Mortgages

Personal Finance

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Curriculum Content

If you cannot buy your home with cash, you will need to know how the mortgage system works. A mortgage simply loans you money to pay for your home and charges you monthly payments with interest until the debt is paid. The loan is a long term loan, ranging between 15 and 30 years in length.

Your application considers your credit history, your personal finances, your job stability, and potentially other personal factors. They will determine if you are fit for a loan, and quote you a maximum qualification number. Note that this number does not mean you can afford the quote. You generally cannot afford the maximum qualification amount. Your ability to afford the home is based on the percentage of monthly income paid into the home itself.

Budgeting Your Mortgage

The maximum percentage you should spend on housing monthly is 30% of your income. Twenty percent or less gives you the maximum amount of financial room for savings, investments, and disposable income. A fixed loan which has monthly payments less than 30% of your monthly income is the loan you should accept. The difference between the loan amount and house’s price should be your personal down payment. This limits your home selection to what you can afford. If you cannot afford the house with these two requirements, continue saving.

Exceeding the monthly payment amount will eat other areas of your budget. You may have to reduce savings, investment, or disposable income. If the mortgage is a large percentage of your budget, you may have to begin passing on other desires and even essentials.

Any resulting situation won’t be easily rectified. Housing is the most difficult of your costs to decrease. You will have to locate a cheaper location, sell your home to a buyer, pay the balance on your mortgage, spend more money moving, and spend even more on your cheaper living space.

The unhappier alternative will be foreclosure. During the subprime mortgage crisis, many people chose to simply allow their home to go into foreclosure when their mortgage bills became 50% or more of their monthly income. Their houses were seized, their credit histories ruined, and they lost all money paid into the home. Any repairs, replacements, modifications, or adjustments made on the home were also lost. Don’t buy a home you can’t afford.

Preparing for your Application

Before applying for a mortgage, there are several actions you should take. You will need multiple documents. Collect your employment history, credit history, bank statements, investment statements, recent paychecks, and a net worth estimate. Improve your credit score before applying to receive better interest rates. You can also improve rates by using your state’s first-time homebuyer program. They may offer loans with lower interest rates and other advantages.

Mortgage Rate Variations

You will also need to decide in advance which type of loan you are applying for. Mortgages come in two major categories, fixed and variable rate. A fixed rate mortgage has a steady payment which does not change over the course of the loan. You will pay the same amount for the term of the mortgage.

An adjustable rate mortgage changes over the course of the loan, typically rising in cost. The opening rate is often substantially lower than a fixed rate mortgage. Unfortunately, the increasing cost of the loan often forces you to pay more long term than a fixed rate mortgage. Beware the maximum potential monthly cost, ignore the initial payments. You will pay the initial payment for a short amount of time, but the maximum potential cost might be paid for the majority of your loan. Ensure this cost is within 30% of your monthly income.

Additionally, beware of any circumstances that result in your adjustable rate changing. Your loan may be tied to the London Inter-Bank Offering Rate or another short-term measure. These will be listed in the mortgage contract or fine print.

Mortgage Term Decisions

Choose your term carefully. A 15-year term will have higher payments but lower total interest costs over the long term. A 30-year term has lower payments but higher long-term interest costs. In both cases, repaying the loan quickly will reduce the amount paid in interest, but your choice determines the monthly cost of housing. It can reduce your disposable or investment income.

Amortization Schedule

No matter which mortgage you chose, you should know precisely how that loan will handle interest and principal. Mortgages can handle payments differently. Loans can direct higher percentages of monthly payments to interest or principal. Some loans may even direct all of your payment to interest. The amount paid into the interest versus mortgage is defined by a document known as the amortization schedule. Get an amortization schedule before you sign for a loan.

Always try to negotiate a higher amount of money being paid into principal versus interest. Only the elimination of principal which increases your ownership of the home, interest is merely pure profit. Interest-only loans are to be avoided like the black plague; they never pay down principal until years into the loan. Your monthly payments will skyrocket when principal payment begins since you’re paying the same amount of principal in less time.

These decisions should be made long before you’re walking into the lender’s office. In actuality, they should be made before you even look for a house. Pre-qualifying for your mortgage is one of the wiser moves you should make when seeking out a home. Always attempt to pre-qualify for a mortgage with a fixed monthly payment between 20% and 25% of your annual income. Pre-qualifying for a mortgage shows the broker and the seller that you are serious about purchasing a home. Acquiring your mortgage financing before finding the house removes the pressure of finding a loan during your negotiation. Pre-qualified financing also lets you focus on what you can afford financially since you are not skewed by emotions or attachments to the house. You will have to commit to the arrangement in advance.

Payment Points

Payment points reduce the interest rate paying up front. One payment point is the equivalent of one interest point on the loan. You pay the loan’s interest rate up front Instead of suffering the interest. Payment point’s benefits increase with the term length. Longer loans have greater benefit since interest will compound less. The shorter the term of the loan, or the quicker you pay it off, the less you benefit from payment points. Your interest has less time to accrue.

Mortgage Insurance

Mortgage insurance typically occurs when you don’t have a substantial down payment, which should be closer to 40% of your home’s total cost. The loan’s interest rate is raised until you’ve paid a specific amount of the home’s total value. The policy typically requires above 20% equity on the home’s total price. Ask the mortgage company about this policy and what you’d have to pay to eliminate it. It may cancel out automatically after the payment is cleared, you may have to request it be removed.

Mortgage Inspection

Mortgage lenders research the quality of the living space purchased and who it truly belongs to. You essentially pay the research costs in both regards. They investigate the living space’s quality and value with an appraisal. They may investigate the property or search city records and previous home value estimates. Their goal is making sure your loan and down payment don’t exceed the value of the home. If it does, your loan may be scaled downward or denied. This is charged to you via a fee of a few hundred dollars.

Title Insurance

The firm will also look at who owns the title of the home. Banks avoid conflicting claims on ownership. A home with claims, liens, or substantial existing debt may be rejected by the company. This is also expenses to you, but through a cleaner sounding name known as “title insurance”.