Preparing to Buy
Save More and More Effectively Through Buying a Home
With each payment made to a home mortgage you are effectively putting money into savings. To understand this theory, you’ll need to understand that a typical mortgage payment can be divided into four, or in some cases five parts. These parts are:
Not all parts can be applied to the idea of hidden savings. In most cases you will be saving money through principal and interest. Here’s how it works. Let’s say your mortgage payment is $1500. You put 20% down when you bought the house, so you don’t have PMI. Then, your payment is made up of principal, interest, tax and insurance.
Principal and Interest
At first, the portion of your payment going to principal will be small and the portion going to interest large. Over time, this will be reversed. In terms of hidden savings, both will do the job. Paying the principal will actually pay down what you owe on your home. By doing so, you are gaining equity (hidden savings). Equity growth is important, but not always consistent. Equity is created in two ways, through the influence of market factors, and more directly, through the money you pay toward principal in your mortgage payment.
Interest is the essence of hidden savings. As stated above, a great majority of your mortgage payment is interest. Out of the $1500 payment, $1000 could be interest paid to the mortgage company. (Interest is the fee a mortgage company charges for lending you money). In this scenario over a one-year period you might pay $12,000 in interest. This money is actually hidden savings. When it comes time to do your taxes at the end of the year you will “write-off” the interest you paid on the loan. To the point, you will save $12,000 of earned income that might normally go to the taxman.
Hidden savings is a gem of home ownership. Not everyone is good at saving money in conventional ways. Through home ownership you can save by default.
The Mortgage-lending World - Keep Your Cash in One Place
The powers that be in the mortgage-lending world want to see where your money is, where it’s been and where it came from. Conventional and conforming loans have down payments commonly ranging from 5% to 20% of the home’s purchase price. A down payment comes from your pocket, checking account, savings account or some other form of liquid asset. Lenders will ask for documentation to support the source of your down. They will require verification that funds you claim to have actually exist. Not only must they exist, but their source will be verified as well. For instance, if you’re getting funds from a friend as a “gift,” then a gift letter needs to go to the lender.
Fraud is the Game and Lenders Aim to Curb It
By leaving your cash in one place, a lender will more easily track the source of your funds. This in turn will speed up the underwriting process, making the entire loan acquisition process a little less lengthy and a little more bearable.
It’s important to note that not all loans require down payment funds. There are many 100% loan programs out there, and with the right credit score you can use one. These nonconforming loans can be divided into two basic categories:
The 80/20 loan is actually two loans, an 80% first and a 20% second. The following should clearly illustrate the program.
Home Purchase at $200,000
Loan #1 @ 80% = $160,000
Loan #2 @ 20% = $40,000
Total = $200,000
The 100% loan is one loan for the full value of the home purchase. This loan is available, but may be hard to find.
Don't Change Jobs
Changing your career path can adversely effect your ability to qualify for a home loan, even if you’re making more money.
From a Lender's Perspective
Mortgage lenders like to see a consistent timeline. Being on the job for a minimum of two years is best. Anything less will lessen your chances of qualifying or at a minimum—raise your interest rate. Think of it in terms of security; the longer you’re on the job, usually, the more secure your position.
The Gray Area
Changing jobs/careers but staying in the same field is usually acceptable. However, if you think you’re going to buy a home this year, whether it’s your first of fifth, stay put.
An explanation: Most of us don’t make dramatic changes to our career paths, so a job change is probably going to be linear. Meaning, if you’re in semi-conductors with Motorola then a move will likely be to another tech company filling roughly the same role. Even a change like this creates instability in the eyes of money lenders.
Get into that new home then make a job/career change. As I’m sure you’ve heard a thousand times: “Timing is everything.” Well, when it comes to acquiring a new mortgage you’ve got to think ahead. Plan for your move. Pay off bills. Get rid of debt. Put your housing goals down on paper and then stick to them. Don’t make drastic changes in your spending habits. In short, be a creature of habit, habits on which people can depend.
Wait to Make that Auto Purchase
The most common mistake made while purchasing a home has the ability to end the deal. Really, it can end the deal—stop the sale—eliminate the ability to be financed. Yes, you’re going to have a new Arizona home. Yes, that new Arizona home would look decked-out in new window coverings, but don’t do it. Yes, your new Arizona home could be fancied-up with custom tile throughout, but don’t make that mistake. And it would be nice to have a new car to go in that new garage in that new Arizona home; don’t even think about it. Sure, the widows of that Arizona home could use some dressing up, but dressing up could mean no widows at all; it could mean no Arizona home, for now. Have you ever bought pants, but didn’t try them on until you were home and then, too late, realized they didn’t fit? Imagine buying $10,000 worth of furniture on your visa, but having no place to put it.
If you’re shopping for an Arizona home, it’s all about ratios. Banks live and breathe ratios, debt to income, credit score vs. risk. When evaluating you for an Arizona home loan banks generally want to see your monthly outflow at about 32% or less of your total monthly inflow. They’ll make loans at higher ratios, but not in every case. That decision will come down to credit score and other related factors.
Once under contract on an Arizona home and approved through the bank for the mortgage most consumers believe the matter to be closed. Not so. Before close of escrow on your new Arizona home the bank will once again check your debt to income ratio. If things have changed because you made some credit purchases, you may no longer qualify to purchase that Arizona home. Even cash purchases during the escrow period should be discussed with your bank prior to execution. The best rule to follow before making large purchases when buying an Arizona home: ask.
Principal is what you borrowed. Money paid toward principal will pay down what is owed on what is borrowed. In fact, many home owners choose to pay additional money each month toward principal. This action will reduce the total interest paid on the loan as well as reduce the amount of time, 30 years needed to pay off the entire mortgage.
With a 30 year mortgage and a payment of $914.74 per month at 10.5% fixed interest, a total of $229,300 is paid in 30 years. (At about 23 years only half of $229,300 is paid off)! With very little change and even less cost, making small additional principal payments will dramatically effect the length of the mortgage and the total amount paid. Check it out figure 1.
Very few mortgages have prepayment penalties, but check with your mortgage lender to ensure you can prepay on your mortgage.
Interest is the fee a mortgage lender will charge to lend money. Interest rates change day-by-day. There are many market influences that effect interest rates. In general, the lower interest rate a borrower can acquire, the less that borrower is being charged for borrowing money. Interest can make a $100,000 home more than double in price over 30 years. See figure 1 and 2.
The difference is tremendous, $107,640! Obviously, buying a home when interest rates are low will have significant economic benefits to the borrower.
Real Estate Tax
Tax is paid to the County in which your home sits. Generally, tax money goes to education. In Maricopa County, Arizona 73% of all property taxes go to education. Tax rates are determined through County budget demands and often go up due to increased property value. Choosing not to pay property taxes can result in a lien on the subject property.
In a typical real estate transaction, taxes are prorated between buyer and seller. At close of escrow on a property taxes must be brought current. The title company should ensure that buyer and seller are paying only for their portions.
Tax payments are commonly impounded by mortgage companies and then paid to the county by the mortgage company at the appropriate time. Mortgage companies like to have taxes collected with the monthly mortgage payments to ensure that they get paid, and a tax lien is not put on the property. However, not all mortgage loans require taxes to be paid in this way. Check with your mortgage lender. Property taxes are paid on October 1st for the first half of the year, and then paid March 1st of the following year for the second half. It’s advisable to contact your mortgage lender to make sure they have paid your property taxes on time.
Homeowner’s insurance is mandatory. In fact, home loans are not made without proof of insurance. A policy to insure your home can be issued through the same company that insures your car or any other company of your choice. Homeowner policies come in many shapes and sizes and the choice of policy coverage, beyond the minimum, is up to each home owner.
Most homeowner’s policies are set up to cover structures, personal property and personal liability.
• Structures: The home and other structures on the property are usually covered for replacement value. (What would it cost to rebuild/replace)?
• Personal Property: Items located on-premises. Often times and with many policies, these personal items are also covered when taken away from the home. For example, personal property stolen while on vacation is often covered.
• Personal Liability: Coverage of persons, their bodies and their property, if you are liable. This coverage is very limited and should be spelled out by your provider.
It is up to each individual to discover exactly what coverage his or her insurance provides, as each policy will be different. Also, check with your provider about optional coverage.
Determining the amount of insurance coverage you need and the type of coverage you need may best be determined after consultation with a professional in the insurance field.
Private Mortgage Insurance (PMI)
Designed to protect the lending institution providing a home loan, PMI makes it possible for potential homebuyers to buy a home with a down payment less than 20% of the home’s purchase value. Mortgage lenders, to determine the need for PMI commonly use loan-to-value ratios, however, not in all cases.
Loan-to-value ratios measure the percentage of the home purchase that will be mortgaged vs. the percentage paid cash through a down payment. Mortgage lenders often require Private Mortgage Insurance when homebuyers purchase a home with less than 20% down. Mortgage insurance can be costly and is not a write-off. Figure 3 is an example of one way to avoid paying PMI with less than 20% down.
Of course loan programs change often, so check with your mortgage lender to see if the right program exists for you.