Chapter 12
Your credit score really comes into play when you're in the market for a home or new vehicle. Since the 1980s, lenders have become more sophisticated about using credit scores to evaluate borrowers. This means both good and bad things for you.
A home loan typically is the largest debt a consumer has. Choosing a mortgage is a big decision, and one that must consider many variables.
One of the biggest mistakes home buyers, particularly first-time home buyers, make is underestimating the expenses related to owning a home—including maintenance costs, repair costs, property taxes and homeowners insurance. That can lead to credit problems, after you’ve gotten a mortgage.
The taxes and insurance on a home can be especially expensive. And the cost is magnified is you borrow heavily to buy the house.
Still, owning a home is a good goal—both personally and financially. People rarely lose money owning a home…and usually make money doing so. Home ownership also tends to improve people’s financial circumstances and attitudes, generally.
Once you’ve analyzed all of the costs associated with your new home, as well as your other monthly expenses, you should have an idea how much you can afford to pay each month for your mortgage. At this point, you’re ready to talk to potential lenders—before you start shopping for a home.
While you may look at all of the expenses related to owning a home, lenders will look at slightly different criteria, known as qualifying ratios. Basically, they want to know what percentage of your income you will be spending on monthly payment.
The front-end ratio, or front ratio, compares your monthly pre-tax income with your house payment. Most lenders want to see a front-end ratio of 28 or lower; this means you'll spend no more than 28 percent of your monthly gross on your mortgage.
The other ratio that lenders look at is the back-end ratio, or back ratio. This calculates how much of your pre-tax income will go toward your house payment, plus all of your other monthly debt payments-such as auto loans, credit cards, etc.
The September 2003 Michigan state appeals court decision Robert H. Roether v. Worldwide Financial Services offers an example of how important pre-approval letters can be. And how much trouble can come when a borrower doesn't manage his credit well.
Before you can be pre-approved for a mortgage, you'll have to answer a whole lot of questions about the type of home loan you would like.
Here are the major variables you'll want to consider when you're comparison shopping:
interest rates, including whether they are fixed or adjustable;
points;
amount of the loan;
the amount of your down payment;
closing costs;
how much information you provide;
the length of the loan; and
whether there's a balloon payment.
Ordinarily, when you get a mortgage, your monthly payments are a combination of interest and principal. Principal is the amount you actually borrowed.
In the early years of a 30-year mortgage, you pay almost entirely interest—which gives you a nice big income tax write-off.
As time goes on, depending on your loan’s amortization schedule, more of your payment applies to the principal.
However, many consumers have opted to take a different route. In an effort to keep their monthly payments lower, many people take out an interest only loan. In this case, you do not pay down the balance on the loan at all.
If the real estate market is flat in your area, then the big drawback to an interest-only loan is the fact that you do not build up equity in the house. However, in areas where real estate values are climbing rapidly, you can build up equity simply through your home’s appreciation.
Some lenders advertise "no points" when trying to get you to apply for a loan. The points in question are actually a percentage point of the amount of the loan. In other words, each point equals 1 percent.
The amount of money you need to borrow can have a profound effect on the interest rate in question.
That's because there are two kinds of mortgages: conventional and jumbo. Conventional loans can be sold in the government-supported wholesale aftermarket. This makes the loan less risky for the lender-regardless of your credit situation.
Historically, American home buyers put down 20 percent of a purchase price and borrowed the other 80 percent. But the booming real estate values of the 1980s and 1990s required more flexible loans. In the 2000s, buyers make a down payments of 10 percent, 5 percent, 3 percent-or even zero. But all of these low down payment loan packages require good credit.
Many first-time home buyers are astonished by the variety and size of the fees that show up on their statement at closing time. You definitely will need to set aside more money than you’ll need for the down payment alone.
You also will want to compare fees when shopping for a mortgage. These fees can include:
an application fee;
a commitment fee;
a loan origination fee;
a loan processing fee;
an appraisal fee;
a recording fee; and
pre-paid expenses.
These fees are often lumped together under the term closing costs. And they vary according to your credit score. High closing costs are perhaps the worst side-effect of having poor credit. They can add thousands of dollars to the cost of buying a house.
You may be able to include the closing costs in your loan. This reduces your out-of-pocket costs up front, but it increases your monthly mortgage payment.
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