Financing
With all the different options to finance a home, what should your #1 consideration be? Choose a loan with payments you can afford. Take your time, analyze your situation, get several opinions, and use your common sense.
Even though there are hundreds of loans available, they really break down into just a few categories: fixed rates versus adjustable rates, and government loans versus conventional loans.
Types of loans
Fixed rate loans:
A fixed rate loan offers an interest rate that is guaranteed for the full term of the loan, and cannot change, regardless of what the economy does. This type of loan is safe and secure, because your payments don’t change. It’s easy to budget, and gives you peace of mind. Fixed rate loans come in a variety of terms, or lengths. While the 30-year term is most popular, 10-, 15-, 20- and 40-year terms are also available.
Adjustable rate loans:
An adjustable rate mortgage, or ARM loan, has an interest rate that is guaranteed only for an initial period, and then can go up or down over the remainder of the loan. While an ARM may make sense if you are sure you will only be in the home for a short period of time, remember that your payment can increase in the future. This can cause anxiety and financial hardship.
Government loans:
These loans are guaranteed, insured, and/or funded by a unit of government. They can have advantages over conventional loans, such as a very low or no down payment, and sometimes no requirement for private mortgage insurance.
Conventional loans:
These traditional mortgages are not directly insured or guaranteed by a unit of government. Most conventional loans under $417,000 are administered through Freddie Mac and Fannie Mae, private corporations regulated by the government. They set the standards and qualifications for these types of loans.
Lenders may also offer in-house programs, where they fund loans with money on deposit with their institution or borrowed from sources other than Freddie Mac and Fannie Mae. These qualification guidelines may be more flexible.
Qualifying for a mortgage
Getting a mortgage boils down to three major things:
1. Capacity: your ability to repay the loan
2. Credit: your willingness to repay the loan, as shown by your credit history
3. Collateral: the property and your equity in it
Capacity
Lenders will consider your income and employment in relation to the amount of the loan you are requesting and your other monthly obligations. Generally, you should not spend more than 28-30% of your gross monthly income on a house payment. Also, your new house payment plus the payments on other long-term debts (car loans and leases, student loans, credit card payments, alimony and child support payments) should not exceed 36-40% of your gross monthly income.
Credit
During the loan approval process, your credit history and credit scores are reviewed. Credit scores are used to help predict how an individual will repay a loan. They are based on the information contained in your credit report on a certain date, and as such can change over time. Scores are calculated with formulas based on experience with millions of consumers. Scores can range from 350-850; higher scores are better.
You can obtain your free credit reports from www.annualcreditreport.com.
If there is a credit problem, the lender may suggest the following credit remedies:
- Get current on all bills and rent payments for a 12-24 month period
- Pay off any outstanding collections, judgments and write-offs
- Reduce your debt by paying off some bills
- Work with an agency for credit counseling, debt reduction, budget counseling and money management workshops:
Consumer Credit Counseling Service 608-252-1334
Credit Counseling Centers of America 608-277-0222
Collateral
The collateral for the loan is the home or condominium you are purchasing. The lender will order an appraisal, which is a report that confirms the market value of the property. Your required minimum down payment is based on the lesser of the actual purchase price or the appraised value of the home.
Down Payment, Closing Costs, and Prepaid Expenses
Often potential home buyers believe they need a 20% down payment to purchase a home. However, you may be able to buy with as little 1% or 5% down payment, or even in some cases, no down payment. Generally, an excellent credit history is required to qualify for a loan with 0% down payment.
If you don’t have sufficient funds for a down payment and/or closing costs, you may qualify for down payment assistance being offered by various agencies in Dane County. Learn more about downpayment assistance.
In addition to down payment, funds are needed to cover closing costs and prepaid expenses. Closing costs may include: credit report, appraisal, property inspection, title insurance, settlement fees, underwriting fees, documentation fees, and discount/origination points, etc. Prepaid expenses may include: private mortgage insurance, pre-paid interest, and amounts to set up an escrow account for homeowner's insurance and property taxes.
Closing costs generally run 1-3% of the loan amount, but can vary greatly depending on the type of loan. Ask your lender for a Good Faith Estimate that will outline the specific closing costs for your loan.