Financing Your First Home
Why America Needs Mortgages!
It is very apparent that the general public is overwhelmingly misinformed and misguided when it comes to real estate financing. Banks, credit unions, and other financial institutions are continuously viewed in a negative light. These institutions are seen as tenacious villains that would stop at nothing to steal every dime you earn. This apparent hatred for conventional lending institutions is perpetuated by the news media and by “finance gurus” who promise to protect you from the evil banks and get you out of debt…FAST!.
Have you ever heard the radio commercial from John Cummuta?? It starts by saying, “Mortgages should be illegal!”. He goes on to explain that throughout the term of a traditional mortgage, the borrower ends up paying more for his home because of the interest he owes to the bank. While the listener with a basic 5th grade education would understand that interest payments are a fundamental necessity of any kind of financing, I fear that many listeners would find themselves nodding their heads in agreement. As they listen to this ridiculous monologue from a self proclaimed “finance guru”, they become potential victims to yet another scam promising to “wash away your problems”.
The indisputable truth is that mortgages are absolutely essential to the American Dream of home ownership. If mortgages were indeed illegal, the more than 80% of home buyers who utilize mortgages to finances their home purchases would be renting and/or homeless. Does the average Western New Yorker have $150-$250K sitting in their bank account just waiting to be spent on a home purchase? Of course not! Hence the need for conventional financing.
The good news is that mortgages have several built in benefits that are intended to serve the borrower. The simple truth is that banks are interested in making low risk loans and getting their money back on a consistent basis. To this end, banks offer rather favorable terms and conditions. One such condition which is an attribute of almost all conventional financing is the ability to pay back your loan earlier than it is due. This means that you have the option to make larger payments that are required so you can save on your long term interest costs. The bank is willing to make less profit just to ensure that their investment is secure.
Will you Qualify for a Mortgage
Banks consider several factors when deciding if and how to lend you the funds to purchase your first home. The first factor they consider is your credit score. Your credit score is a quantifiable measure used to indicate your “creditworthiness”. That is, “How likely is it that you will make your payments to fulfill your debt obligations?”. Things that effect your credit score are the following:
- Payment History – 35%
- Current Outstanding Debt – 30%
- How Long You Have Had Credit – 15%
- Last Application for Credit – 10%
- Types of Credit you are Using – 10%
There is a lot that can be said about strategies for maximizing your credit score. That can be saved for a more detailed post. In general, if you make your payments, and don’t go crazy applying to 1,000’s of credit cards, you should be fine. If you are interested in buying your first home, chances are you have not filed for bankruptcy in your life. That is a good thing! Credit scores break down as follows:
- 726-850 -> Excellent
- 700-725 -> Good
- 626-699 -> Average
- 330-625 -> Poor
- 0-329 – >Limited / No credit
If your credit score is over 626 you can expect to be approved for some kind of mortgage. Obviously your terms and conditions improve the higher your credit score.
Another factor that has a major influence on your ability to obtain a mortgage is your current monthly debt obligations. That is, “How much do you owe per month to pay off your debt?”. This is the sum of all the mandatory payments you make on a monthly basis. This consists of student loan payments, credit card payments, car payments, payments on another mortgage, etc. The bank needs to know what other debts you have to pay off to ensure that you can afford to pay everyone and keep all your creditors happy. A factor that goes hand in hand with your monthly debt obligations is your pre-tax income. Banks need to know how much you make on a monthly basis to make sure you have enough money to pay off your debt and keep yourself alive with other costs of living. The bank will require you to provide at least 1 month’s worth of pay stubs from your employer.
There are many other factors that could come into play when applying for financing. These factors include potential rental income from the property you are trying to finance and income you generate from self-employment. These factors get quite complicated and will be addressed in a later post.
In general, the banks will use a combination of your credit score and your ability to make monthly payments to determine whether to approve you for a loans and for what amount you can be approved. When you hear of a person or family being “pre-approved” for a loan, this means they have been to the bank and have gone through this exercise. Getting a pre-approval letter is the first step toward getting serious about buying a home.
There are countless tools that allow you to get a quick idea of what kind of home you can afford. Give this a try to see where you stand: Yahoo Affordable Home Calculator.
To be Continued! – In the next post we will discuss where to go to seek out your first mortgage and what documentation will be required.