|Step 1: Check Your Credit Score|
|Step 2: How Much Can You Afford?|
|Step 3: Finding the Best Mortgage For You|
|Step 4: Getting Prequalified for a Mortgage|
|Step 5: Getting Pre-Approved|
|Step 6: Locking Your Interest Rate|
|Step 7: Closing Your Mortgage Loan|
|Step 8: Mortgage Check-Up|
Deciding to purchase a home is a very important financial decision. For 99% of us, buying a home cannot be done without a mortgage. Hence, it is especially important that you know where you stand financially before making a vast financial commitment. One important measure of your financial fitness is your credit report and score. The information in your credit report is critical to your financial life, and it plays a large part in determining the interest rate you are offered on a loan. This is why it important to check your credit before getting preapproved for a mortgage.
You are entitled for a free credit report once a year for free from each of the three credit bureaus (Equifax, Experian and TransUnion). These companies gather information about your payment and borrowing habits and form your credit report from the information they collect.
The information on your credit report determines your credit score, which is a number between 300 and 850. The higher your credit score, the better your chances of getting the best interest rates and a larger loan amount. If your credit score is low, it may reflect that you don’t pay your bills on time or that your outstanding debts are close to your credit limit. Lenders offset the risk of lending to people with low credit scores by increasing interest rates and lowering the limit that you can borrow.
When you receive your report, look it over for mistakes. Mistakes do happen, including mix-ups with similar names and Social Security Numbers. So if you have incorrect information on your credit report, you run the risk of having a lower credit score than you actually deserve, which can affect your mortgage rate. If you find incorrect information on your credit score, contact the credit agency to have them correct or remove the error. This may take a while, so do this as early as possible in the mortgage process.
Before you start looking at homes, it’s important to start off with a budget so you know how much you can afford. Knowing how much you can handle will also help you narrow the field so you don’t waste time looking at homes that out of your reach.
Debt-to-income ratio The key to figuring how much home you can afford is your debt-to-income ratio. This is the figure lenders use to determine how much mortgage debt you can handle, and thus the maximum loan amount you will be offered. The ratio is based on how much personal debt you are carrying in relation to how much you earn, and it’s expressed as a percentage.
Mortgage lenders generally use a ratio of 36 percent as the guideline for how high your debt-to-income ratio should be. At Gold Quest, we can go higher; I will briefly speak about that below. So a ratio above 36 percent might sound risky to lenders, and the lender will likely either deny the loan or charge a higher mortgage interest rate. Another good guideline is that no more than 28 percent of your gross monthly income goes to housing expenses.
Doing the math First, figure out how much total debt you (and your spouse, if applicable) can carry with a 36 percent ratio. To do this, multiply your monthly gross income (your total income before taxes and other expenses such as health care) by .36. For example, if your gross income is $6,500:
$6,500 (Gross monthly income)
x .36 (Debt-to-income ratio)
= $2,340 (Total allowable monthly debt payments)
Next, add up all your family’s fixed monthly debt expenses, such as car payments, your minimum credit card payments, student loans and any other regular debt payments. (Include monthly child support, but not bills such as groceries or utilities.)
Minimum monthly credit card payments*: _________
+ Monthly car loan payments: _________________
+ Other monthly debt payments: ________________
= Total monthly debt payments: ________________
*Your minimum credit card payment is not your total balance every month. It is your required minimum payment -- usually between two and three percent of the outstanding balance. To continue with the above example, let’s assume your total monthly debt payments come to $750. You would then subtract $750 from your total allowable monthly debt payments to calculate your maximum monthly mortgage payment: $2,340 (Total allowable monthly debt payments)
- $750 (Total monthly debt payments other than mortgage)
= $1,590 (Maximum mortgage payment)
In this example, the most you could afford for a home would be $1,590 per month. And keep in mind that this number includes private mortgage insurance, homeowner’s insurance and property taxes.
Exceptions to the 36 percent rule
In regions with higher home prices, it may be hard to stay within the 36 percent guideline. There are lenders that allow a debt-to-income ratio as high as 45 percent. In addition, some mortgage programs, such as Federal Housing Authority mortgages and Veterans Administration mortgages, allow a ratio higher than 36 percent. But keep in mind that a higher ratio may increase your interest rate, so you may be better off in the long run with a less expensive home. It’s also important to try to pay down as much debt as possible before you begin looking for a mortgage, as that can help lower your debt-to-income ratio.
One of the most important steps in buying a home is determining what kind of mortgage is right for you. After all, a mortgage is a financial commitment that will last for many years. Make sure you select a mortgage that matches your risk tolerance and financial situation.
Fixed rate mortgages
With a fixed rate mortgage, the interest rate and monthly payments stay the same for the life of the loan.
These mortgages are usually fully amortizing, meaning that your payments combine interest and principal in such a way that the loan will be fully paid off in a specified number years. A 30-year term is the most common, although if you want to build equity more quickly, you might opt for a 15- or 20-year term, which usually carries a lower interest rate. For homebuyers seeking the lowest possible monthly payment, 40-year terms are available with a higher interest rate.
Consider a fixed rate mortgage if you:
• are planning to stay in your home for several years.
• want the security of regular payments and an unchanging interest rate.
• believe interest rates are likely to rise.
Adjustable rate mortgages (ARMs)
With an adjustable rate mortgage (ARM), the interest rate changes periodically, and payments may go up or down accordingly. Adjustment periods generally occur at intervals of one, three or five years.
All ARMs are tied to an index, which is an independently published rate (such as those set by the Federal Reserve) that changes regularly to reflect economic conditions. Common indexes you’ll encounter include COFI (11th District Cost of Funds Index), LIBOR (London Interbank Offered Rate), MTA (12-month Treasury Average, also called MAT) and CMT (Constant Maturity Treasury). At each adjustment period, the lender adds a specified number of percentage points, called a margin, to determine the new interest rate on your mortgage. For example, if the index is at 5 percent and your ARM has a margin of 2.5 percent, your “fully indexed” rate would be 7.5 percent.
ARMs offer a lower initial rate than fixed rate mortgages, and if interest rates remain steady or decrease, they may be less expensive over time. However, if interest rates increase, you’ll be faced with higher monthly payments in the future.
Consider an adjustable rate mortgage if you:
• are planning to be in your home for less than three years.
• want the lowest interest rate possible and are willing to tolerate some risk to achieve it.
• believe interest rates are likely to go down.
A hybrid mortgage combines the features of fixed rate and adjustable rate loans. It starts off with a stable interest rate for several years, after which it converts to an ARM, with the rate being adjusted every year for the remaining life of the loan.
Hybrid mortgages are often referred to as 3/1 or 5/1, and so on. The first number is the length of the fixed term -- usually three, five, seven or ten years. The second is the adjustment interval that applies when the fixed term is over. So with a 7/1 hybrid, you pay a fixed rate of interest for seven years; after that, the interest rate will change annually.
Consider a hybrid mortgage if you:
• would like the peace of mind that comes with a consistent monthly payment for three or more years, with an interest rate that’s only slightly higher than an annually adjusted ARM.
• are planning to sell your home or refinance shortly after the fixed term is over.
Once you know what type of loan is right for you, look at the specifics. First, of course, is the interest rate. Remember, however, that the rate you’re offered may not tell the whole story. Are there closing costs, points or other charges tacked on? Make sure you ask for the loan’s annual percentage rate (APR), which adds up all the costs of the loan and expresses them as a simple percentage. Lenders are required by law to calculate this rate using the same formula, so it’s a good benchmark for comparison.
The features of your loan -- which may be in small print -- are just as important. A favorable adjustable-rate loan, for example, protects you with caps, which limit how much the rate and/or monthly payment can increase from one year to the next. Ask whether a mortgage carries a prepayment penalty, which may make it expensive to refinance. And don’t be seduced by low monthly payments -- some of these loans leave you with a large balloon payment due all at once when the term is up.
It’s a good idea to get prequalified for your mortgage before shopping for a home. Prequalification involves supplying a lender with basic information regarding your debt, income and assets. From this information, lenders can get an idea of the mortgage amount for which you qualify, and it’s done at no cost at Gold Quest Group.
Being prequalified can help you narrow the range of homes in which you are interested, as it’s another way of knowing what you can afford. It can also help you act fast if a home you’re interested in has a lot of interest. Prequalification shows you are a serious shopper and your offer will be taken more seriously than an offer from someone who has not spoken with a lender.
The initial pre-qualification stage also allows you to discuss with is, any goals or needs you may have regarding your mortgage. Gold Quest Group can then explain your mortgage options and recommend the type that might be best suited to your particular requirements.
It’s easy to get prequalified for your loan at Gold Quest Group. Apply now to get started!
Now that you’ve chosen your Gold Quest, you’ll want to get preapproved. Preapproval means that Gold Quest has to thoroughly check your finances, including your income and debts, and has given you the thumbs up for a loan of a certain amount.
Gold Quest Group can give you a preapproval letter, which will make it easier to shop for a home. With pre-approval, you won’t have a loan contingency as part of your offer, meaning it’s likely more attractive to the seller, even if it’s not the highest price. Preapproval also expedites the home buying process, as much of your loan paperwork is already taken care.
Remember, prequalification is not the same as preapproval. Prequalification is an estimate of how much you can afford and the figure is not guaranteed. Prequalification is a good step to take in the home buying process because it can narrow down the homes you look at, but ultimately, it does not take into consideration you entire financial picture. Preapproval is a more thorough and official look at your finances, so don’t assume that because you prequalify for a certain amount, you will be preapproved for the same figure.
Since it’s often weeks, and sometimes months, between getting prequalified and closing on your home, it’s a good idea to lock in your interest rate and points.
What is a rate lock?
A lock is a commitment by the lender that guarantees you a certain interest rate for a specific period of time. For example, your lender might offer you a 6 percent interest rate for zero points for thirty days, or 6. 25 percent rate for forty-five days for one point.
The most common amount of time for a lock is 30 days. However, locks come in fifteen day increments and you can get a lock for 15, 30, 45 or 60 days. Some lenders even let you lock past sixty days. It is good to remember, though, that the shorter the lock period, typically the lower the rate will be. The longer the lock period, the greater the risk to the lender that rates will change, and not necessarily in the lender’s favor. That’s why lenders usually charge more for a longer time period with a lock.
Locking into rates and points means that your lender commits to giving you a specified interest rate for a specified period of time. If you don’t lock into rates and points, you risk your mortgage costing you more than it needs to, so be sure that you are clear about what you lock into and for how long.
After locking in your rate and points, you’re close to the finish line. The last step is closing.
Closing requires a great deal of paperwork. You should keep your records organized and also ask about documents you might need, though everything should be taken care of regarding your loan at this point. Make sure to ask to send you the Settlement Statement a few days before closing so you have time to review it.
Before signing, review all your loan documents, especially your Settlement Statement, which is also called a HUD-1. (The HUD stands for Housing and Urban Development, the federal agency responsible for the statement.) This is your final account of all of the costs and figures related to the deal. Many of the fees listed in the HUD-1 form also have been included in the Good Faith Estimate (GFE) of mortgage costs that you have already received; however, the HUD-1 amounts are final.
You may find some of the HUD-1 figures are different from those in your GFE. This could be because third-party fees such as appraisal fees ended up being slightly different than originally estimated. However, if there are large discrepancies, or new fees that weren’t in the GFE, check with us to see if there’s a mistake that needs to be corrected.
Once you sign the loan documentation and write your check for closing costs and your down payment, the home is yours!
Once you have bought your house and settled in, it is important give yourself a mortgage check-up every few years. Keeping your eye on interest rates can help save you money on your mortgage.
Reassess your mortgage if your financial situation has changed.
Since you bought your house, has your salary increased significantly? Have you had another child? Started your own business? If any of these are true, it’s a good idea to reassess your mortgage. Perhaps you can find a mortgage product the better suits your financial situation. Or you may be able to accelerate your payments to boost your home equity faster. Regardless, as your career and family grow, your finances change and you might able to lower your monthly payment or pay off your home faster.
Have interest rates dropped?
If you have a fixed-rate mortgage and interest rates have fallen, you might want to consider refinancing. Refinancing is when you replace your current mortgage with a loan that offers better rates and terms. This can end up saving you a significant amount of money on your monthly mortgage payments. If you do decide to refinance your mortgage, be sure that the fees and costs associated with refinancing are worth the new rates and terms. Research the loan market and stay updated on trends so that you know when the right time is.
Have interest rates increased?
If you have an adjustable rate mortgage (ARM) or hybrid ARM, rising interest rates can increase your payments. Make sure you “stress test” your ARM: Can you afford to pay up to your lifetime rate cap? If not and rates continue to rise, refinancing to a fixed-rate loan may help limit your exposure to rising rates. Again, make sure the costs of refinancing don’t outweigh any benefit.
As you gain more equity in your home, it becomes a more and more valuable financial resource. Be sure your mortgage works for you and you are getting the best deal.
Gold Quest Group, LLC., is regulated and licensed by Texas Department of Savings and Mortgage Lending located at 2601 N. Lamar, Suite 201 Austin, TX 78705. © 2008 - Gold Quest Group, LLC., Nationwide Mortgage Licensing System (NMLS) ID # 212990. All Rights Reserved. This site is directed at, and made available to, persons in the continental U.S., Alaska and Hawaii only.