PLANNING
House hunting begins at home—with planning. In today’s
market, an affordable home is not so much determined by sales price
as it is by the financing which translates that price into a monthly
payment.
How Much House Can I Afford?
How much house you can afford to buy depends on two things: how
much you can invest in the down payment, and how much you can afford
for the monthly housing payment. These payments include principal
and interest on the mortgage loan, and property taxes and insurance,
or PITI:
- Principal – The amount of the payment
that goes towards paying down the loan amount. Since, for most
loans, part of your mortgage payment gets applied towards principal,
over time, your outstanding principal balance will go down.
- Interest – The interest rate lenders
charge is the cost of the borrowed money. The interest and principal
payments equal your monthly mortgage payment.
- Taxes – The local government where the
home is located will assess your home and determine its real estate
taxes. Most lenders will collect this as part of your monthly
payment and then pay your local government on your behalf. This
is commonly referred to as tax escrow.
- Insurance – Homeowner’s insurance
(or hazard insurance) covers you in the event of damage to your
property caused by fire, wind, or other hazards.
For some buyers, monthly housing costs may also include homeowners
association dues, condominium fees, and mortgage insurance.
Down Payment Sources
The traditional source of money for your down payment is either
your savings or the proceeds from the sale of a home you already
own. But there are some other not so obvious sources.
Home Equity Loan – Parents often have considerable
equity built up in their own homes, and through a home equity loan,
can gift a down payment for a home to their children. Often lenders
will require a “gift letter” to verify the parents don’t
expect repayment. In return for providing a part of the down payment,
the parents (or another investor) share in the profit or net equity
of the house when it is eventually sold. Ask your tax advisor for
current information.
Life Insurance – If you have built up a
cash value on your life insurance policy, you may be able to borrow
up to this amount from your insurance company. You may even get
a more favorable interest rate for this type of loan.
Stocks and Bonds – You may be able to secure
a bank loan using your portfolio as security, without selling your
stocks and bonds.
Company Profit Sharing or Savings Plan –
Look into the possibility of withdrawing or borrowing against what
you have in your employer’s profit sharing or savings plan
account.
Don’t plan to put your last penny down on the closing table.
The larger the down payment, the less money you need to borrow.
However, you will still need money for closing costs, moving, setting
up your new home, and other miscellaneous expenses.
Pre-qualification vs. Pre-approval
Knowing your affordable price range will bring your house hunting
into focus. How much money you qualify for will depend on a variety
of factors including credit history, length of employment, and down
payment amount.
Based on information you provide, your lender can estimate how
much money you can borrow before applying for a loan. This non-binding
process is called pre-qualifying.
Your lender can also take detailed look at your financial and
credit profiles (including a credit check) and commit to lending
you a specified amount of money pending specific property details.
The lender will then provide you with a letter stating how much
mortgage you qualify for. This process is called pre-approval. With
a pre-approval letter, you can:
- Shop for a home with the confidence of knowing exactly how
much you can afford.
- Show sellers you are serious about buying and that you can afford
to make a purchase.
- Discover any qualification issues early in the home buying process.
Because a pre-approval takes a closer look at your background and
includes a credit check, it holds more weight with sellers than
pre-qualification.
Mortgage Insurance
If you obtain a conventional loan, depending on your loan program
and down payment amount, you may be required to buy private mortgage
insurance (PMI). This insurance protects the lender in case you
default on the loan, allowing the lender to approve a larger loan
amount.
Mortgage insurance offers a variety of payment options, including
making an initial payment at closing or making monthly payments
with the house payment. You may even increase your interest rate
and have the lender pay the insurance. Be sure to ask your lender
to compare the benefits of the different plans.
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