By Gary A. Miller
Homeownership is a common goal in the United States and is often seen as a key goal to building generational wealth (that is, wealth that is passed from generation to generation). But, if you have never gone through the home-buying process, it can be intimidating and filled with myths and assumptions, many related to the loan secured to purchase the home: the mortgage.
What makes up your monthly mortgage payment? The acronym is PITI — principal and interest (the payment on the principal amount of the loan, and the interest the lender charges you for borrowing), plus taxes and insurance (which typically get bundled into your monthly payment). There are many online calculators available that can give you estimates of these four factors based on your anticipated purchase price and down payment.
It is important to realistically evaluate what you’re comfortable paying each month for your housing in relation to your desired lifestyle and expenses. There are differing recommendations on this, but often it is said that your monthly payment should be around 30-35 percent of your monthly income.
This will be part of the consideration your lender will use when evaluating your application. But, the factors are varied and complex.
Your financial situation
Not surprisingly, any organization considering lending you money for a home will look carefully at your financial situation. This can include (but not limited to):
- your credit score,
- your employment history and stability,
- your debt-to-income ratio.
Each of these will impact what lending programs and rates are available to you. You don’t have to have perfect credit to be approved for a loan. However, having a credit rating at or above 740 will give you the most options.
If your work history is uneven or has involved a lack of stability, this may be seen as having more risk and may impact your rate or the programs available to you. However, it does not mean you can’t be approved for a loan.
Similarly, if you have a lot of debt in relation to your income, you will have a harder time getting approved for a loan or securing the best interest rate. As such, pay down credit cards, and don’t take on new debt, such as a car loan or getting store credit for large purchases.
The down payment
You will have several expenses when purchasing a home, including paying for inspections, an appraisal and attorney fees. One frequent myth of home buying is that the down payment will always be the largest expense.
For loans that are below 20 percent of the purchase price, you will almost certainly need to carry Private Mortgage Insurance (PMI), which protects the lender. However, PMI is not nearly as much of a financial burden as it once was. With interest rates being historically low, many buyers are worried less about the 20 percent threshold.
In truth, the size of your down payment depends on the loan programs for which you are eligible and which you ultimately choose. So, I would classify this as a “partial myth.” Certainly, if you have the means to put down a sizable down payment, you will likely qualify for better rates and save on PMI.
There are zero-down programs that can sometimes be used, especially by first-time buyers. However, many buyers find that putting a smaller amount down (such as 3 percent) can be a way to keep your upfront-cash commitment low, while also getting a better interest rate.
The variables related to your loan should be, of course, explored with your lender and a financial adviser.
Other items to consider
Getting pre-approved for a loan is one of the first steps you will want to undertake when preparing for a home purchase, likely the second thing you will do after finding a real estate professional you trust. In the current market, you won’t be able to make offers on listed homes without a pre-approval in place.
Thankfully, most lenders make this process quite easy, with online applications and documentation submission.
Choosing a lender can impact the buying process in many ways. There is an argument to be made for using a local lender, as they are often more responsive and have local appraisers who know the market. Credit unions and large retail banking institutions are also options.
You will want to discuss not only fees and interest rates with lenders you are considering, but also the time they need to close the loan. Often banking institutions move more slowly than independent mortgage brokers, and often banks and credit unions do not provide the lowest interest rates. However, sometimes fees may be higher with independent brokers.
Your real estate agent will be able to help you make connections with a variety of lender options to help you compare, be well-positioned to get an approval and be ready to submit offers.
Gary A. Miller is co-owner of Red Bloom Realty. He has lived and worked in Chapel Hill off and on since 1994 and is an avid musician, kayaker, traveler and former educator.