Getting a real estate loan is easy. It’s understanding how much you can afford that is one of the most important rules of home buying. Depending on your individual situation, your budget can affect everything from the neighborhoods where you look, to the size of the house, and even what type of financing you choose.
Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.
Loan prequalification vs. preapproval
One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval because it is only an estimate of what you’ll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.
What will the lender ask for?
A crucial step in starting your search for a new home is having a clear idea of your financial situation. By getting a handle on your income, expenses, and debts, you’ll have a much better idea of what you can afford and how much you’ll need to borrow.
For lenders to verify this information, though, they’re going to need to look at your financial records. It is also important to remember that you should include records for each person who will be the owner of the house. So before you even visit the bank, make sure you’ll be able to provide copies of these important documents:
Paycheck Stubs
Remember that lenders are most interested in your average income. Not only will they want to see this month’s paycheck, but also how much you’ve been making for the past two years. Steady employment is also more attractive to lenders, so if you’ve been hopping from job to job, be prepared to discuss the reasons why.
Bank Statements
In order to qualify you for a loan, most lenders will also ask you for copies of your bank statements. Ideally, they’d like to see a steady history of savings–or at the very least, that you’re not bouncing checks every month.
Tax Records
It’s always a good idea to save copies of your tax returns, especially if you’re self-employed. If you own your own business, it’s important to note that lenders generally consider your income as the amount you paid taxes on–not the gross income of the business.
Dividends‚ Investments
Lenders will usually consider long-term investment dividends, as well as your investment portfolio when evaluating your income.
Alimony/Child Support
If you receive steady payments as part of a divorce settlement or for child support, you can also include this as part of your gross income. Just remember that lenders will want to see a copy of your divorce/court settlement verifying the amount of the payments.
Credit Report
Virtually every lender will want to see a copy of your credit report as part of the loan application process. The report lists all of your long-term debts, as well as your payment history. In general, they will require you to pay for the credit report (approximately $50), but if you have a recent copy, they may accept that instead.
As part of the loan application process, virtually all lenders will want to see a copy of your credit report. The report will list all your long-term debts (credit cards, mortgage payments, automobile, and student loans, etc), as well as your payment history. If you don’t have a copy of your credit report, most lenders will generally require you to pay for a copy when they process your loan application.
However, most real estate experts agree that it is a good idea to obtain a copy of your credit report several months before you apply for a loan. This is so you have a chance to resolve any problems with your credit before your bank sees it. U.S. Federal law ensures that you have access to your credit report, which may be obtained from your local credit bureau or any of several national firms that specialize in credit reports.
Late Payments
For most people, problems with their credit report are likely related to late payments on a debt. If you were late one month in paying off your credit card but otherwise have a good payment history, chances are most lenders won’t be too concerned. But if you have a history of late payments you’ll need to document the reasons why. A slow payment history won’t necessarily get you turned down for a loan, but you may have to pay a higher rate of interest or otherwise prove to the lender that you can repay your loan in a timely fashion.
Errors on your credit report
Many people are surprised to learn that credit reports can often contain errors or inaccurate information. If this is the case with your credit report, you’ll need to contact the reporting agency or creditor to have the problem resolved. This can sometimes be a slow process, so make sure to give yourself time to clear up the mistake.
Bankruptcies and foreclosures
There’s no getting around it, a bankruptcy on your credit report is not a good thing. But that doesn’t mean you still can’t obtain a loan. Even though a bankruptcy may stay on your credit report for seven to ten years, lenders will often consider the circumstances surrounding a bankruptcy (family illness, injury, etc.). Moreover, if you have reestablished good credit since the bankruptcy, a lender will be more inclined to approve your application.
What factors are important to lenders?
Banks and lending institutions will use several criteria to determine how much money they’ll agree to lend. These include:
Your gross monthly income
Your credit history
The amount of your outstanding debt
Your savings–or the amount of money you have available for a down payment and closing costs
Your choice of mortgage (i.e. 30-year, FHA, etc.)
Current interest rates
Two important ratios
Lenders also use your financial information to figure out two, very important ratios: the debt-to-income ratio and the housing expense ratio.
Debt-to-income ratio
Many lenders use a rule of thumb that the amount of debt you are paying each month (car payment, student loan, credit card, etc,) shouldn’t exceed more than 36 percent of your gross monthly income. FHA loans are slightly more lenient.
A standard ratio used by lenders limits the mortgage payment to 28 percent of the borrower’s gross income and the mortgage payment, combined with all other debts, to 36 percent of the total.
The fact that some loan applicants are accustomed to spending 40 percent of their monthly income on rent — and still promptly make the payment each time — has prompted some lenders to broaden their acceptable mortgage payment amount when considered as a percentage of the applicant’s income.
Other real estate experts tell borrowers facing rejection to compensate for negative factors by saving up a larger down payment. Mortgage loans requiring little or no outside documentation often can be obtained with down payments of 25 percent or more of the purchase price.
Housing expense ratio
It is generally difficult to obtain a loan if the mortgage payment will be more than 28 to 33 percent of your gross monthly income.
Down Payments In A Real Estate Loan
If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20 percent down payment may be qualified with the 33 percent housing expense ratio, while someone with a 5 percent down payment is held to the stricter 28 percent ratio.
What is a low down payment?
A low down payment is anything less than the standard 20 percent. Many people borrow with less than 20 percent down by obtaining private mortgage insurance, or PMI. There also are numerous programs to help first-time buyers with little or no down payment, including FHA, VA and Fannie Mae’s Community Home Buyers Program.
How Much Should I Put Down?
Putting down as little as possible allows buyers to take full advantage of the tax benefits of home ownership, many experts say. Mortgage interest and property taxes are fully deductible from state and federal income taxes. Buyers using a small down payment also have a reserve for making unexpected improvements.
Other real estate experts, however, advise that it is more prudent to make a larger down payment and thereby reduce the amount of debt that must be financed.
Is PMI always required on low-down home loans?
A growing number of private lenders are loosening up their requirements for low-down-payment loans. But private mortgage insurance, or PMI, usually is required on very low-down loans.
Can someone who is unemployed get a loan?
Generally, lenders will not make loans to unemployed persons because someone without an income would seemingly have no way of making monthly mortgage payments.
However, there are home loans for which lenders require very little loan documentation as long as the borrower puts down a sizable down payment, generally 25 percent or more. These “no-doc” loans are common among self-employed people who say they earn a certain amount of money but whose income tax returns show that their earnings are much lower.
Are there gov’t programs for rehab?
The U.S. Department of Housing and Urban Development’s Section 203 (K) rehabilitation loan program is designed to facilitate major structural rehabilitation of houses with one to four units that are more than one year old. Condominiums are not eligible.
The 203(K) loan is usually done as a combination loan to purchase a fixer-upper property “as is” and rehabilitate it, or to refinance a temporary loan to buy the property and do the rehabilitation. It can also be done as a rehabilitation-only loan.
Plans and specifications for the proposed work must be submitted for architectural review and cost estimation. Mortgage proceeds are advanced periodically during the rehabilitation period to finance the construction costs.
For a list of participating lenders, call HUD at (202) 708-2720.
If you are a veteran, loans from the U.S. Department of Veterans Affairs also can be used to buy a home, build a home, improve a home or refinance an existing loan. VA loans frequently offer lower interest rates than ordinarily available with other kinds of loans. To qualify for a loan, the first step is to apply for a Certificate of Eligibility.
Another program is the Federal Housing Administration’s Title 1 FHA loan program.
Other ways to improve your purchasing power
Gifts
If you’re having trouble saving money, many lenders will allow you to use gift funds for the down payment and closing costs. However, most lenders require a “gift letter” stating the gift doesn’t have to be repaid, and will also require you to pay at least a portion of the down payment with your own cash.
Negotiating Closing Costs
Through negotiation, some sellers may agree to pay all or most of your closing costs (for example, if you agree to meet their full asking price). If you choose to try this, make sure to ask your real estate agent for advice.
Loan Programs
Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at reduced interest rates, or with little or no down payments. Check with your local housing authority for more information.
Fannie Mae’s low-down program
Fannie Mae is expanding the availability of low-down-payment loans in an effort to help more people nationwide qualify for a mortgage.
Two new programs will help potential buyers overcome two of the most common obstacles to homeownership, low savings, and a modest income.
To address many first-time buyers’ struggles to save the down payment, Fannie Mae developed Fannie 97. The program provides 97 percent financing on a fixed-rate mortgage with either a 25- or 30-year loan term through Fannie Mae’s Community Home Buyers Program.
Fannie Mae’s new Start-Up Mortgage will assist buyers with a 5 percent down payment who are at any income level. Applicants do not need as much income to qualify and less cash for closing than with traditional mortgages. Borrowers will receive a 30-year, fixed-rate mortgage with a first-year monthly payment that is lower than the standard fixed-rate loan.
Freddie Mac, Fannie Mae’s counterpart, also offers low-down-payment loan programs.
Loan Types
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low initial interest rates. Others opt for 30-year loans because they have lower monthly payments than 15-year loans. There are significant differences between different loans, so make sure to discuss the pros and cons of different loans with your agent or lender before making a decision.
Assumable Loans
What is a wrap-around loan?
This method of seller financing is risky if the underlying first loan has a “due on sale” clause because the loan might be called due when the first lender becomes aware that the property has transferred title,” says Dian Hymer, author of “Buying and Selling a Home, A Complete Guide,” Chronicle Books, 1994.
A seller usually will want to incorporate a late charge to encourage the buyer to make monthly loan payments on time. “A buyer will probably want to stipulate that prepayment of the loan be without penalty. This should not cause a problem unless the loan payments are a source of retirement income, in which case early prepayment could have negative financial repercussions for the seller…
“Most sellers prefer to have a due-on-sale provision included in the note, but this can be a negotiable item. Buyers who are concerned that they might be forced to sell during a period of high interest rates can request that the note be assumable by a future buyer, and sellers might find this provision agreeable as long as they have the right to approve the future buyer’s credit report and financial statement,” Hymer writes.
Are FHA loans assumable?
Lenders will only permit those loans that have a “subject to transfer” clause to be taken over through a formal assumption process. Look to your loan agreement for specific terms. In addition, you should candidly discuss any risks with your lender, and possibly consult an attorney before signing the final agreement.
How do you find out if a loan is assumable?
Look to the loan agreement to determine if it is assumable by someone else. Then talk to the lender about specific requirements based on the value of the home.
Assumable loans permit one borrower to take over a loan from another borrower without any change in the loan terms. Such loans still exist but they aren’t very common or popular (for buyers) in a low-interest-rate environment. Plus, today new assumable loans are almost always adjustable rate mortgages.
No-doc Loans
“No-doc” loans are mortgages for which lenders require very little loan documentation as long as the borrower puts down a sizable down payment, generally 25 percent or more.
These mortgages are common among self-employed people who say they earn a certain amount of money but whose tax returns show that their earnings are much lower.
No Money Down Loans
Though some real estate experts advise against it, home buyers interested in buying a house with nothing down can do so. Occasionally, a builder will offer no-down-payment loans to induce sales in an otherwise slow-moving project. Desperate sellers will also promise to finance the down payment to get out from under a property. A veteran can buy a house with nothing down through a VA home loan, as can members of some pension funds
Negative Amortization Loans
What is negative amortization?
Negative amortization occurs when the monthly payments on a loan are insufficient to pay the interest accruing on the principal balance. The unpaid interest is added to the remaining principal due.
When home prices are appreciating rapidly, negative amortization is less of a possibility than when prices are stable or dropping, particularly for the borrower who made a small cash down payment to begin with. The combination of negative amortization and depreciation in home prices can result in a loan balance that is higher than the market value of the home.
Adjustable rate mortgages with payment caps and negative amortization are usually reamortized at some point so that the remaining loan balance can be fully paid off during the term of the loan. This could necessitate a substantial increase in the monthly payment. Most ARMs have a limit on the amount of negative amortization allowed, usually 110 to 125 percent of the original loan amount. If the loan balance exceeds this amount, the borrower has to start paying off the excess.
When is a negative amortization loan a good idea?
Experts don’t agree on this question. Negative amortization is less likely to occur in rapidly appreciating markets. In markets where prices are stable or dropping, it is possible to end up with a loan balance that is higher than the market value of your home.
Adjustable rate mortgages with payment caps and negative amortization are usually reamortized at some point so that the remaining loan balance can be fully paid off during the term of the loan. This could necessitate a substantial increase in the monthly payment. Most ARMs have a limit on the amount of negative amortization allowed, usually 110 to 125 percent of the original loan amount. If the loan balance exceeds this amount, the borrower has to start paying off the excess.
Negative amortization can be avoided by paying the additional interest owed monthly. ARMs that don’t have payment caps usually don’t have negative amortization.
Can I convert a negative amortization loan to a regular loan?
Loan terms vary and each agreement needs to be reviewed carefully. Talk to your lender about specific situations.
Negative amortization occurs when monthly payments on a loan are not enough to pay the interest accruing on the principal balance. The unpaid interest is added to the principal due.
Adjustable rate mortgages with payment caps and negative amortization are usually reamortized at some point so that the remaining loan balance can be fully paid off during the term of the loan. This could necessitate a substantial increase in the monthly payment. Most ARMs have a limit on the amount of negative amortization allowed, usually 110 to 125 percent of the original loan amount. If the loan balance exceeds this amount, the borrower has to start paying off the excess.
Negative amortization can be avoided by paying the additional interest owed monthly. ARMs that don’t have payment caps usually don’t have negative mortization.
Saving for the Down Payment
Saving funds for a down payment should be part of an overall program to get your finances in order prior to shopping for a home. This includes rounding up financial records, examining your spending habits, and setting a budget you can live with. Remember, too, that the down payment is not the only up-front expense. An allowance for closing costs should also be included in your savings budget.
How much is required?
The down payment is usually expressed as a percentage of the overall purchase price of the home and varies depending on the lender, the type of financing, and the amount of money being lent. In the past, the typical down payment was 20%, but in recent years lenders have been willing to offer conventional financing with as little as 3% down. U.S. Government financing programs, such as those offered by the Dept. of Veterans Affairs (VA) or the Federal Housing Administration (FHA), also require minimal down payments.
Private mortgage insurance
Typically, if your down payment is less than 20% of the purchase price, lenders will require you to carry PMI or private mortgage insurance. This insurance protects the lender in case of loan default, and usually involves an up-front payment at closing, as well as a monthly premium. However, once you have paid off 20% of the loan, you can request the policy be canceled. Some lenders cancel the premium automatically, while others require you to make a request in writing.
Gifts
If you are having trouble saving enough money, many lenders will allow you to use gift funds for the down payment–as well as for related closing costs. The gift may come from family, friends, or other sources, but remember that lenders usually require a “gift letter” stating the gift doesn’t have to be repaid. In addition, some lenders will also require you to pay at least a portion of the down payment with your own cash. Thus, if you plan to use gift money to purchase your house, ask your lender about their policies regarding gifts.
Earnest money
Buyers are usually required to deposit earnest money with the seller when they make an offer. If the offer is accepted, the earnest money is then credited towards the down payment. The amount varies widely depending on the seller and local custom, but be prepared from the outset to have funds earmarked for this purpose.
Don’t forget closing costs
In addition to the down payment, you will also need to save for additional fees associated with the loan. Known as closing costs, these charges cover items such as title insurance, documentary stamps, loan origination fees, the survey, attorney’s fees, etc. When you submit your loan application, lenders are required to supply you with a good faith estimate of your closing costs.
Some buyers are surprised by the amount of the closing costs, which can easily run into thousands of dollars. Remember, though, that closing costs can be negotiated with the seller. For example, you may agree to pay the full asking price in exchange for the seller paying all the allowable closing costs.
When Should You Pay Points on a Loan?
When it comes to comparing interest rates for a mortgage loan, homebuyers often have the option of choosing a loan with a lower interest rate by paying points. Simply put, a point is equal to 1 percent of the loan amount. For example, with a $100,000 loan, one point equals $1,000. Points are usually paid out-of-pocket by the buyer at closing.
Paying points may seem attractive because a lower interest rate means smaller monthly payments. But is paying points always a good idea? The answer generally depends on how long you plan to stay in the house. Let’s look at an example:
Bob and Betty Smith are shopping for loan rates on a $150,000 home. Their bank has offered them a 30-year loan at 7.5 percent with no points. This works out to a monthly payment of $1,049.
However, their bank has also offered them a loan at 7 percent if they agree to pay 2 points (or $3,000). At this lower rate, their monthly payment drops to $998, or a savings of $51 per month.
By dividing the amount they paid for the points ($3,000) by the monthly savings ($51), we see that they will have to own the house for 59 months (or just under 5 years) before they will start to see savings as a result of paying points. If Bob and Betty plan to stay in the house for many years, then paying points could make good sense. But if they see themselves moving to another house in the near future, they’d be better off paying the higher interest and no points. (Note: for simplicity, the above example does not take into account the time value of money, which would slightly lengthen the break-even time.)
Can you deduct points on your income taxes?
In the United States, one side benefit of paying points on a mortgage loan is that they are fully tax-deductible for the same tax year as your closing. However, this does not apply to points paid for a refinance loan. For refinances, the IRS requires you to spread out the deduction over the life of the loan. For example, if you paid $5,000 in points for a 30-year refinance loan, you can only deduct 1/30 of the $5,000 each year for 30 years. If you pay off the loan early, though, you can deduct the remaining amount that tax year. As to this page and all pages regarding tax situations, please check with your tax professional.
Can I get a HUD home for as little as $100 down?
If you are strapped for cash and looking for a bargain, you may be able to buy a foreclosure property acquired by the U.S. Department of Housing and Urban Development for as little as $100 down.
With HUD foreclosures, down payments vary depending on whether the property is eligible for FHA insurance. If not, payments range from 5 to 20 percent. But when the property is FHA-insured, the down payment can go much lower.
Each offer must be accompanied by an “earnest money” deposit equal to 5 percent of the bid price, not to exceed $2,000 but not less than $500.
The U.S. Department of Veterans Affairs also offers foreclosure properties which can be purchased directly from the VA often well below market value and with a down payment amount as low as 2 percent for owner-occupants. Investors may be required to pay up to 10 percent of the purchase price as a down payment. This is because the VA guarantees home loans and often ends up owning the property if the veteran defaults.
If you are interested in purchasing a VA foreclosure, call 1-800-827-1000 to request a current listing. About 100 new properties are listed every two weeks.
You should be aware that foreclosure properties are sold “as is,” meaning limited repairs have been made but no structural or mechanical warranties are implied.
