Fleshing Out The Mortgage Costs

Let's cut right to the chase. To be considered for a mortgage loan, you generally need to have:

• Sufficient income to support the monthly mortgage payment.
• Enough cash to cover the down payment.
• Sufficient cash to cover normal closing costs and related costs (explained below).
• A good credit background that indicates your payment history or “willingness to pay.”
• Sufficient appraisal value, which shows the house is at least equal to the purchase price.
• In some instances, a cash reserve equal to two monthly mortgage payments.

Closing costs, or settlement costs, are paid when the home buyer and seller meet to exchange the necessary papers for the house to be legally transferred. On average, mortgage closing costs run 2 to 3 percent of the house price. This percentage may vary, depending on where you live.

Closing costs include the loan origination fee (if not already paid), points, prepaid homeowner’s insurance, appraisal fee, lawyer’s fee, recording fee, title search and insurance, tax adjustments, agent commissions, mortgage insurance (if you are putting less than 20 percent down) and other expenses. Your mortgage lender will give you a more exact estimate of your closing costs. You can eliminate the need to pay a year’s mortgage insurance premium at closing by choosing a monthly premium program.

Points are finance charges that are calculated by the mortgage lender at closing. Each point equals 1 percent of the mortgage loan amount. For example, two points on a $100,000 loan equal $2,000. Mortgage lenders may charge one, two or three points in up-front costs in addition to the down payment. The more points you pay, the lower your interest rate will be. In some cases, you may be able to finance the points.

So, How Much Of A Mortgage Can You Afford?

There are two basic formulas commonly used by lenders to determine how much of a mortgage you can reasonably afford. These formulas are called qualifying ratios because they estimate the amount of money you should spend on mortgage payments in relation to your income and other expenses.

It is important to remember that the following ratios may vary from mortgage lender to mortgage lender and each application is handled on an individual basis, so the guidelines are just that — guidelines. There are many affordable housing programs, both government and conventional, that have more lenient requirements for low- and moderate-income families. Many of these mortgage programs involve financial counseling to help potential home buyers learn about the financial responsibilities of owning a home.

Generally speaking, to qualify for conventional mortgage loans, housing costs should not exceed 26 to 28 percent of your gross monthly income. For FHA loans, the ratio is 29 percent of gross monthly income. Monthly housing costs include the mortgage principal, interest, taxes and insurance — often abbreviated PITI. For example, if your annual income is $30,000, your gross monthly income is $2,500, and $2,500 x 28 percent = $700. So you would probably qualify for a conventional home loan that requires monthly payments of $700.

Find A Home That Will Meet Your Family's Needs, And Mortgage Costs You Can Live With

Any costs that extend 11 or more months into the future, such as a car loan, are termed long-term debt. Total monthly costs, including PITI and all other long-term debt, should equal no more than 33 to 36 percent of your gross monthly income for conventional loans. Using the same example, $2,500 x 36 percent = $900. So the total of your monthly housing costs plus any long-term debts each month cannot exceed $900. For FHA loans, the ratio is 41 percent.

Maximum allowable monthly housing costs:
26–28 percent of gross monthly income — conventional
29 percent of gross monthly income — FHA

Maximum allowable monthly housing costs and long-term debt:
33–36 percent of gross monthly income — conventional
41 percent of gross monthly income — FHA

One way to determine how much to spend for housing is to compare your monthly income with monthly long-term obligations and expenses. Use the worksheet, “Evaluating Financial Resources,” to determine how much money you can spend on housing. Be sure to include only income you can definitely count on.

When budgeting to buy a home, it is important to allow enough money for additional expenses such as maintenance and insurance costs. If you are purchasing an existing home, gather information such as utility costs and maintenance costs from previous owners or tenants to help you better prepare for homeownership.

Homeowner’s insurance or property insurance is another cost you will have to consider. The lending institution holding the mortgage will require insurance in an amount sufficient to cover the loan. To protect the full value of your investment, however, you might want to consider purchasing insurance that provides full replacement costs if the home is destroyed. Some insurance provides only a fixed dollar amount, which may be insufficient to rebuild a badly damaged house.

Source: U.S. General Services Administration