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
pre-qualification vs. pre-approval
One of the best ways to determine your budget is to
have your real estate agent or lender pre-qualify
you for a loan. Pre-qualification is different from
pre-approval, because it is only an estimate
of what you'll be able to afford. On the other hand,
pre-approval 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 home buyers. 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 home buyers. 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.
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