Many people assume they need a 20% down payment to buy a home! This is simply untrue!
What does it take to purchase a home? Qualifying for a home loan is complex, but easy to understand if you know what factors lenders use to qualify you for that loan. What are they?
Income – Obviously Income is the most important item in the puzzle. Your income determines how much you can afford. Loan qualification for most loans use the 28%/42% ratio (although some lenders allow higher DTI’s (debt to income ratios – see below). The lower these ratios are the better! Simply put, the higher your debt, the higher risk YOU are to the mortgage lender.
Interest Rate – Interest rate is the cost of borrowing money! Most interest rates are expressed as a annual percentage rate (APR). Your objective is to get the best APR you can get. The lower the rate, the lower your payment. The critical thing to remember is this rate is determined by lending institutions and is affected by YOUR credit rating, down payment and debt-to-income ratio.
Credit Rating – Credit rating is critical, and reflects your payment history and credit ‘worthiness’. Most lenders require at least a 620 credit rating to qualify for a loan. The higher your credit rating, the lower your interest rate can be! If you are shopping for a home loan and have a good credit rating, check with several lenders and use your credit rating to get a better rate! Lenders and credit coaching agencies can help identify what is affecting your credit rating – so it is important to ask what can be done to increase your credit rating before shopping for a home! Why? You get a better interest rate, and most likely, a lower PMI payment (see below) if you cannot afford to put 20% down!
House Payment – Remember the 28%/42% ratio mentioned above? Generally, lenders allow up to 28% of your income to be allocated to your house payment. What makes up your house payment? Ever seen the acronym PITI? This stands for Principal, Interest, Taxes and Insurance. This is where it gets confusing. The more expensive a home is, the higher the Principal and Interest will be. PLUS, the taxes and property insurance will be higher. On top of this, PMI (Private Mortgage Insurance) is part of your payment too! For those who can’t afford the 20% down payment, PMI insurance is normally required by the lender or governmant loan program. This insurance protects the mortgage backer (Government Agency or lender) from people who fail to make their payment and default on their loan.
Debt to Income Ratio (DTI) – What is DTI? This is simply your total of all credit payments compared to your income. The total amount is your House Payment, plus car payment(s), revolving credit card payments, etc… Lenders use that ‘minimum payment’ amount your cards have to determine this total debt number. Sometimes a low balance can be paid off to help you qualify and raise your credit score!
Down Payments – Have you heard the term Equity? Equity is your vested interest in your home. This is where people make the incorrect assumption that a lender wants 20% down on a home loan. The more money you put down on your home, the higher your vested interest in the property! People who have more than 20% equity in their home are less likely to default on their loan. Government backed loan programs and conventional loan programs require Private Mortgage Insurance (PMI) when they loan over 80% of the value of the property.
There are many loan programs and government backed loans to choose from. Vetrans Affair (VA), USDA and FHA are loan programs backed by US Government agencies. Conventional loans normally are bank owned mortgages (loans). For home buyers that cannot afford to put 20% down on a home, this is where Private Mortgage Insurance (PMI) fills the gap. PMI protects the mortgage holder (the lender) from people who do not make their payments. This is the ‘gotcha’ that can increase your payment and generally increases if you have a high Debt to Income Ratio or low credit rating. Many lenders have programs allowing conventional loans with LTV (loan to value) percentages that match government programs. What that means is some can get a conventional loan with as little as 3.5% down, but most lenders require 5%.
Down Payment Assistance – many states and local municipalities have down payment assistance programs that will contribute that 3.5 to 5% required for your down payment. These are generally for lower income home-buyers, and have income limits, minimum credit rating requirements, and maximum home price limitatins. It is best to check with an approved lender in your area to see if you qualify for down payment assistance. In Oklahoma, the Oklahoma Housing Finance Agency (OHFA) provides down payment assistance and has programs for low-income applicants, teachers, law-enforcement and fire-fighters. Don’t overlook this chance at FREE money!
– OK, now that you have an understanding of the factors that affect loan qualification, what your payment consists of, and contributing factors that affect your final payment, understand you can buy down your interest rate (with cash), or the seller/lender can help you do this with many lending programs. Have you ever seen or heard builders say, “Use our preferred lender for up to $5,000 down payment assistance!” What does this mean? For home buyers, the lender or seller will kick in money toward your down-payment. What they fail to tell you is they are raising this money by increasing your interest rate (in most cases). They don’t just give you the money! Ever heard, “Nobody ever gets a free lunch?” Well, lenders and home builders understand the cost of money, and this “discount” is usually at your bottom line expense. This is important to remember, and something you can use when shopping for a lender.
In summary, KNOWLEDGE IS POWER. Understanding what criteria affects your qualification for a loan, and understanding what makes up your payment is critical in the home buying process. Why would you blindly go out and purchase home without knowing all the details? This is what a good realtor and lender will do for you! Most home-buyers are uninformed and many lenders take advantage of this fact. Imagine, you have a more than enough income, a great credit rating, very little debt, and enough to put 20% down on a home purchase! You are the perfect buyer and lending institutions will fight over your business! Why? It’s all about RISK! You are a very little risk to them, and lenders will lower your Interest Rate, and even contribute to your loan (with discount points) to get your business! Even if you barely qualify, understanding these factors can still put you in a good position! Being patient and informed is your KEY to getting your dream home. Again, this knowledge is power – you should use this power to your advantage!
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