Mortgage Borrowing Basics For First-Time Home Buyers
1. How to Get a Mortgage & Loan Eligibility
What lenders look for
When you apply for a mortgage, lenders try to figure out if you’re a safe borrower who will pay the money back.
To figure out your mortgage eligibility, they’ll look at your total income, your income compared to the size of the expected home loan payments, your credit history, any other large loans you have outstanding, and the amount of money you have saved up to use as a down payment.
What mortgage documents you should have ready
You should have copies of your pay stubs, your old tax returns from the last couple years, your most recent bank statements and statements from any investment accounts, statements from any other loans showing how much you owe and the payment terms, your personal ID like a driver’s license, and your Social Security number.
If you’ve already found the house you want to buy, you should bring a copy of the purchase agreement and the property information sheet.
Your real estate agent should be able to give you these documents.
Credit score for mortgage loans
You should know your credit score before you start the application process.
This is a number between 300 and 850 that reflects how trustworthy you are as a borrower.
A higher score makes it easier to qualify for a mortgage and also for a lower interest rate, which leads to lower monthly payments.
While there’s no set cutoff, most mortgage loans go out to applicants with a score of 700 or higher.
If your score is below this range, you could still qualify by making a larger down payment, accepting a higher interest, or having someone with a better credit score cosign your loan.
2. How Much House Can I Afford?
Total loan payments
To figure out how much house you can afford, you need to compare the monthly mortgage payments against your income.
As a rule of thumb, lenders don’t want your monthly debt payments to go over 36 percent of your gross income.
For example, if you’re making $5,000 a month, your total debt payments should be no more than $1,800 per month.
Remember, this is for all your debt payments.
If you’re paying off car or student loans, you’ll need to borrow less for your house.
Use MyBankTracker mortgage affordability calculator to help you figure out how much house you can afford based on your monthly budget.
Enter your salary, your monthly budget, your mortgage down payment, and the expected interest rate you’ll pay on your loan.
The calculator will then tell you how much house you can afford to buy.
Closing costs and mortgage rates
As you set a budget, don’t forget about closing costs.
These are the costs you need to pay to buy a house and include the fee to launch your mortgage, the real estate agent’s commission, the fee for transferring the property title, the cost of a home inspection and appraisal.
Altogether, these will add another 2 to 5 percent to the cost of the house.
Also, unless you’ve been pre-approved for a mortgage, you’re going to be estimating the mortgage interest rate.
Your monthly payments could be higher or lower depending on what rate you qualify for so this could impact how much house you can afford.
3. Types of Mortgages
Fixed-rate mortgages are the most common types of mortgages. With these loans, your monthly payments stay the same over the entire loan.
When you sign up, you decide how long you want the loan to be. A longer loan will have lower monthly payments.
With a variable-rate mortgage, your monthly payments will change based on the market interest rate.
Your payments can go both up and down.
These loans, also known as adjustable-rate mortgages (also known as an ARM), start out with lower monthly payments than fixed-rate mortgages.
However, over time, an ARM can become more expensive if rates go up.
Variable-rate mortgages usually have a set period where payments stay the same, like the first two years, and then payments can start changing after that.
A jumbo mortgage borrows more money than a regular mortgage.
The cutoff for jumbo loans depends on the average price of houses in your area and ranges from $417,000 to $721,050.
The interest rate is a bit higher on jumbo mortgages than for regular mortgages.
Balloon mortgages have smaller monthly payments than regular mortgages because the monthly payments don’t pay off the entire loan.
At the end of the loan, the borrower needs to make one large payment to pay off the remaining balance. This is the “balloon” payment.
The government helps homeowners qualify for mortgages with FHA loans.
The government guarantees repayment of the loan to the lender so borrowers who couldn’t qualify for a regular mortgage can still buy a house and can buy with a smaller down payment.
In exchange, the government charges the borrower insurance payments which adds to the cost of the house.
4. Mortgage Points
What are mortgage points?
Mortgage points are an upfront charge at the start of the loan. Each point is 1% of the entire mortgage.
For example, if you’re taking out a mortgage for $100,000, 2 points would cost be $2,000 ($100,000 x 0.02).
There are two kinds of points. Origination points are an extra fee charged by the lender for setting up the mortgage.
Not all lenders charge origination points but if your lender does, you’ll need to pay this origination fee to set up the mortgage.
Discount points are a way to prepay the interest on the loan.
By paying this money upfront, you’ll lower the interest rate on your mortgage so your monthly payments will be smaller.
Discount points are optional and you get to decide whether or not you want to pay this money upfront.
Should you buy mortgage points?
Whether you should buy mortgage points depends on a couple of factors.
First, how long do you plan on living in the same house?
The longer you plan on staying, the more it makes sense to buy mortgage discount points.
That’s because buying points will save you a little bit of money each month and it takes time to break even.
For example, if you pay $3,000 for discount points to lower the monthly payments by $50, you’d need to live in the same house for five years to break even.
You should also consider whether you have the money to spare for discount points.
It’s nice to save a little bit on the monthly payments but putting all this money upfront could strain your budget, especially if it costs most of your savings.
Paying off your mortgage
Paying off your mortgage successfully takes time and discipline.
The key to a good mortgage payment plan is to take out a loan you can comfortably afford so you can always make your monthly payments.
If you have a variable-rate mortgage with payments that can change, save more when the monthly payments are low so you can prepare for when the monthly payments go up.
Avoid taking on other large debts while you’re paying off the house so you don’t strain your budget.
You should also keep enough money in your emergency fund so you can keep up with the mortgage payments even if you lose your job.
Paying down your mortgage takes work but think of it as an investment for the future.
After you’ve finally paid off the loan, you’ll be the owner of a valuable asset, your house!
Is it better to pay off a mortgage early?
If you have any extra money in your budget, you can make extra mortgage payments to pay off your loan more quickly.
You can send extra money to your lender and they will credit the extra payments against the remaining mortgage balance.
You have to be careful though because some lenders charge a penalty if you pay off the loan too fast, which could wipe out any interest savings.
Whether this is a good move really depends on your financial situation.
If your lender does not charge a penalty, paying off your mortgage early will get you out of debt faster and will lower the amount of interest you’ll end up paying.
You also need to consider whether you want to use that extra money to pay off other debts or to invest for other financial goals.