Housing Services Resources

How much money do you feel comfortable applying to your down payment? Before you decide, you’ll need to consider closing costs, moving expenses, home furnishing expenses, and any needed upcoming “big ticket” items. And remember, lenders may require you to have two months of mortgage payments in reserve when you go to closing.

Lenders often view mortgages with larger down payments as more secure because you have more of your own money invested in the property. Therefore, putting less than 20 percent down often means you will be required to purchase private mortgage insurance. Private mortgage insurance protects the lending institution in case you fail to make payments on your mortgage. Its cost will be added to your monthly mortgage payments and to your closing costs.

Some types of mortgages for which you put less than 20 percent down do not require private mortgage insurance. These include loans insured by the federal government such as an FHA loan or a VA loan. Your state may also offer special mortgages for low- and moderate-income home buyers that use state-sponsored mortgage insurance programs.

Your actual mortgage payments will depend in large part on the amount you borrow—your mortgage principal. Your income and your debts are the most important factors for determining how large a mortgage you will be able to get. If you are buying a house with someone else, you should consider your co-purchaser’s earnings and existing debts as well. (If you apply for a loan with somebody else, you and your co-borrower are both legally responsible for repayment of the mortgage).

Lenders use two guidelines to determine the amount of money they will lend. The first guideline says that a household should spend no more than 28 percent of its gross monthly income (income before taxes) on monthly housing expenses. Monthly housing expenses include mortgage principal and interest, hazard insurance, real estate taxes, and private mortgage insurance (if applicable). Lenders do not include monthly utility bills in your monthly housing expense ratio.

The second guideline says that monthly housing expenses and other long-term debts combined generally should not be more than 36 percent of total monthly income. That means that your monthly mortgage principal and interest payments, real estate taxes, hazard insurance, car loan, credit card payments, and other long-term debts combined generally may not exceed 36 percent of your gross monthly income.

These ratios (28 percent of total income for housing expenses and 36 percent for total debt) are flexible guidelines. If you have a consistent record of paying rent that is very close in amount to your proposed monthly mortgage payments or you make a large down payment, you may be able to use somewhat higher ratios. What’s more, some lenders offer special loan programs for lower-and moderate-income home buyers that allow as much as 33 percent of their gross monthly income to be used toward housing expenses and 38 percent for total debt.

One easy way to find out how much you can afford to borrow is to get pre-qualified by a mortgage lender. Many lenders will be happy to tell you how large a mortgage they might offer you. At the prequalification stage, you do not need to obligate yourself by paying an application fee and actually applying for the mortgage. However, keep in mind that lender pre-qualifications are only “ballpark” ranges of your buying power and don’t obligate the lender to approve your loan.

Here are some points to keep in mind when you compare interest rates among loans:

• Shorter term loans offer lower interest rates. Keep in mind that each type of mortgage loan may carry a different interest rate. As a general rule, the shorter the term of the loan, the lower the interest rate you will pay. So, a 15-year fixed-rate mortgage usually has a lower interest rate than a 30-year fixed-rate mortgage.

• A fixed versus an adjustable interest rate. Also keep in mind that you can choose a mortgage with an interest rate that is fixed for the entire term of the loan, or an interest rate that adjusts during the loan term. A fixed-rate loan gives you the security of knowing that your interest rate will never change during the entire term of the loan. An adjustable-rate mortgage loan (called an ARM) has an interest rate that will vary during the life of the loan, with the possibility of both increases and decreases to the interest rate and consequently to your mortgage payment. An ARM frequently offers a lower initial interest rate than a fixed rate mortgage. However, when comparing interest rates between ARMs and fixed-rate mortgages, you need to know the adjustable rate mortgage’s interest rate caps. There is a cap or limit for how much the interest rate can increase over the life of the loan, and a cap for how much the interest rate can increase at each adjustment date. These caps tell you the maximum interest rate you could be required to pay during each adjustment period and over the life of the loan.

• Paying discount “points” can lower your interest rate. In the special vocabulary of mortgage lending, “points” is a difficult term for many home buyers to understand. “Points” are often used to describe a type of fee lenders charge. (The full term to describe this fee is “discount points.” Simply put, a point is a unit of measure that means 1 percent of the loan amount. So, if you take out a $100,000 loan, one point equals $1,000. Discount points represent additional money you can pay to the lender at closing. In return, the lender will provide you a lower interest rate on your loan.

• Interest Rate Lock-ins: While you shop for a loan, interest rates can change frequently. So it’s important to ask if the mortgage lender will offer you a rate lock-in. This can guarantee you a specified interest rate, provided the loan is closed within a set period of time. When you apply for your mortgage, you should have a good idea of when you want to close on your house. If your lock-in period expires before you go to closing, your lender is not obligated to give you the same interest rate you had locked in earlier. So, it is important to lock in for a period that will cover the time until your expected closing date. Locking in a quoted rate when rates are rising may save you thousands of dollars in interest over the life of the loan. If the rates are falling, it may be best to wait until the last possible moment before locking in.

• Annual Percentage Rate: This percentage figure includes interest plus points and closing costs and spreads them over the life of the loan. The APR gives your “effective rate of interest” and must be disclosed to you according to federal truth-in-lending laws.