To be considered for a low down payment loan, you generally need to have:
- Sufficient income to support the monthly mortgage payment
- Enough cash to cover the down payment
- Sufficient cash to cover normal closing costs and related expenses
(explained below)
- A good credit background that indicates your payment history or "willingness
to pay"
- Sufficient appraisal value, which shows the house is at least equal to the
purchase price
- In some instances, a cash reserve equivalent to two monthly mortgage
payments
Closing costs, or settlement costs, are paid when the home buyer and the
seller meet to exchange the necessary papers for the house to be legally
transferred. On the average, closing costs run approximately 2% to 3% of the
house price. This percentage may vary, depending on where you live.
Closing costs include the loan origination fee (if not already paid), points,
prepaid homeowners insurance, appraisal fee, lawyers fee, recording fee, title
search and insurance, tax adjustments, agent commissions, mortgage insurance (if
you are putting less than 20% down) and other expenses. Your mortgage
professional will give you a more exact estimate of your closing costs.
Points are finance charges that are calculated at closing. Each point equals
1% of the loan amount. For example, 2 points on a $100,000 loan equals $2,000.
Companies may charge 1, 2 or 3 points in up-front costs in addition to the down
payment. The more points you pay, the lower your interest rate will be. In some
cases, you may be able to finance the points.
So How Much of a Mortgage Can You Afford?
There are two basic formulas commonly used to determine how much of a
mortgage you can reasonably afford. These formulas are called qualifying ratios
because they estimate the amount of money you should spend on mortgage payments
in relation to your income and other expenses.
It is important to remember that the following ratios may vary and each
application is handled on an individual basis, so the guidelines are just that
-- guidelines. There are many affordability programs, both government and
conventional, that have more lenient requirements for low- and moderate-income
families.
Many of these programs involve financial counseling for low- and
moderate-income people interested in buying a home and in return, offer more
lenient requirements.
Generally speaking, to qualify for conventional loans, housing expenses
should not exceed 26% to 28% of your gross monthly income. For FHA loans, the
ratio is 29% of gross monthly income. Monthly housing costs include the mortgage
principal, interest, taxes and insurance, often abbreviated PITI. For example,
if your annual income is $30,000, your gross monthly income is $2,500, times 28%
= $700. So you would probably qualify for a conventional home loan that requires
monthly payments of $700.
Any expenses that extend 11 months or more into the future are termed
long-term debt, such as a car loan. Total monthly costs, including PITI and all
other long-term debt, should equal no greater than 33% to 36% of your gross
monthly income for conventional loans. Using the same example, $2,500 x 36% =
$900. So the total of your monthly housing expenses plus any long-term debts
each month cannot exceed $900. For FHA the ratio is 41%.
Maximum allowable monthly housing expense
26% - 28% of gross monthly
income - Conventional
29% of gross monthly income - FHA
Maximum allowable monthly housing expense and long-term debt
33% - 36% of
gross monthly income - Conventional
41% of gross monthly income - FHA
One way to determine how much to spend for housing is to compare your monthly
income with monthly long-term obligations and expenses. Use the worksheet,
"Evaluating Your Financial Resources," to determine how much money you can spend
on housing. Be sure to only include income you can definitely count on.
When budgeting to buy a home, it is important to allow enough money for
additional expenses such as maintenance and insurance costs. If you are
purchasing an existing home, gather information such as utility cost averages
and maintenance costs from previous owners or tenants to help you better prepare
for homeownership.
Homeowners insurance or property insurance is another cost you will have to
consider. The lending institution holding the mortgage will require insurance in
an amount sufficient to cover the loan. However, to protect the full value of
your investment, you might want to consider purchasing insurance that provides
the full replacement cost if the home is destroyed. Some insurance only provides
a fixed dollar amount which may be insufficient to rebuild a badly damaged
house.
