The nation’s residential housing market is experiencing the best period it has in years. New home sales and existing home sales are on the increase; creating a seller’s market in some areas of the country.
For most Americans, purchasing a home represents one of the most important decisions they will make in their life—financial or otherwise.
Despite the significant financial investment, a survey conducted by the real estate website Zillow reveals that most people do not properly prepare themselves for the home buying process and later they don’t know when is best to mortgage refinance.
More than 1,000 current homeowners and soon-to-be home buyers responding to the poll answered basic questions concerning aspects of getting a mortgage—terms, how to select a mortgage lender and home loan financing.
One-third of the answers were wrong. In addition, the survey revealed the following results:
- Thirty-four percent of respondent do not understand the term “annual percentage rate (APR)
- Thirty-one percent of buyers don’t not think you can get a home mortgage for less than a 5% down payment
- Twenty-five percent of those polled believe you must close with loan with a lender who pre-approves the mortgage
- Thirty-four percent of respondents believe the law requires banks to charge the same fees to all customers for credit reports
In the mind of most home buyers they focus their attention on negotiating the lowest possible price. They ignore the importance of “finding the right loan” said Erin Lantz Director of mortgages for Zillow.
Here are some fundamentals to help you determine how much home you can afford and some of the most common terms used in the home mortgage industry.
Determining How Much Home to Buy
You can get good idea of the amount of the mortgage or “affordable home price” you can comfortably allocate for housing using the following underwriting ratios typically used by most mortgage lenders:
- Totally debt-to-income ratio of no more than 36% percent
- Housing expense-to-income ratio of 28%
Your debt-to-income ratio refers to the amount you owe compared against your income. Naturally, the higher your income, the more debt you can afford take on. To calculate your debt-to-income ratio, begin by adding up your monthly debt payments, including:
- Minimum monthly credit card payment
- Car loan payment
- Other debt obligations
Related: Mortgage Affordability Calculator
Next, calculate your annual gross salary; add plus bonuses, overtime, alimony, and other income. Divide the total by 12. This is your monthly debt-to-income ratio.
Calculate the housing expense-to-income ratio, which shows how much of your gross monthly income would go toward the monthly mortgage payment, which includes your monthly mortgage payment (principal and interest) real estate taxes and homeowners insurance.
Simply multiply your annual gross salary by 0.28 and divide by 12.
You should also consider your needs to save money for other needs like college and retirement. You will also need to make certain assumption about other housing-related costs. For example: your mortgage term is 30 years; annual property tax runs $3,500 and homeowners insurance cost $481 per year.
Important mortgage terms to know
The more information you have about securing a mortgage, the higher your chances of getting a home loan at the interest rate and other terms you desire and the smoother the transaction with the mortgage lender. The following terms mortgage terms will help choosing the right home loan easier
Adjustable Rate Mortgage (ARM) - Typically, ARMs loans have an initial mortgage interest that is lower than convention fixed-rate home mortgages. Borrowers can lock in the low rate for one year or more depending on the product. When the “introductory” period for the low rate expires, the interest rate can increase, but within specified limits and only at certain intervals as outlined in the loan agreement.
In a trade off for lower monthly payments in the first few years, a borrower risk higher mortgage payment if mortgage interest rates increase.
Annual Percentage Rate (APR) - The APR refers to an annual computation based on the mortgage amount, which includes the interest rate quoted by your bank plus additional mortgage costs like origination fees or points. The APR is usually higher than the advertised interest rate because of additional costs.
Closing costs - This term refers to the transactional expenses and other charges associated with buying residential real estate. According to the Federal Reserve Bank, it can run anywhere from 3% to 6% of the cost of the home. It may include origination fees, points, title insurance, and attorney fees.
These costs may vary from lender to lender. Always ask the bank loan officer to explain any expense you do not understand. And you can always negotiate these costs with the lender.
Escrow - An account usually held by a third party called an “ Escrow” has the responsibility to hold documents, earnest money deposits and other funds for safekeeping until the real estate transaction is complete. Sometimes, a lender sets up an escrow account to accumulate and pay the annual property tax and insurance monies submitted with the monthly mortgage payment.
Fixed-Rate Mortgage – This loan carries the same interest rate for the entire period of the mortgage. It may be spread out over a period of 10, 15, 20, or 30 years. Many home buyers choose a fixed-rate mortgage product because it provides them security to know that their mortgage payment will be the same each month regardless of what occurs with rising and falling mortgage interest rates.
Loan to Value Ratio (LVR) – The LTV is a ratio that determines the amount of financing you are getting compared to the actual market value or appraised value of the home. For example, an $180,000 mortgage on a $200,000 home has an LVR of 80 percent.
This is important for the following reason: If your LTV exceeds 80 percent, you must purchase private mortgage insurance (PMI).
Lock-in - Since interest rates for home mortgage vary from day to day, during the period you are buying a home and securing financing, you should “lock- in” a particular interest rate with your bank. Consequently, even if interest rates increase before you close the loan, “the lock-in” guarantees that the lender will process your home mortgage at the “lock-in” interest rate.
If interest rates decrease during this period, you can negotiate a better rate with the lender
Points – Home buyers can pay two types of point: discount points and origination points. Some buyers choose to pay discount points upfront to reduce the interest rate of a home loan. Lenders add origination points to help cover the expenses associated with processing the loan. One point is equivalent to one percent of the loan amount. For example, you can lower your interest rate on a $200,000 home loan by one point if you pay an additional $2,000 at closing.
You should always shop around and make comparison between lenders. If you get pre-approved for a mortgage or lock-in an interest rate, you do not have to obtain your home loan from the lender if you find a better deal elsewhere. Even down payment requirements may vary from lender to lender.
If you can afford the 10% or 20% down payment that some lenders require, investigate into the Federal Housing Agency (FHA) or other federal government, state or local government program that may require a lower down payment or provide some type of down payment assistance, such as a grant or home buyers rebate.