We have examined the credit score and how to improve it. The next step in buying a home is to determine how much money you can borrow. The amount that you can borrow along with the money you have saved for a down payment will determine how much money you can spend on a house.
To understand how much money to lend a person, banks and mortgage companies undertake a process called prequalification. Prequalification looks at your credit as well as your income and your long term debt to understand how much money can you afford to spend each month for the purchase of your home. Today we will give you a few pointers for understanding how this is determined, so that you may also understand what affects your ability to borrow money.
The first thing is to determine your income. Since most lenders require a monthly payment, you need to know how much money your family makes each month. If you get paid weekly, how much gross income (before taxes, health insurance, Social Security and other deductions) do you make in 4 weeks? If you and your spouse both work, use both incomes to arrive at a monthly income.
The second thing to do is to determine your long-term debt. Long term debt is debt that you will be paying on for more than 12 months. Car payments are long term debt, unless you are almost finished paying for your car. If you buy boats, furniture, ATV’s, appliances, lawn mowers or anything else with credit, list it. Student loans also count as long term credit. Determine the amount you pay monthly on all of these debts.
If you have not bought these types of items, and you intend to purchase a home in the near future, WAIT until after you purchase a home to make these long term debt purchases. Why is this important?
Lenders evaluate long term debt as a percentage of your income. One ratio they use is mortgage debt as a percentage of income; the other is total debt (mortgage debt + other long term debt) as a percentage of your gross income. This debt to income ratios are what determine how much money you can borrow. Typically as an average your mortgage debt cannot exceed 28% of your gross income and your total debt cannot exceed 40% of your total income.
So, why is it important to wait on other purchases? These purchases using long term credit reduce the amount of credit a lender will allow you to purchase a home. If you have 15% of your income going towards debt, you will only have 25% left to apply towards purchasing a home. It is important for your non mortgage debt to be less than 10% of your gross income if you want to maximize the amount you can borrow towards a home.
Most lenders require some down payment, that is, money you have saved to help pay for the home. A few programs, such as VA and FHA loans, may not require down payments, but most require some money. The more money you can pay, the less you have to borrow, and the safer the lending institution is loaning money to you. It stands to reason that the bigger investment you make, the more you have to lose by not paying your mortgage, and the less the lender has to lose. So, people making large deposits are much less likely to go into foreclosure. If you make a large down payment, a lender may let you exceed the debt ratios of 28% and 40%. A down payment of 20% of the value of the home also allows you to avoid paying private mortgage insurance, commonly referred to as PMI. Mortgage insurance is money you pay monthly to insure the lender against default, since you are investing a relatively small amount of your own funds.
Once you know your credit, understand your income and your current debt status, and know how much money you have saved toward a down payment and closing costs, you can closely estimate how much money you have each month to pay on a mortgage, and how much house you can purchase.
Most conventional loans require that a mortgage is no more than 28% of your gross income. If you have other debt that is no more than 10%, you’ve got a good chance. More than that means you’ll be able to borrow less than the maximum. And that’s OK, but knowing how this is figured gives you the choice to decide how and when to borrow, not only for your home, but for other items as well.
Currently 30 year fixed mortgages are near 6%. At 6%, (do not try to use this at any other rate, the multipliers are not linear), the cost (principal and interest) of borrowing money is $6 per $1000. So, for example, if you borrow $100,000 for 30 years at 6%, you will pay $600/month principal and interest (amount to be borrowed times 0.006). Most loans will require you to pay escrows for taxes and insurance, so that you and the lender’s interest are protected. Your actual payment, including Principal, Interest, Taxes and Insurance, is commonly referred to as PITI, and is what most people pay monthly for as a home payment.
If you are getting serious about buying a home, understand and verify your income and debt. Take this information to one of the mortgage lenders in our community who can assist and pre-qualify you for a home. If you want to proceed in your search, they can even issue a prequalification letter, letting your sales agent and prospective sellers know that you are credit worthy.
Local lenders include but are not limited to the following:
Carolina Community Mortgage
First Citizens Bank & Trust Co.
RBC Centura Bank
SunTrust Mortgage, Inc.
Wells Fargo Home Mortgage
If you are a first time buyer or have limited financial experience, we especially do not recommend out-of-town or on-line lenders. For the more financially sophisticated buyers there is nothing wrong with shopping or comparing on-line mortgages.
For the past 38 years the staff at The Groce Companies has helped consumers in central North Carolina design, build and secure financing to build or buy their homes. We find many people who do not fully understand the home buying process. If you are interested in attending a seminar on these issues call (919) 775-1497. And visit our web site, www.grocecompanies.com where we will be posting this entire series of helpful hints.
(This information obtained from various news and industry sources and is believed to be correct.)