Talk Money to Me: A Guide to Financing
Unfortunately, to buy a home you need money, and let's be real...nobody likes talking about the big "B"--that's right, budgeting. Already know you have enough money saved to buy a place? Scroll down to "Money's in the Bank." You're welcome.
So, obviously we know you're interested in buying your first place (you're reading this, right?)--either you've got house envy about your friend's new condo or you're ready to build equity of your own. Either way, the moment you start thinking about buying is the time you should start your financial planning--basically budgeting and saving.
I know you're thinking, "Wait, does this mean I can't go to Summer House anymore for brunch?!" No, you can still brunch--just maybe don't get 5 mimosas next time.
Talk Budget to Me
When you're ready to talk to a lender to find out if you can be approved for a home, the lender is going to look at your credit, income, assets, job history and debt-to-income ratio. What's that? It's your monthly minimum payments for your credit card debt, student loans, car loans and personal loans compared to your gross monthly income. Simple terms: how much you owe vs how much you make.
A lot of the times, the amount you end up getting approved for is more than you feel comfortable borrowing, so it's crucial you figure out what's important to you and work with that number. Don't feel pressured to spend more! Also, don't forget to add in those other things you're saving for--that new car, that vacation you've been dying to go on, that dog you've always wanted, etc. Those kinds of expenses won't be apart of your lender's calculations.
Most lenders allow a maximum overall debt-to-income ratio of 43%, and some allow only a 41% ratio. The housing payment portion of your income should be a maximum of 31%, so if your annual income is $60,000 and your monthly gross income is $5,000, then your housing payment should be $1,550 or less.
This might be obvious, but when you actually own a home there are other expenses to account for like property taxes and homeowner's insurance. Luckily, your mortgage payment will factor in those costs. You may also pay mortgage insurance if your down payment is less than 20%. Wanting to live in a condo or a community with a homeowner's association? Those fees are additional too. And one last thing--you should budget at least 1% of the home value for any maintenance and repairs that might come up. You'll thank me later.
Money's in the Bank
Now that you've got your finances sorted out, you're ready for that pre-approval everyone keeps talking about. The big old stamp of approval that you have the money, credit history, and other credentials to buy a home up to a certain price. But how do you get it?
Like I mentioned earlier, your lender is going to review your credit, income and assets. Typically you're going to get asked for the following:
Pay stubs from the past 30 days showing your year-to-date income
Two years of federal tax returns
Two years of W2 forms from your employer
60 days or a quarterly statement of all of your asset accounts, which include your checking and savings, as well as any investment accounts such as CDs, IRAs, and other stocks or bonds
Any other current real estate holdings
Residential history for the past two years, including landlord contact information if you rented
It seems like a lot, but with a few clicks, you'll be sending over your documents in no time!
"But wait, why do I even need a pre-approval?" Plain and simple: a seller will likely not accept your offer without one.
Talk Mortgage to Me
Up until now, you've been making a monthly payment to your landlord which covers the apartment and maybe some utilities. Mortgages are another animal--easily tamed but nonetheless a different animal.
So, what does your monthly mortgage payment include? There are 4 parts to it which are referred to as PITI. Meet Principal, Interest, Taxes & Insurance.
Principal: This is the portion of your payment that goes to pay down the balance that you borrowed.
Interest: This will be the interest rate you lock in.
Taxes: Your lender usually requires an escrow account and will collect one-twelfth of your annual property tax bill in this account with each mortgage payment.
Insurance: You will pay one year of homeowner's insurance premiums at your new home as part of your closing costs, and then your lender will collect one-twelfth of your annual insurance premium in this account with each mortgage payment. While most lenders require you to pay your homeowners' insurance this way, some offer you the option to pay the insurance company directly rather than include it in your monthly bill.
As I mentioned earlier, if you put down less than 20%, you're also going to have the mortgage insurance added to your monthly payments, which protects your lender if you default on your loan.
I get it. It seems like a lot but don't sweat! A good lender will help you out step by step to ensure that you're comfortable and have all your questions answered. Also, don't forget that owning is typically cheaper than renting!
For any other questions about loans like the different types, feel free to shoot my guy, Joe Burke, an email. He loves fan mail.