Guide to Homeownership

Unit 2: Housing Affordability

If you’re thinking of buying a home, you need to consider whether you can afford it.  You don’t want to find yourself struggling to pay for anything else.  So, begin with analyzing your monthly budget. You will need to include your total housing costs and all expenses: the monthly mortgage payment, taxes, insurance, and property maintenance.  You should not consider buying a home until you can handle the mortgage payment and other housing-related costs.  If you find that you can do this, you may be ready for homeownership. 

How Much Home Can I Afford?

To answer that question, lenders look at all the elements that make up your financial profile, including your credit history, the cash you have available for a down payment and closing costs, your income and your existing debt and financial obligations. Then, taking the current market interest rate into account, a lender can give you an estimate of the maximum mortgage amount you can afford. By adding your maximum mortgage amount to the funds you plan to use for your down payment, you will know your home purchase price range. 

How Large of a Loan Can I Be Approved For?

Two general guidelines are used by lenders to determine the loan amount for which you may qualify. Based on your individual financial profile, these guidelines ensure that your housing expenses and debt payments don’t take up too much of your income.

The first guideline, known as the housing expense-to-income ratio (or front-end ratio), compares your proposed monthly house payment to your total household gross monthly income.

The second guideline, known as the debt-to-income ratio (or back-end ratio), compares your proposed monthly house payment to your gross monthly income and monthly debt requirements. Traditionally, loan programs required 28/36 ratios, which meant you could devote up to 28% of your gross monthly income to housing expenses (the front-end ratio), while your monthly housing expenses plus monthly debt combined could be as high as 36% (the back-end ratio).   Your credit union mortgage consultant can help you get a better idea of the maximum mortgage amount you can afford.

How Important Is My Credit?

Your credit report is an important consideration to lenders reviewing your financial profile. If you have a history of paying your monthly obligations on time, that’s a signal to a lender that you are likely to make your monthly mortgage payments on time as well. So your credit can be a factor in the kind of mortgage program you may qualify for. Your credit history can also affect the amount required for a down payment, the amount of money you can borrow in relation to your income, and the interest rate you are offered. But keep in mind that even if you have no established credit history or less-than-perfect credit, there are still loan programs that can help you buy a home.

How Much Do I Need for a Down Payment?

In the past, saving money for a down payment on a home was often the largest obstacle to homeownership with lenders requiring a minimum of a 20% down payment. But today’s flexible home loan programs make this issue less of a challenge, with some programs allowing you to put very little down (3% or less). In fact, you may qualify for programs that don’t require down payments at all. Some homebuyers may be eligible for local down payment assistance programs. If one is available in your area, your credit union mortgage consultant can give you further details. If you decide to use less than a 20% down payment, your lender will require Private Mortgage Insurance (PMI). These insurance programs protect the lender in the event you do not fulfill your commitment to repay the mortgage.

Obtaining A Mortgage

A mortgage is a loan secured by real estate. In other words, in return for the funds necessary to purchase a home, a lender, such as your credit union, gets your promise to pay back the funds over a certain period at a certain cost. Backing your promise to repay is the property. Should you default or stop paying, the loan, the lender would take over ownership of that property. The repayment of a mortgage occurs through monthly payments.

How Do I Qualify For a Mortgage?

In general, all lenders use the same four basic standards to approve applicants for a mortgage. Different mortgage products have varying guidelines within those standards. The lender looks at what is referred to as the “the four C’s”: capacity, character, capital and collateral.

Income (Capacity)

Do you have steady and sufficient income to make the monthly payments? This income can come from a primary, second, or part-time job, overtime and bonuses, commissions, self-employment, retirement benefits, pensions and annuities, public assistance, child support, alimony or maintenance payments, veterans benefits, disability payments or rental property income.

Credit History (Character)

Have you paid back money you borrowed in the past? Have you been late in making your payments? Have you filed for bankruptcy? Do you have a record of judgments and collection accounts filed?  If you have a limited or no credit history, a “nontraditional” credit history will be considered. You may need to show paid receipts and canceled checks for rent and utility payments that document a pattern of paying your monthly obligations on time.

Savings (Capital)

Have you saved any money that can be used toward the purchase of your home? The savings can be money in a savings account, certificate of deposit, retirement [401(k)] account, or a gift from a relative or friend. A lender wants to see that you have the capital to fulfill your current obligations as well as your new mortgage. Ideally, you should have enough savings to act as a source of funds for your down payment and several months of reserve funds to cover your anticipated monthly mortgage payments should anything happen to you or your job.

Property (Collateral)

Your lender will require an appraisal on your home to determine its market value in comparison to similar houses that sold recently in the neighborhood. Your lender will also look at the type of the property and whether there are additional fees such as homeowner’s association dues.  If you’d like to be pre-approved for a mortgage loan, you do not need to have a property in mind. You can actually get a conditional approval pending the property appraisal, if you qualify.

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