Mortgages For Purchasing A Home

Mortgages For Purchasing A Home

One of the main uses for a home mortgage is to purchase a home. This article will focus on the two most common home buyers, those purchasing their first home, and those selling an existing home and purchasing another.

How Much Home Can an Individual or Couple Afford

Whether an individual is a first time home buyer, or an old veteran at the home purchase game, the first and most fundamental thing for the individual to do is to figure out how much home they can afford. It is best for an individual to know how much they can afford before they start shopping for a home and looking for a mortgage. Doing so can help to save a lot of time either looking at homes out of their price range, and/or considering loan options that are not appropriate for their situation.

As a rule of thumb, an individual should not pay more than 28% to 33% of their monthly income to cover their housing expenses. Remember that housing expenses include the mortgage's principal and interest payment, as well as property taxes, and insurance (often referred to as PITI). It should be noted that insurance is homeowner's insurance, and for individuals putting less than 20% down also private mortgage insurance or PMI.

In addition to the housing expense rule of thumb, an individual should also expect to pay no more than 36% to 38% of their monthly income to cover all of the debt obligations (housing and expenses to service other debt).

For example, for an individual or couple with a monthly income of $5,000 ($60,000 per year):

  • They can afford a housing expense of between $1,400 and $1,650 per month.
  • They should spend no more than $1,800 and $1,900 per month to cover all of their monthly debt payments.

Please note: The percentages provided are "rule of thumb". With the advent of highly sophisticated computer underwriting, some lenders may be willing to go above these percentages, especially for borrowers with particularly strong credit scores, strong financial position, and large down payments (20% or more). The low end of the percentage range is best used as the rule of thumb for conforming loans (loans below the Fannie Mae/Freddie Mac loan limits). The high end of the percentage range is best used as the rule of thumb for jumbo loans (loans above the Fannie Mae/Freddie Mac loan limits).

One very important thing for any potential home buyer to remember is that at the end of the day, they must be comfortable that they can meet these financial obligations and still maintain a lifestyle that they find acceptable. Potential borrowers will always be able to find lenders who will exceed these limits, potentially by a lot. They will hear from many lenders that they can "afford" these loans. Just because someone is willing to lend the money and says that it can be afforded does not necessarily mean that it is so. It is incumbent upon the borrower to be realistic and comfortable with what they feel they can afford.

The Down Payment

The final thing that a potential home buyer must consider is how much money they have for a down payment and closing costs. The ideal situation is for the home buyer to have enough money to cover a 20% down payment and closing costs. Putting less money down can potentially limit available loan options, especially if the home buyer is putting down less than 10%. Home buyers without a lot of available cash will have to cover their closing costs and see how much is left over for a down payment. Lenders can provide a potential home buyer with an estimate of closing costs. As a rough rule of thumb, a home buyer can assume that points and closing costs will be about 4% of the value of the loan. So for a $200,000 loan, the closing costs would be $8,000. Closing costs can sometimes be added into the amount of the loan, as long as debt-to-equity ratio requirements are still met (debt-to-equity is the loan amount divided by the house value).

Mortgages for Home Buyers

By far the most popular type of mortgage for home purchase is the traditional 30 year fixed rate mortgage (FRM). The second most popular type of mortgage for home purchase is a 30 year adjustable rate mortgage (ARM). Other types of mortgages that home buyers may consider include:

  • Balloon mortgage - A balloon mortgage can be an interesting strategy for a borrower who knows that they will be selling the house or refinancing the mortgage before the balloon payment comes due. Using a balloon mortgage may get the borrower a lower interest rate and monthly payment than a traditional 30 year fixed mortgage.
  • Graduated payment mortgage (GPM) - A graduated payment mortgage may also be a means of obtaining a lower payment during the early years of a mortgage. A borrower thinking of this option should be confident that they will be able to cover the monthly payments as payments go up to their ultimate level over two or three years.
  • Interest only mortgage - An interest only mortgage is yet another strategy for obtaining lower payments during the early years of a mortgage. For some period of time the borrower will need to pay only the interest and not the principal on the mortgage. As with a GPM, the borrower should have a high degree of confidence that they will be able to cover the higher monthly payments when the interest-only period ends.

Reduced to No-Doc Mortgage Programs for the Self Employed

Some home buyers have non-traditional jobs, or are self employed, which can make the task of documenting their income more difficult. Reduced documentation or no documentation loans can be a great vehicle to simplify obtaining a mortgage for these individuals. These programs range from stated income/no-income verification programs to absolutely no income or asset documentation whatsoever. In essence, the borrower is applying on the strength of their credit and down payment. It should be noted that low and no documentation loans typically have a higher interest rate. Reduced and no documentation can be a feature for either fixed rate mortgages or adjustable rate mortgages.

First Time Home Buyer Programs

There are also many home loan programs for the first-time home buyer. These programs typically:

  • Have lower down payment requirements. Many first-time home buyer programs go as low as 3% down, and some even go as low as no money down. Please remember that with these programs the borrower still needs to have the cash to cover the closing costs.
  • Have less stringent guidelines for loan approval.
  • May make use of alternative forms of credit if the borrower has not yet established credit.
  • May have reduced interest rates.

First time home buyer programs are available from:

  • Private lenders
  • The U.S. federal government
  • State housing authorities

U.S. Government Programs for the First-Time Home Buyer

The U.S. Department of Housing and Urban Development (HUD) offers FHA loans. HUD also has other special home buying programs that may be helpful to first-time home buyers who fall into special categories, such as:

  • Firefighter/Emergency Medical Technician
  • Officer Next Door
  • Teacher Next Door
  • Hurricane Evacuees discounted sales
  • Home ownership for public housing residents
  • Indian Home Loan Guarantee Program

The USDA offers the Rural Housing Service (RHS) Section 502 Rural Housing Guaranteed Loan Program.

The U.S. Department of Veterans Affairs also offers VA loans for veterans.

State First-Time Home Buyer Programs

Many states also have housing finance agencies or housing authorities that offer first-time and low-income home buyer programs. For example, the Massachusetts Housing Finance Authority (MHFA) has first time home buyer programs such as:

  • MassAdvantage
  • MassHousing MyCommunity Loans
  • Municipal Mortgage Program for municipal workers
  • Purchase and Rehab

Most other states have similar housing authorities that offer similar first-time home buyer programs.

It should be noted that most first-time home buyer programs, especially U.S. Government or state programs have income and purchase price limits. Some first-time home buyer programs also require buyer education.

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