Financial well-being March 31, 2016 By
As a lender, the most frequent questions I hear regarding a home purchase involve the loan amount, down payment requirements, interest rate and loan structure, and the closing costs related to the loan. Hopefully, the below information will answer some of your questions about buying a home:
What can I afford?
The affordability factor, when purchasing or constructing a home, is of key importance and depends on your other household expenses. While banks and mortgage companies work with defined parameters and ratios, you should have some idea of an affordable range. To determine this, total up all monthly expenses, including actual hard expenses and expenses spent on luxuries and lifestyle. Also include a monthly contribution to savings or retirement and a buffer for unexpected emergencies. Subtract this from your monthly income to determine an affordable payment range for your purchase. Doing this will help you determine for yourself what you can comfortably afford.
Do I need a down payment (even if I purchased the home at a discounted price)?
Yes, all banks and mortgage companies require a form of down payment. The percentage can vary from bank to bank; however, a good average number to keep in mind is 10 percent down. The down payment is always based on the purchase price of the home and does not always have to be cash; it can be in the form of other equity. Each lending institution will have specific equity requirements, but generally, the equity must be in the form of cash or similar in nature and value to the purchase. Common examples of equity used in home purchases are certificates of deposit, cash, or other land owned. Sometimes borrowers qualify for a separate down payment loan, which is secured with an asset value of a shorter life, such as a vehicle or equipment.
Is my interest rate fixed?
Knowing if the loan is fixed or an adjustable rate mortgage (ARM) is key in determining your ability to make the payments for the longevity of the loan. A loan financed "in house" with a local lending institution is an adjustable rate mortgage. This means the interest rate is based on a certain index rate (usually a treasury rate). The bank determines the margin of earnings needed. The difference between the loan rate and the index rate is considered the spread. Thus, an ARM will be fixed for a particular period of the loan and then adjust to current rates based on the spread calculated at origination. Likewise, the payment will adjust to the rate, which can result in an increase. This structure is for loans that do not fit the perimeters of conventional fixed-rate financing, such as construction loans, loans to finance farms with larger tracts of land, and homes of atypical configuration for the current market.
The primary mortgage market allows you to lock in the interest rate for the entire life of the loan. Typical financing terms are 15, 20, and 30 years. These lenders are mortgage originators, mortgage brokers, and mortgage bankers. The reason for the lower, fixed-rate financing is, after origination, the loan will be sold to investors on the secondary market, usually as a mortgage-backed security.
The closing costs are comprised of third-party vendor fees needed to secure the purchase and title of the home. Examples are title insurance, appraisal fee, homeowners insurance, surveys, origination fee, and filing fees. These fees can vary depending on location and loan amount; however, closing costs are typically going to range 4–6 percent of the loan amount.
The above tools can be used as a reference when making a home purchase; however, don’t be afraid to consult your local lending representative to develop your home buying needs.