Borrowing Basics – Definitions

Mortgage loans differ with lenders and loan types.  Each will limit the maximum percentage of monthly income to be used for monthly housing cost.  This housing cost, known as PITI, is the monthly amount that includes Principle & Interest  + Property Taxes  +  Insurance (Property, Mortgage, Title).

    • Mortgage –  A lien against property (as for securing a loan) that becomes void upon payment or performance according to stipulated terms.
    • Principle – The amount borrowed after a Down Payment.
    • Down Payment – A part of the full price paid at the time of purchase or delivery with the balance to be paid later. (Down Payment is what the buyer puts toward the purchase price of a home.  Mortgage loans generally require some down payment, but little or no down payment loans are often available to First-time and Lower-income buyers through federal and state programs.  A smaller down payment means a larger Principle and higher monthly payment for a property.  Government assisted mortgages can also allow higher limits for monthly housing costs which sound attractive in opening doors, but which create greater risks for buyers.  Financial stability after a home purchase rests with how the buyer can manage all other cost of living expenses, planned and unplanned, after mortgage obligations are met.)
    • Interest – A percent of each mortgage payment set by loan contract, payable to the lender.  (Interest is what consumers pay for the use of borrowed money.  It is accounted for by a portion of each payment made over the term specified in loan documents.  The interest is added to the cost of the home loan amount.)
      Interest Rates are most commonly Fixed Rate which are set higher but never change, or Adjustable Rate Mortgages (ARMs).  A Fixed Rate gives buyers a predictable payment amount throughout the term of the loan.  ARMs change according to a designated margin (the percentage above an index which is the specific to the market.  The monthly payments are expected to changes throughout the term of the loan. With ARMs, it is important for buyers to have some certainty about how long they will be in the home and to look at how potential increases over that time will effect family finances.  A secure anticipation of income growth or a planned second household income can support the choice of an ARM.  Most important in selecting this option is the affordability at the maximum rate if they should remain for the full term of the loan.There are also Mortgage options that can switch from Fixed to ARM or ARMs that offer a low introductory rate.  The interest paid over the life of a loan will be the larger part of total payments.  A strategy to lessen interest paid for a Fixed-rate loan is that any amount over the required monthly payment is applied to Principle which can end the Term early which means less time to be charged interest.
    • Term – The length of time of the loan.
    • Amortization – The schedule of payments. (Amortization is the schedule of payments, most often monthly, that specifies the amount due for each $1,000 borrowed through the duration of a loan’s term based on interest rate.  It is calculated to give lenders and investors the larger share of their anticipated interest earnings through the early part of the term.   A borrowers can reduce interest paid and loan duration by paying more than the scheduled amount whereby the overage goes directly to a remaining principle. ) Amortization tables and forms that calculate a payment based on any rate and term can be found online – i.e. Amortization Calculator at Calculator.net

Credit and Credit Score

Lenders measure a potential borrower by looking at their income, other existing debt, and ability to manage personal finances.  Credit scores and reports of past debt are required for mortgage applications.

The most important first step in the plan to buying a home is to run a Credit Check on yourself.  That is to request and receive a Credit Report.  Then read each entry to verify it is accurate.  Old debts paid in the past sometimes still show as unpaid.  These need to be fixed before showing up as a surprise in a loan application.     The Federal Trade Commission (FTC) advises obtaining a free copy of your credit report at visit www.annualcreditreport.com or by calling (877) 322-8228.

Borrowing Limits

Debt-to-Income Ratio: The anticipated monthly housing payment, PITI, is added to existing debts and obligations such as loans (car, school, personal), credit and charge cards, and other, such as hospital bills or consumer contracts.  This number is than compared to your monthly gross income to calculate a projected debt-to-income ratio.  This is the key measure of your borrowing ability and risk that the lender is obligated to address for government and banking auditors.

These ratios vary depending on individual mortgage loan “products” offered by lenders.  But, more important to the buyer than a lending standard is the amount of debt that the loan will place on the individual buyer.  The effect of a monthly housing obligation on managing personal finances for the individual or family is what defines Affordability.  Beware!  In years past, the universal lending standard capped debt at 32% of income which then moved up to 36%.  Now, federally insured loans meant to expand greater home ownership go as high as 41%.  And where the lender’s risk is passed on to the government in cases of default, the borrower is faced with a very narrow if not impossible margin to live by.

The smaller an amount of discretionary income a buyer has at the time of purchase or after honest consideration of new post-purchase expenses, the greater the financial risk of taking on the loan.

Affordability

How much a borrower can afford and how much can be borrowed are not necessarily the same. Lenders calculate the financial risk of a buyer and measure it against governing regulations of a specific loan.  These can often allow for higher payments than the buyer will safely sustain. There are, however, state and federal assisted mortgage programs that can be used to advantage.  Apart from the amount “allowable” is what the payment does to a buyer’s day-to-day costs of living and ability to manage unexpected expenses.  What is left each month after debts and expenses are paid is referred to as discretionary spending.

One other note regarding First-time and Low-income buyer Programs is that they might allow borrowers to finance closing costs which, again, increases monthly costs and pays significantly more interest over time.

 

Shop the Loan Market

Compare loan requirements, rates, monthly payments, cash at closing, and how much your income and existing debt will allow you to borrow before looking at homes.  This will show which type of loan and what price range fits best your needs with a realistic financial plan as your foundation.  It can help you avoid ending up with a mortgage that gets you the dream home but that you can’t realistically afford.

 

Managing Your Personal Finances

Accounting for personal or family finances is not simple.  It requires keeping track of all money that comes into and out of your household and includes looking closely at your bank accounts, your credit and debit card charges, cash incidental purchases, charges from cellphone apps and more.  Your ability to borrow money is measured by accurate accounting of your household income and your detailed monthly expenses to determine how much of a housing payment can be supported in your monthly budget.

Starting a Savings Account proves that a borrower can manage personal finances and creates a pool of money that can be used for closing costs that lenders require as well as for a down payment that will lower the monthly loan cost.  A higher down payment gives the buyer greater amount of equity in the home.  Equity is the portion of market value held by an owner apart from the principle on the remaining cost of the home/loan amount.