Are you dreaming of owning a home, a place to call your own? In a neighborhood, you love, with shopping nearby, a yard for your children (and dog) and maybe even a neighborhood pool.
For most people, buying a house requires a mortgage. The definition of a mortgage is a loan from a creditor in which they agree to lend you money for your home, and you repay them over time. Getting a mortgage is a complex process with some important considerations.
In this article, you will find the most common questions and answers regarding home mortgages.
Are you financially ready to buy a home?
You should determine how much of a mortgage payment you could afford. Are you ready to buy a house or should you wait? If you are ready to buy, how much can you afford? Before you are financially ready to buy a home you need to consider critical factors such as the debt-to-income (DTI) ratio.
How much of a home can you afford?
The amount you can afford to spend to buy a house has financial variables. If you have the cash to pay for your dream home, then you can buy one today. But, if you need financing to buy a house, you need to qualify for a mortgage first. But, before a lender approves you for a home loan, it has to determine how much of a mortgage you can afford.
Most Important Factors Determining “How Much House You Can Afford”
The most important factors in calculating home affordability are 1) your credit profile; 2) your monthly expenses; 3) cash available to cover your down payment and closing costs; 4) your monthly income.
- Credit profile – A mortgage-worthy credit profile is critical to qualify for a home loan. The amount of debt you owe and your credit score influence a lender’s view of you as a borrower. Your credit history will help determine the mortgage interest rate you will earn and how much money you can borrow. Before you start the mortgage application process, pull copies of your credit report from all three credit bureaus.
- Debt and expenses – Monthly obligations you may have, such as student loans, car payments, insurance, utilities, groceries, and credit cards, etc.
- Cash available for the down payment – This is the amount of cash you have available to cover closing costs and make a down payment. The downpayment has to be your own money, or it can be gifted to you by someone such as a parent. Homebuyers usually use their investments, savings, or other sources.
- Income – Money that you receive regularly, such as your income from investments or salary. Lenders look at your income to establish a baseline for what you can afford to pay each month.
What is the debt-to-income ratio?
The debt-to-income ratio or DTI is a critical factor in your mortgage application process. Your DTI is an important metric that your bank uses to calculate the amount of money you can borrow. The DTI ratio is comparing your total monthly debts such as your mortgage payments including property tax and insurance payments to your monthly pre-tax income.
Your housing expenses shouldn’t exceed 28% of your monthly income. People with an excellent credit score may qualify at a higher debt-to-income ratio.
What debt is included in the debt-to-income ratio?
- The minimum required payments for every credit card you own.
- Monthly mortgage payment
- Monthly HOA dues
- Monthly homeowners insurance
- Monthly property taxes
- Monthly car payments
- Monthly debt consolidation loan payments
- Monthly personal loan payments
How to calculate the debt-to-income ratio?
For example, if your monthly mortgage payment, with taxes and insurance, is $1,530 a month and you have a monthly income of $5,450 before taxes, your DTI is 28%. (1530 / 5450 = 0.28)
You can also reverse the process to find what your housing budget should be by multiplying your income by 0.28. In the above example, that would allow a mortgage payment of $1,526 to achieve a 28% DTI. (5450 X 0.28 = 1,526)
Can I buy a house with a lot of debt?
What is a lot of debt? Homeownership is not out of reach for people in debt, but a lot of debt might be a problem. Lenders care less about the amount of debt than the debt-to-income ratio. In other words, you might have a lot of debt but a very high income, and you might still qualify for a mortgage.
Lenders will loan you money for a house as long as your debt-to-income ratio is within their requirements. Most lenders will approve people for a home loan as long as their DTI exceeds 43 percent.
How much house can I afford with an FHA loan?
In the perfect world, everyone could afford a 20 percent down payment. If you can afford a 20 percent downpayment you might be able to qualify for a conventional loan. Unfortunately, with the high cost of real estate in the United States many people can only afford to pay for a smaller down payment. If you can only come up with a 3.5 percent down payment, you might consider an FHA loan.
In addition to the smaller down payment requirement, mortgages backed by the FHA also have more relaxed qualifying requirements. For home buyers with lower credit scores and FHA home loan might be ideal.
How does your credit affect your ability to get a mortgage?
Your credit history is the most important when you apply for a home loan. Your credit score is based on your credit history, and it greatly influences the mortgage rates available to you. People with higher credit scores have more home loan options. Before you apply for a home loan, run your credit. If you know your credit score, you can avoid any surprises about your credit situation. It is important to know that lenders consider other factors, too, when you apply for a home loan.
Should you get a 15-year mortgage?
15-year mortgages have lower interest rates than 30-year home loans. A 15-year mortgage can help you pay off your loan in half time compared to a 30-year loan. Paying off your home loan faster is a huge win for you. After you pay off your mortgage, you can use the money for other things.
What are the advantages of a 30-year mortgage?
If you want a lower monthly payment, you might want to consider a 30-year mortgage. The payments are lower because you have a longer time period to repay your home loan. Many borrowers prefer this option because the monthly payment is more affordable.
How do mortgage interest rates affect you?
The interest rate of your mortgage is one of the most important numbers. The interest rate and the amount of money you borrow determine your monthly payments. With each monthly payment, you pay back a chunk of the principal plus interest accrued. Mortgage lenders use an amortization formula to calculate how much of your mortgage payment is principal and how much is the interest.
Do I need a mortgage pre-approval?
A mortgage pre-approval is a great way to help you understand your mortgage options. During the pre-approval process, you share your financial information with a mortgage lender to see how much home you can afford. The pre-approval can be useful as you decide which home fits your budget.
How are my property taxes paid with my home loan?
Most lenders require an escrow account for your mortgage. Each month you pay into the escrow account. Your escrow account includes your property tax and your required homeowner insurance. If you have an FHA loan, you must have an escrow account. Before you sign your loan documents, you should check with your mortgage broker to find out how property taxes are handled with your mortgage.
What could be included in my monthly mortgage payment?
In its most basic form, the monthly mortgage payment includes principal and interest. In addition, some lenders might require you to pay property tax and home insurance into an escrow account.
Should you refinance your mortgage?
If the current mortgage rates are lower than the rates on your current loan, you might want to look at refinancing your mortgage, which might reduce your monthly payment. You may even choose to do a “cash-out refinance” of your home loan if you have substantial home equity built-up.
What is a reverse mortgage?
A home equity conversion mortgage, frequently called a reverse mortgage is a financial product for homeowners 62 or older. A reverse mortgage is an option if the homeowner has substantial home equity. A reverse mortgage is an option for qualified homeowners to supplement their retirement income.