card debt, household expenses and others).

The lender will run a credit check to determine your credit status, but you’ll have to supply additional documentation including paycheck stubs, bank account statements, tax returns, investment earnings reports, rental agreements, divorce decrees, proof of insurance and other documentation. A lender that deems you creditworthy will likely hire a professional appraiser to make sure the value of the home you are about to buy is truly worth your loan amount.