Are You Clueless About Mortgages? Start Here!

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The following is a guest post. Enjoy!


This post was selected as an editor’s pick in the August 15th, 2011 (32nd) Totally Money Blog Carnival “A Flood of Great Articles Edition.” Be sure to stop by the carnival page to read all of the interesting and educating posts!

Are You Clueless About Mortgages? Start Here!

Purchasing a house is probably the biggest purchase most people make in their lives. To make the process less stressful, it is important to know a few pertinent facts first.

Utility of Mortgage Calculators

It is always useful to use some form of mortgage calculator to give a rough idea of whether or not it is affordable before making applications to mortgage lenders.

What’s Needed to Get Approved for a Mortgage?

In today’s difficult financial climate, lenders are very specific with their financial requirements before they will consider making a mortgage offer.

Minimum Requirements

As a minimum, a lender will require two years employment history, proof of assets in your bank account over at least a three month period, and three current finance lines, e.g. credit cards, car finance etc.

Debt to Income Ratio

Decisions are based on several factors, including down payment and credit scoring, as well as the all-important Debt to Income Ratio (DTI). This is a measure that compares income against certain monies owed.

To complete the DTI calculation, all monthly commitments or debts are listed. This includes mortgage or rent payments, loan repayments (secured and unsecured), minimum payments for credit and store cards, bank charges (for overdraft), insurance premiums, child-care, and student loan payments. Next, all monthly income is listed and totaled. This includes basic salary or wages, commission, overtime, bonuses, tax credits, state benefits, child-care, pensions, and any other documented income.

The debt to income ratio is then calculated by dividing the total of monthly debt repayments by the total monthly income. When a DTI calculation is used by mortgage lenders, it is to check that the monthly mortgage repayment does not exceed 30% of gross income.

Different Types of Mortgages – Fixed and Adjustable Rate

Once an application is successful, a decision must be made as to the most suitable type of mortgage (Fixed or Adjustable Rate) for the individual. A mortgage broker can often assist with this, but having an idea of what is available will help.

Fixed Rate mortgages ‘fix’ the interest rate at a certain level for a pre-arranged period of time. This is usually for anything from 2 to 10 years (note from Jacob – in the USA, it’s either 15 or 30 years), although longer periods are available. A mortgage calculator can be used to work out the repayments for a variety of periods. The main advantage is knowing what the repayment will be each month, but disadvantages include paying a higher rate of interest and missing out on savings if the interest rate should fall.

Adjustable Rate mortgages periodically adjust the monthly repayment based on an index that reflects the cost to the lender of borrowing on the credit market. The borrower benefits if the interest rate falls by having reduced payments, but pays more if it increases. Mortgages of this type should be ‘index-linked’ or ‘capped’ to avoid payments being inflated by unscrupulous lenders.

Miscellaneous Mortgage Fees to Consider

Other than the mortgage repayments themselves, there are other initial costs to take into account that need to be budgeted for. These include arrangement fees, a lender’s or broker’s charge for setting up the mortgage, valuation fees, and legal fees.

Mortgage Repayment

It is essential to make each repayment in a timely manner in order to avoid additional financial penalty, or at worst, foreclosure. It is also worthy of note to add that whilst it is a good thing to overpay monthly payments, thus reducing the term of the loan, some lenders will charge exit fees for early redemption.

Conclusions

A mortgage is an important and very long term commitment. Use a mortgage calculator to help work out what repayments will be. And, before agreeing to anything or signing a binding contract, it is essential to ‘read the small print’ to protect your interests. Best of luck!

How about you all? What do you look for as a crucial aspect of a mortgage? 


What’s your opinion of Adjustable Rate Mortgages vs. Fixed Rate? Which is better?


Share your experiences by commenting below!

Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

  • @ Mortgage calculators –
    • In my opinion, mortgage calculators are quite essential. There is an ENORMOUS selection of online mortgage calculators created by different organizations. If you decide to use one of these, you will definitely want to make sure it is from a reputable source.
    • Personally, I use a mortgage calculator that I derived myself. I actually wrote a post about this in April of 2010 when I was preparing to buy a condo and was applying for home loans. You can view the complete post at the following link and create your own calculator (I recommend making your own calculator because it is a very valuable learning experience)! – How To Create Your Own Home Mortgage Calculator
  • @ Getting approved for home loans in today’s post-bank crash economy –
    • It’s almost annoying how hard it is to qualify these days for a home loan. Gone are the days of loose banking where almost any one with any type of income could qualify to buy a house because “the housing market never goes down.”
    • Personally, last year, I tried and failed to obtain a home mortgage loan since my graduate school employment didn’t appear solid enough for a 3 year minimum time period. You can read all about that experience at the following post – Can Graduate Students Obtain a Home Mortgage Loan?
    • Even though it is more difficult to obtain a loan, it is far from impossible/futile. Furthermore, there are several steps you can take to improve your chances of being approved for a home loan.
    • In a post I wrote in April of 2010, I detailed 7 ways to improve your chances of being approved for a home loan.
  • @ Debt to income ratio and how much house you can afford vs. how much you can qualify for –
    • In the post above, it mentions that 30% is the highest debt-to-income ratio that mortgage issuers will look for in prospective mortgagees.
    • However, what I’ve read is that here in the United States, a debt-to-income ratio of 28% is generally accepted as the level at which you can comfortably afford house payments, but that you can be approved for home loan which correlates to you having up to a 40% debt-to-income ratio. Quite interesting! The mortgage issuers want to get you in to the biggest loan they can it seems!
  • @ Fixed rate vs. adjustable-rate mortgages –
    • In the United States, adjustable-rate mortgages got a terrible “rep” after the financial sub-prime crisis of 2008-2009. However, this type of mortgage is not as devilish as the press would make them out to be, provided that you use a little common sense and vigilance when investigating your options.
    • Personally, I would probably prefer a fixed-rate mortgage loan, just because I really like the idea of being able to predict what my loan repayments will be for the entire course of the loan.
    • However, I would also consider the possibility of an adjustable-rate mortgage loan in the following circumstances –
      • The introductory “teaser” rate was very low / a really good deal.
      • There was a cap in how much my loan interest rate could increase, both per year and total.
      • There were no balloon repayment requirements.
      • I was only planning to live in a house for 3-5 years.
  • @ Mortgage pre-payment and biweekly mortgage payment plans – 
    • This post bring up a very important point about loan repayment.
    • When you are signing up for your loan, you will want to make sure that it does not contain any penalties for prepaying/paying off your loan early.
    • In the US, most loans these days do not carry this type of fee. However, it is worthwhile to check.
    • Another good option to investigate is a biweekly mortgage payment plan option. I could go in to a lot of detail about how this works, but essentially, a biweekly plan forces you to pay the equivalent of one extra month’s worth of mortgage payments spread throughout the entire year.
    • In this way, paying this extra amount lets you get ahead on your principal payments and decrease your home loan balance sooner, saving you thousands of Dollars in the end.
    • Theoretically, a person could do this type of plan by himself or herselft, but life almost always gets in the way, and people have a lot of trouble sticking to their plan if they are not forced to pay the extra payment with the structure of a biweekly payment plan.

***Photo courtesy of http://www.flickr.com/photos/truliavisuals/5241592552/sizes/o/in/photostream/

Comments

  1. This is a great post for those starting out and are afraid to jump into getting a mortgage for the first time. Home ownership can seem scary with paying for repairs, insurance, maintenance, etc. but it can also be very satisfying and ultimately a great investment. If you have the right information, it will lead to making the best decision.

  2. Interest only mortgage repayments are lower because you don’t repay any of the capital owing. If you take out an interest only mortgage, you should consider an insurance or investment to ensure you are able to repay the capital at the end of the term.

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