When you are ready to begin looking at various houses to find your dream home you need to prepare all of the necessary materials to present to the lender. Your lender will tell you exactly what you can afford so that you do not spend time looking at “too much” home. There are three key factors that you will need to consider when determining how much home you can afford. These are the down payment, your ability to qualify for a mortgage, and the closing costs associated with your transaction.
Down Payment Requirements:
Most loans today require a down payment of between 3.5% and 5% depending on the type and terms of the loan. If you are able to come up with a 20% down payment you may be eligible to take advantage of special fast-track programs and possibly eliminate mortgage insurance.
It is often thought that bigger is better when it comes to down payments. In many cases this may be true. However, the arithmetic will differ from case to case. A bigger down payment means smaller monthly payments, and lower interest expense for as long as you remain with a mortgage. This can be an important factor for many people.
But if you can put your available funds to work for you, so that they can earn more than the interest rate on your loan, you could be dollars ahead with a smaller down payment. Also, a smaller down payment may allow you to keep your extra cash liquid and available for an emergency.
Don’t forget to think ahead carefully. In addition to the down payment on your dream home, you will be required to pay fees for loan processing and other closing costs. These fees must be paid in cash at the time of the final settlement, unless you are able to include these in your financing. Typically, total closing costs will range between 1-2% of your mortgage loan. A more detailed schedule will be available from your lender.
Qualifying for the Mortgage:
Most lenders require that your monthly payment ranges between 25-28% of your gross monthly income. Your mortgage payment to the lender includes four items -- the PITI. These items are discussed in detail on a following page entitled “Predicting your monthly payment -- the PITI.” Remember, when you buy a home all interest is tax deductible so you will qualify for a major tax advantage that will effectively increase your take-home pay. Your total monthly PITI and all debts (from installments to revolving charge accounts) should range between 33-38% of your gross monthly income. This is a general rule of thumb, but other key factors specifically determine your ability to qualify for a home loan. These factors are:
History of employment, stability of income, potential for future earnings, education, vocational training and background, and any secondary income such as bonuses, commissions, child support, etc.
History of debt repayment, total outstanding debt and total available credit. If you have concerns about your credit record consider contacting one of the major credit bureaus for a copy of your file: Equifax (800) 685-1111; TRW (800) 392-1122; and Trans Union (312) 408-1050.
Cash on hand, other liquid assets such as savings, checking, CDs, stocks, etc.
The home you are buying must be appraised to determine that it has adequate value and is marketable to ensure it will secure the loan.