Buyer’s Guide – Q & A

Owning your own home is the American Dream. And that dream is more alive today than ever before.

Experience has taught us that the buying process involves common stages for all home buyers. To help you understand that process, and make the most of every day and dollar you spend, Long & Foster®, Realtors® has prepared this Home Buyers Guide to provide an overview from the planning table to the closing. After all, helping you fulfill your home ownership dream is our business.
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In today’s market an “affordable” home is not so much determined by sales price as it is by the financing which translates that price into a monthly payment. A house hunter’s first step is to set a housing budget, then go shopping for the house (price) and payments (P.I.T.I. or or Principal of loan, Interest on the Loan, Taxes and Insurance) that fit that budget.

Even though there are many ways to qualify to buy a home, make sure the monthly payment makes sense for you. A current rule of thumb is that the monthly payment should not be more than 25-33% of gross monthly income. Restrictions will apply for smaller down payments.

How Much Can I Afford?

The key items are the cash down payment, the amount of the loan, the number of years it takes to repay and the amount of interest. Some loans have a zero down payment (VA loans or community based lenders), 3-5 % in the case of FHA or community based groups or other amounts under 20%. These often require a mortgage insurance premium to protect the lender. Thinking through just which financial package can be very helpful in determining just how sellers’ house prices line up with the buyers’ capacity to buy.

Sources For Your Down Payment

The obvious source of money for your down payment is either your savings or the proceeds from the sale of a home you already own. But there are some other not so obvious sources. In recent years, for example, “parent power” has taken some new twists for first-time buyers.

Home Equity Loan
Parents often have considerable equity built up in their own homes-and many are tapping that asset through home equity loans to make a gift to the youngsters. Ask your tax advisor for current information. Often lenders will require a “gift letter” to verify that parents don’t expect repayment.

Shared Equity/Profit-Sharing
In return for providing a part of the down payment, the parents (or another investor) share in the “profit” or net equity of the house when the home owners eventually sell it.

Life Insurance
If you have built up a cash value on your life insurance policy over the years, you may be able to borrow from your insurance company up to the amount of this accumulated cash value. Often the insurance company will even ask a more favorable interest rate than would be asked for other types of loans.

Stocks and Bonds
If you feel the market doesn’t favor selling your stocks or bonds now, you may be able to secure a bank loan using your portfolio as security.

Company Profit Sharing or Savings Plan
Look into the possibility of withdrawing what you have in your profit sharing or savings plan account or borrowing against it, if your company has these programs. You might check on the IRS offering for a one time withdrawal of your personal IRA.

How To Reduce Down Payment

Mortgage Insurance Can Reduce Down Payment. If you need a conventional loan, loan definitions change, ask me what makes a loan “conventional”,  there is a way to put down only 5 or 10 percent. Through the lender, you will be required to buy private mortgage insurance (PMI). This insurance provides protection for the lender in case of default, and allows the lender to approve a larger mortgage amount.

In a common approach, you’d pay an initial amount at closing (often one percent of the mortgage if your down payment is 5 percent, 1/2 of 1 percent if you put down 10 percent). Then, included in your monthly payments for your mortgage, you would pay an additional one-twelfth of 1/4 percent of the mortgage balance. This payment will usually continue until dropped at the discretion of the lender, unless a stop point is specifically written into the deed of trust, such as accumulating a 20% equity. Ask your lender for specific figures for any loan program you are considering, as the amount of mortgage insurance varies by the type of loan.

One Caution

The larger the down payment, the less money you need to borrow, which means a lower monthly payment. However, remember that in addition to your down payment and monthly payments, you will need money to pay for closing costs, moving, appliances, household setup, a reserve for family emergencies, a reserve fund for replacement of appliances and other items noted on the home inspection report after ratification of the sale and other miscellaneous items. So don’t plan to put your last penny down on the closing table

Figuring Your Housing Budget

Generally, lenders figure that the home buyer shouldn’t pay more than 28-38 percent of gross income for P.I.T.I. payments, or 36-38 percent for both P.I.T.I. and monthly debts combined. This might be a little more or a little less depending on other outstanding long term debts (more than 10 months), alimony/child support payments, number of children and their ages, and other household budget items.

The easiest way to make a quick estimate of the mortgage amount you may qualify for requires applying the two basic formulas for loan application that lenders use. Keep in mind the loan balance will vary over the term of the loan, although the monthly payment remains the same.

Two Lender Formulas

Two Lender Formulas Most lenders will require that loan applicants meet both guidelines before approving a mortgage loan. The first formula compares income to housing costs without including long term debts, the second includes all debts.

28% Formula
Total Monthly Housing Costs
__________________ = 28% (or less)
Gross Monthly Income

36% Formula
P.I.T.l. + All Monthly Debt Payments
__________________ = 36% (or less)
Gross Monthly Income

A variety of other formulas exist. VA and some lenders use a single ratio based on mortgage payment and all debts, which allows easier qualifying for a more expensive home for a borrower with little debt.

To figure your housing budget, simply multiply your gross monthly income (before taxes) by 28% and 36%. For example, a family with a monthly income of $3,500 might qualify for a mortgage with payments up to $980. For specific figures, ask us.

Mortgage Help

More Mortgage Help New types of mortgages, such as graduated payment mortgages, flexible payment mortgages and deferred interest loans, feature monthly payments that start lower than usual in the early years–and thus help home buyers “afford” more house and buy sooner by qualifying on a lower mortgage payment.

Thirty year, twenty year, adjustable rate mortgages such as the true 3 year, the 3/1, 5/1, 10/1, 7/23 or 5/25, the two step, the or a negative amortization loan are all features of the contemporary lenders inventory of loans. These loans may or may not be useful for your consideration, but a quick study of them may alert you to options which you might not have realized. Please call or email me if I can be useful in explaining any or all of them. At the end, let me help to suggest responsible, responsive lenders who can help you to achieve your investment goals.

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