To determine how much home you can afford, you should sit down with a loan officer at a bank or mortgage company. Typically, loan officers will need the following information to help you find how much you can borrow. This list is general and may not include everything your particular lender may require:
- Last 2 Years of W-2 Forms
- Paystubs for all borrowers covering the most recent one month period
- If you are self-employed or derive income from rental real estate, provide the last 2 years Federal Tax Returns (signed and with all schedules attached) and a year-to-date financial statement (Profit and Loss)
- Copies of bank statements for the most recent 3 months
After the loan officer looks over the requested forms, they will discuss with you the different programs that are available and what you can qualify for. They will discuss different topics as listed below:
What is the difference between fixed rate and variable rate mortgages?
A fixed rate mortgage is a loan where the principle and interest payment never change during the life of the loan. Fixed rates are usually for 15 and 30 year loans.
A variable or adjustable rate mortgage (ARM) is a loan in which the interest rate can change periodically. The changes in the interest rate are related to the market rates that exist at the time the rate is subject to change. Variable rate mortgages usually offer lower interest rates than fixed rate mortgages, but can adjust upward if interest rates go up. There is a predetermind cap which defines how high the interest rate can adjust. Typically, you will see these loans listed as 3/1, 5/1, and 7/1. For 3/1, the first 3 years are fixed at the specified rate and the 4th year will be an adjusted rate.
Fixed rate mortgages are beneficial to those who prefer fixed payment schedules for the life of the loan. These work best when you are planning to remain in the home for more than 5 years.
Adjustable rate mortgages are advantageous for those who do not plan to stay in their home for a long time, for those borrowers who do not qualify at higher fixed interest rates, and those who can financially accomodate fluctuating payments when the loan reaches the adjustable stage. Since adjustable rate mortgages are lower in percentage rate, you can sometimes be approved for a little more money than in a fixed rate mortgage.
What are "Points"?
Points are prepaid interest. By paying points the lender collects interest up front and the borrower may be able to obtain a lower interest rate on their mortgage. A point is 1% of the mortgage amount. As an example, 1 point on a $200,000 loan would be $2,000.00.
What is PMI?
PMI stands for Private Mortgage Insurance. This insurance, provided by non-government insurers, protects a lender against loss if the borrower defaults. PMI insurance is required on any loan with a LTV (Loan To Value) of greater than 80%. The amount of coverage depends on the loan program and the level of down payment. PMI costs more on a loan with 5% down than a loan with 15% down
What are escrow accounts and how much do I need in my escrow account?
Escrows are payments made by a mortgagor to a mortgagee for the purpose of paying the mortgagorâs taxes, insurance, and other payments associated with home ownership. The mortgagee is responsible for the timely disbursement of escrow funds to pay the mortgagorâs bills as they become due.
Usually, a mortgage company collects funds for placement into the mortgagorâs escrow account with the mortgagorâs periodic payment for principal and interest. An escrow account has sufficient funds if there is enough to pay all bills when they become due.
It is common practice for mortgage companies to hold an "escrow cushion" for a mortgagor. The "cushion" is kept by the mortgage company to assure that if the cost of any escrowed item were to increase in the future, there would be sufficient funds to pay all bills as they become due.
What does LTV mean?
LTV means loan-to-Value. The loan balance is compared to the purchase price or the value of the home. For an example, a loan balance of $80,000 on a home valued at $100,000 would carry an LTV of 80%.
What is the difference between "pre-qualified" and "pre-approved"?
There is considerable difference between being "pre-qualified" for a mortgage and being "pre-approved." Generally becoming pre-qualified only requires a brief discussion with a loan officer outlining credit, income, debts and liabilities with no actual, verification of this information. Obviously a borrower's picture can change if the information given at the pre-qualification meeting cannot be verified. On the other hand a pre-approval actually approves a borrower for a pre-determined amount pending only the appraisal of the home selected to purchase. All information about the borrower's credit history, income, debts, liabilities and work is verified before a pre-approval status is given.
What are the advantages of being pre-approved?
The advantages are many:
- Sellers take an approved buyer more seriously when making an offer on the home.
- Approved buyers may gain a competitive advantage in negotiating with the seller.
- An approved buyer can make an offer more quickly.
- Realtors work harder for pre-approved buyers.
How do I know how much I can afford?
Before you start looking for a home you need to speak to a loan officer who is trained to make an accurate determination upon reviewing your financial situation and employment history.
How much do I need as a down payment on a home?
It is probably less than you think! Many first time buyers are surprised to learn there is no set answer and often times you can move in with nothing down. Generally your down payment can be anywhere from 3% to 20% of the home's value.
Your best bet before starting your home search, is to sit down with a loan officer and discuss how much home you can afford. The loan officer will also discuss different types of loans such as fixed and adjustable rates. Also, they will discuss first time home buyer programs. Oftentimes, first time home buyerâs programs will waive closing costs.
More about closing costs on the closing page.
Now that you have your Pre-approval letter, lets start to define your ideal home.