Fun with Financing

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“Fun and financing” just doesn’t have the same ring as “peanut butter and jelly.” They don’t really go together. But for most home buyers, “home and financing” do go together, so you should probably learn a little about where and how to get a home loan. Maybe you will even discover that financing is fun. There are those people out there. They are the same ones who still balance their checkbook each month.

A mortgage is a loan you take on to purchase a home. It’s different from other loans because the house you are buying is used as collateral. In other words, if you don’t make your loan payments, you get to hand the keys back to your lender.

Getting a loan is not as simple as finding a bank with really nice employees. Banks need to make money, so you and other customers are required to pay loans back with interest, and on time. Buyers need to save money, which they can do by getting the lowest interest rate possible. Shopping around for the best interest rate is crucial, as is good credit. Make no mistake, credit matters.

It matters so much that you should check your credit score annually (you are entitled to one free report per year from each of the three big credit companies). Go to annualcreditreport.com or call 1-877-322-8228 even if you aren’t planning to buy a house. Don’t make the mistake of not checking your credit score before you get the ball rolling on the buying process, or the ball might stop rolling very quickly. All lenders check your credit report before they loan you money—can you really blame them? If you haven’t been paying your debt, or have too much debt or too much credit, then it negatively impacts your credit report and score. If your score is too low, lenders might decide you’re not worth the risk, or they might decide you are worth the risk, but only if you pay a higher interest rate.

There is no such thing as privacy if you want to borrow A LOT of money. The bank loan officer (your Living TN agent can recommend a bank with good rates and good customer service) will ask for copies of your most recent W-2s, paycheck stubs, and tax returns, to see that you are employed and make enough money to pay the mortgage on a house. This also helps them determine how much money they are willing to lend you.

No matter how much the bank likes you, they aren’t going to lend you every cent of your home’s price. They expect you to dip into the old piggy bank for a down payment, which is most often 20% of the cost of the house.

What’s that? Your piggy bank is a bit short? That brings us to PMI or private mortgage insurance, which varies between .3% and 1.5% (depending on credit score) of the loan amount. Most lenders require you to pay PMI until you have 20% equity in the home. So, if you’ve been exercising all that self control and saving up – good job – you might be able to avoid paying PMI.

The majority of home buyers have conventional loans, with interest rates based on the current market and a buyer’s credit worthiness. Again, the norm is for the buyer to put 20% of the price of the home down.

There are a few options of loan terms. A fixed-rate mortgage, the most common type, is spread over a certain number of years, like 15, 20, or 30. The interest rate is fixed, meaning, as the name indicates, that the rate will not change during the life of the loan. A 30-year fixed rate mortgage loan has lower monthly payments than a 15-year fixed mortgage loan. 15-year mortgage payments will be higher, but the loan will be paid off sooner (15 years sooner) and, since you won’t be paying interest for all those extra years, the house will cost you less (than a 20- or 30-year fixed rate) in the end.

There are also adjustable rate mortgages, or ARMs. An ARM has a lower interest rate for the first 5, 7, or 10 years, after which the rate can change annually based on current rates. There’s a lot of risk in an ARM, so don’t be too distracted by the lower rate in the early years.

There are a variety of other choices for those who don’t fit into the conventional category. Hopefully, one will work for you:

  • VA (Veteran’s Administration) loans are available to U.S. military veterans and active military members. They don’t require a down payment or charge PMI, but there are other fees involved with this type of loan. If you have ever been in the military, definitely check these out—you deserve a deal!
  • USDA loans are backed by the U.S. department of agriculture, and are geared toward low-income buyers in rural areas. USDA loans don’t require a down payment, but you have to buy a home in a designated area. Nothing like a stilt-house in a swamp or a nuclear waste plant area, promise.
  • Jumbo mortgages are conventional mortgages that exceed maximum borrowing limits. They are riskier for the lender and therefore, it’s harder to qualify for a jumbo mortgage. You will still need a conventional loan, usually with a 20% down payment.

Ultimately, a mortgage includes the price of the home (aka, principal), the term of the loan, the interest rate, property taxes, private mortgage insurance (if required), homeowners insurance, and closing costs (if rolled into the loan).

In conclusion: in a perfect world, you have an excellent credit score (which you checked many moons ago), which earned you a great interest rate. You have saved enough for a 20% down payment, so you aren’t required to pay PMI. You’ve chosen a 15-year-fixed (or 10 year, if you are feeling wealthy) interest rate, so you will do my math homework have the home paid off in 15 years, as opposed to 20 or 30 and therefore, will pay less interest. Of course, the house is in a nice area with low property taxes and your excellent agent sets you up with the best homeowner’s (more coverage, less money) insurance. And all goes quickly and smoothly.

Actually, in a perfect world, you would have an infinite amount of money and wouldn’t need to borrow money. But almost everything else is under your control. Good luck!

 

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