Deciding How Much Home You Can Afford

Understanding how much you can afford is one of the most important rules of home buying. Depending on your individual situation, your budget can affect everything from the neighborhoods where you look, to the size of the house, and even what type of financing you choose.

Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.

Loan prequalification vs. preapproval

One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.

What factors are important to lenders?

Banks and lending institutions will use several criteria to determine how much money they'll agree to lend. These include:

• Your gross monthly income
  
• Your credit history
  
• The amount of your outstanding debts
  
• Your savings--or the amount of money you have available for a down payment and closing costs
  
• Your choice of mortgage (i.e. 30-year, FHA, etc.)
  
• Current interest rates
  

Two important ratios

Lenders also use your financial information to figure out two, very important ratios: the debt-to-income ratio and the housing expense ratio.

• Debt-to-income ratio
  
  Many lenders use a rule of thumb that the amount of debt you are paying on each month (car payment, student loan, credit card, etc,) shouldn't exceed more than 36 percent of your gross monthly income. FHA loans are slightly more lenient.
  
  
• Housing expense ratio
  
  It is generally difficult to obtain a loan if the mortgage payment will be more than 28 to 33 percent of your gross monthly income.

Down payments make a difference

If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20 percent down payment may be qualified with the 33 percent housing expense ratio, while someone with a 5 percent down payment is held to the stricter 28 percent ratio.

Other ways to improve your purchasing power

• Gifts
  
  If you're having trouble saving money, many lenders will allow you to use gift funds for the down payment and closing costs. However, most lenders require a "gift letter" stating the gift doesn't have to be repaid, and will also require you to pay at least a portion of the down payment with your own cash.
  
  
• Negotiating Closing Costs
  
  Through negotiation, some sellers may agree to pay all or most of your closing costs (for example, if you agree to meet their full asking price). If you choose to try this, make sure to ask your real estate agent for advice.
  
  
• Loan Programs
  
  Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at reduced interest rates, or with little or no down payments. Check with your local housing authority for more information.
  
  
• Loan Types
  
  Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low initial interest rates. Others opt for 30-year loans because they have lower monthly payments than 15-year loans. There are significant differences between different loans, so make sure to discuss the pros and cons of different loans with your agent or lender before making a decision.
  
  
  

RESPA Disclosures

One of the purposes of RESPA is to help consumers become better shoppers for settlement services. RESPA requires that borrowers receive disclosures at various times. Some disclosures spell out the costs associated with the settlement, outline lender servicing and escrow account practices and describe business relationships between settlement service providers.

Good Faith Estimate of Settlement Costs.

RESPA requires that, when you apply for a loan, the lender or mortgage broker give you a Good Faith Estimate of settlement service charges you will likely have to pay. If you do not get this Good Faith Estimate when you apply, the lender or mortgage broker must mail or deliver it to you within the next three business days.

Be aware that the amounts listed on the Good Faith Estimate are only estimates. Actual costs may vary. Changing market conditions can affect prices. Remember that the lender's estimate is not a guarantee. Keep your Good Faith Estimate so you can compare it with the final settlement costs and ask the lender questions about any changes.

Servicing Disclosure Statement.

RESPA requires the lender or mortgage broker to tell you in writing, when you apply for a loan or within the next three business days, whether it expects that someone else will be servicing your loan (collecting your payments).

Affiliated Business Arrangements.

Sometimes, several businesses that offer settlement services are owned or controlled by a common corporate parent. These businesses are known as "affiliates." When a lender, real estate broker, or other participant in your settlement refers you to an affiliate for a settlement service (such as when a real estate broker refers you to a mortgage broker affiliate), RESPA requires the referring party to give you an Affiliated Business Arrangement Disclosure. This form will remind you that you are generally not required, with certain exceptions, to use the affiliate and are free to shop for other providers.

HUD-1 Settlement Statement.

One business day before the settlement, you have the right to inspect the HUD-1 Settlement Statement. This statement itemizes the services provided to you and the fees charged to you. This form is filled out by the settlement agent who will conduct the settlement. Be sure you have the name, address, and telephone number of the settlement agent if you wish to inspect this form. The fully completed HUD-1 Settlement Statement generally must be delivered or mailed to you at or before the settlement. In cases where there is no settlement meeting, the escrow agent will mail you the HUD-1 after settlement, and you have no right to inspect it one day before settlement.

Escrow Account Operation & Disclosures.

Your lender may require you to establish an escrow or impound account to insure that your taxes and insurance premiums are paid on time. If so, you will probably have to pay an initial amount at the settlement to start the account and an additional amount with each month's regular payment. Your escrow account payments may include a "cushion" or an extra amount to ensure that the lender has enough money to make the payments when due. RESPA limits the amount of the cushion to a maximum of two months of escrow payments.

At the settlement or within the next 45 days, the person servicing your loan must give you an initial escrow account statement. That form will show all of the payments which are expected to be deposited into the escrow account and all of the disbursements which are expected to be made from the escrow account during the year ahead. Your lender or servicer will review the escrow account annually and send you a disclosure each year which shows the prior year's activity and any adjustments necessary in the escrow payments that you will make in the forthcoming year.

10 Tips for Homebuyers

What You Should Know Before Buying a Home

1. Before you start looking for a home, get pre-qualified for a loan.
   
   Banks, Credit Unions, Mortgage Bankers, and Mortgage Brokers make home loans. These lenders will take an application, process the loan documents, and see the loan through to the funding stage.
   


2. If you have marginal or bad credit, consult your lender.
   
   You may be able to qualify for a loan depending on how long ago and what reason(s) caused the bad credit.
   
   A lender should be able to advise you on whether your credit history will prevent you from qualifying for a home loan.
   


3. You will need a downpayment.
   
   Downpayment requirements vary between 3 to 20% or more depending on the type of loan. Many downpayment assistant programs exist. These programs may loan or grant you the funds necessary for the downpayment. Consult with a lender about programs available in your area.
   


4. You will need funds for closing costs
   
   Closing costs are charges for services related to the closing of your real estate transaction. They include, but are not limited to:
   
   
• Escrow fees charged by company handling the transaction


• Title policy issuance fees charged by the title insurance company


• Mortgage insurance fees


• Fire and homeowners insurance


• County Recorder fees for recording your deed


• Loan origination fees
  
  Consult your lender for an actual estimate of these costs, as well as information about loan programs which can assist in financing your closing costs.
  
  
5. Some loans have "points" and some do not.
   
   A point is a loan origination fee equivalent to 1% of the loan amount. Together with the interest rate they constitute the yield on your loan for the lender. Some lenders charge a higher interest rate to compensate for charging no points. It is important to comparison shop lenders to make sure your loan is at a competitive yield.
   


6. Should you select a mortgage with a fixed rate or an adjustable rate?
   
   The answer to this question depends on whether mortgage rates are at a high or a low point when you purchase, and on how long you plan to live in the home. If rates are high, an adjustable rate might be attractive since subsequent rate drops could reduce your monthly payments.
   
   Additionally, lenders may offer a below-market rate during the first few years of an adjustable mortgage to make it appealing to you. However, many people who got these loans years ago are now having their homes foreclosed on because the banks are refusing to refinance the loans and large payments are now due. If interest rates are low you might want to take a fixed rate to protect yourself against the possibility of rising interest rates.



7. Be aware of the two main types of loan categories.
   
   
• Conventional Loans.
  
  Conventional mortgage loans are available up to a maximum of 97% loan-to-value. Interest rates may be fixed or adjustable for the term of the loan. Loans with high loan-to-value may require mortgage insurance.


• Government Loans.
  
  These include Federal Housing Administration (FHA) fixed and adjustable rate mortgage loans, and Veterans Administration (VA) fixed rate mortgage loans. FHA loans are available up to 97.65% loan-to-value. Eligible U.S. veterans can receive up to 100% loan-to-value financing through VA loans.
  
  
8. If you are a low or moderate income homebuyer, there are special programs designed to help you.
   
   Most lenders specializing in real estate mortgage loans are
   aware of these types of loan programs.
   


9. Why might I have to pay mortgage insurance?
   
   Mortgage insurance protects the lender from potential loss if you should default on your mortgage loan payment.
   
   Generally, conventional loans that are less than 80% loan-to-value do not require mortgage insurance. For FHA mortgage loans, mortgage insurance is always required. It is referred to as a Mortgage Insurance Premium (MIP) and is collected regardless of the Loan-to-Value.
   
   
10. Many organizations offer home loan counseling to prospective homebuyers.
    
    These organizations provide classes for homebuyers to cover the steps
    to homeownership. They will cover home selection, realtor services, lenders, loan programs, homeownership responsibilities, saving for a downpayment, and other important pieces of information. Many first-time homebuyer programs require homebuyers to attend this type of class to be eligible for selected programs.

June Watson is neither a banker nor an attorney and strongly advises everyone to seek advise from these qualified professionals.