Selecting the best financing package is nearly as important as finding a home that meets your needs. In fact, determining how much you can afford before you begin your home search will save you valuable time in choosing the right home in the right neighborhood.
There are three factors to consider in figuring how much you can afford:
- the down payment
- the monthly mortgage payment you qualify for based on credit score, income, and debts
- closing costs
Choosing A Loan Type
Typically loans require a down-payment of between 3.5% (FHA) and 20% (conventional) of the home price.
Most lenders prefer that your total monthly mortgage payment, including principal, interest, taxes and insurance, not exceed 28% of your gross monthly income.
They also look for your total installment debt (regularly scheduled payments of 6-months or longer), including the proposed monthly mortgage payment on your new loan, to not exceed 38% of your gross monthly income. They also look at a composite credit scoring service, usually called your FICO score. Scores over 700 are preferred by lenders. These are only guidelines, however, and you should discuss your specific circumstances with a loan officer to determine what you qualify for.
The most common conventional loan is amortized over 30 years (though others programs exist from 15 to 50 years). Historically you’ve needed a 20% down-payment to qualify but most lenders now offer two types of alternatives.
High Loan To Value (LTV) – some lenders offer 85% to 95% financing in one loan. However, because this type of loan is considered risky, you will probably have to pay a higher interest rate and PMI or MIP (Mortgage Insurance). This an insurance policy that covers the lender, NOT YOU, in the case of default. Often you will pay an upfront fee as part of your closing costs as well as monthly payments until your loan reaches 78% of current market value. Occasionally you might see “Lender Paid PMI” as part of a promotion. If that is the case, trust that you are paying higher closing costs or a higher interest rate – those fees must be accounted for somewhere.
80% First Mortgage with Piggyback Home Equity Line of Credit (HELOC) – To avoid paying PMI, some lenders may offer an 80% First (or Primary) loan supplemented by a 5% to 15% HELOC. In this case, you will typically pay two separate monthly bills. Because HELOC rates are typically tied to the (now low) federal prime rate, these loans are becoming more popular. Here are a few things to keep in mind when considering this type of loan: HELOC rates can and do fluctuate. Starting in 2018 HELOC interest payments will not be tax deductible. HELOC payments amortize much like a credit card; minimum payments may not reduce the debt.
FHA is a great tool for First-Time Buyers or those with limited down-payment funds. The standard FHA loan only requires a 3.5% down-payment, it also requires monthly mortgage insurance as well as an upfront mortgage insurance fee that is rolled on top of the loan balance.
This down-payment must either be personal cash from savings, a cash gift from a family member, or perhaps a gift from your employer. The seller is NOT allowed to pay any portion of your down-payment. However, the seller can assist with closing costs if the contract is negotiated with those terms. FHA says that they offer loans for borrowers with credit scores as low as 580 however, most reputable lenders have additional in-house requirements they lay on top of the government guidelines.
Most local lenders now require a minimum 620 credit score.
FHA Facts and Tips:
- Closing costs can be slightly higher with FHA loans and underwriters now require full income, credit, and employment verifications.
- FHA buyers must be owner-occupants, investors are not allowed.
- An individual can not have more than one FHA loan at a time. If you plan to keep you current residence as an investment property, you will likely need to refinance it to a conventional loan before buying a new property.
- FHA is not encouraged for properties in need of substantial work or repairs, although they do make a special loan product for this purpose called 203k.
- Because FHA is partially underwritten by the federal government these loans can take a bit more time to close with last-minute requests for paperwork; I would recommend at least 45 days from contract date to the closing date.
- If purchasing a condominium with an FHA loan, make sure the development is on the HUD-Approved Condo Development List.
- If you are unable to put 3.5% down, there are still a couple of loan programs for you, but understand that the interest rate and closing costs may be a little higher. It’s not an ideal scenario.
Closing Costs & Pre-Paids
Closing costs can vary greatly depending the type of loan and the borrower’s credit score (from 2% to 5%). ALWAYS, ALWAYS, ALWAYS get a Loan Estimate (in writing) from your lender outlining the costs you will be expected to pay. Here are some fees you might see on that estimate:
- Origination Fee (usually around 1% of the loan amount). This is how the mortgage broker gets paid for selling you a loan. The low rates you see in any advertising almost always include an origination fee. If there is no origination fee, typically the interest rate will be slightly higher.
- Appraisal Fee. Sometimes required as an upfront fee. This typically runs $450 to $550. If you have an appraisal done and don’t close on the property for some reason, you will forfeit this charge.
- Credit Check Fee. $15 to $50
- Flood Certification Fee. $10 to $25
- Attorney Fees. $350 to $450. Sometimes separated into two categories (closing fee & document prep).
- Courier Fees. $20 to $75
- Power of Attorney. $25 to $100 if needed.
- Title Insurance. Though negotiable, the seller typically pays for the title insurance policy in Davidson county EXCEPT in the case of new construction when the buyer becomes responsible. Samples (100k = $595, 200k =$901, 300k =$1375)
- Tax Stamps/Transfer Tax. Typically one of the buyers largest closing cost. These fees are based on sales price and set by the state & city.
- Filing Fees/Recording Fees. Varies by number of pages in the property deed
- Discount Points – if buying down rate.
- Tax Service Fee. $50 to $100
- Processing/Underwriting Fee. Varies by lender
- Document Review.
Pre-Paids: Pro-rated Taxes. Pro-rated Mortgage Interest (varies by closing date). HOA Start-Up or Transfer – $100 to $495 HOA Reserve Cushion – two months is typical.
- Pro-rated Taxes.
- Pro-rated Mortgage Interest (varies by closing date).
- HOA Start-Up or Transfer – $100 to $495 HOA Reserve Cushion – two months is typical.
- Lender Required Reserves – When setting up a monthly escrow account, most lenders require 3-6 months worth of taxes and/or insurance be placed in reserve.
- Other Fees To Consider: Home Warranty. If ordered ~$400
- Various Inspections (Formal Home Inspection, Radon, Air-Quality, Lead-Based Paint, etc.- usually paid in advance) ~$350+
- Interest Rate Lock Fees (applied as a credit at closing).
- Earnest Money Deposit (applied as a credit at closing).
- I recommend between one and two percent as a base earnest money deposit. A larger deposit usually conveys a stronger offer.