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Financing a Home Purchase



By Heath Copps

As you prepare to buy a home it helps to have a good grasp of the exciting but complex process. A home is one of the biggest purchases you can make in your lifetime. With thousands and thousands of dollars on the table, you want to avoid unpleasant surprises and negotiate with confidence.

Know What You Can Afford
First, you need to figure out what you can afford. Look at houses for sale that match your requirements: location, square footage, rooms, lot size, etc. Get an average price and plug that value into a mortgage calculator < http://www.smartmoney.com/home/buying/index.cfm?story=howmuch>.

A good calculator will come up with estimates for how much you'll pay each month on the principal (the actual purchase price) and the interest (percentage charged for the loan). It will also allow you to add estimated property taxes and homeowner's insurance, so you get an accurate picture of your monthly housing expense.

Housing Ratio
Take your house payment and plug it into the housing ratio formula that lenders use to determine how much they'll loan. Simply divide your monthly housing payment by your monthly gross income. Lenders like to see your housing ratio at 28-29% or under.

Debt Ratio
Add up all of your monthly debt payments (i.e. credit cards, auto loan). Take your monthly housing cost estimate and add it to your total monthly debt payment. Take that figure and divide by your gross monthly income. This is your debt ratio, which lenders like to see at 36% or less.

Credit Report
Your credit history plays a huge role in the home loan process.

Credit agencies use scores compiled by the Fair Isaac & Company (FICO) or a formula based on their work, that range from 300 to 950.

  • Above 680 is considered "prime borrower." If you fall in this range, you should have no problem getting a loan within your budget.
  • Under 680 is considered "subprime." It will be more difficult to get loan acceptance in this range and any approval will have higher interest rates.
  • Below 560. You'll have a very difficult time getting a mortgage.

    Here's how FICO rates your credit:

  • 35% previous credit payment
  • 30% current debt
  • 15% how long you've used credit
  • 15% types and amount of credit available to you
  • 5% how many times have you applied for credit in a specific period of time

    Credit reports may contain errors, so make sure yours are accurate by obtaining a report from each of the three main agencies: TransUnion, Experian and Equifax. You can dispute any erroneous information that negatively affects your credit score and your ability to obtain home financing.

    Also, lenders are required to tell you if your credit score was the reason they turned you down for a loan or pre-approval. If this is the case, you're entitled to a free credit report.

    What To Do If the Numbers Don't Add Up
    If your calculations fail to fall within the general guidelines there are several things you can do.

  • Look at less expensive houses.
  • Find ways to reduce your debt or increase your income.
  • Ask your lender about the numerous programs for potential homebuyers that don't qualify for traditional mortgage products, such as FHA, VA, HUD and first-time homebuyer loans.

    Interest Rates
    Lenders look at numerous factors when determining your interest rate, including the current prime rate (the basic interest rate that the Federal Reserve has set), your credit history and your down payment. Basically, the better your credit score and the more you put down, the less you will have to pay in interest. Additionally, you can lower your interest by paying points, also known as discount points, mortgage points, loan discount points and loan origination fees, to your lender during closing. One point is equal to 1% of the loan. Paying points during closing amounts to buying a lower interest rate.

    The slightest adjustment in rates can make a big difference in how much you pay over the life of your loan. On the other hand, when interest rates drop, housing prices generally go up. So, by all means jump on good rates, but waiting for just the right rate before buying a home may prove to be futile.

    Down Payment
    Down payments can come in the form of cash, liquid assets, other loans, gifts from friends or relatives, or any asset negotiated with the seller. Down payments of less than 20% of the total purchase price, require mortgage insurance to cover the lenders extra liability.

    If you can't make a large down payment, special mortgage programs exist that allow you to pay very little upfront, though interest rates will be higher. Check with your lender for available options.

    Closing Costs
    The finalization of the purchase is called the closing and the charges required to complete the transaction are closing costs. Your lender is required by law to give you a Good Faith Estimate of all your closing costs within three business days of your application for a loan.

    Closing costs can include...
  • Title search, title insurance and related escrow fees.
  • Local government fees - city, county and state transfer taxes, recordation fees, and prepaid property taxes.
  • Appraisal, credit checks, loan documentation fees, loan origination, notary charges, underwriting, commitment and processing fees, hazard insurance, interest prepayments, and lender's inspection fees.

    Types of Loans
    Fixed rate home loans guarantee the same interest rate for the length of the loan. They're normally available for 15 or 30 years.

    Adjustable rate home loans or adjustable rate mortgages (ARM) are loans that have an adjustable interest rate after an agreed upon amount of time. The initial rates are generally lower than those of a fixed rate loan.

    There are many other types of loans available and a good lender can help you find the best one to suit your needs, so shop around before you sign on the dotted line.
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