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Money Guide – Home Ownership



The following is adapted from “Living in the Village: Build Your Financial Future and Strengthen Your Community” by Ryan C. Mack.

– Count Your Costs Before Entering the Home Buying Process
– Mortgages Should Never Be More Than 30% of Your Monthly Budget
– Pretend You’re Buying a Home Before You Actually Make the Purchase


– How to Perform a Rent vs. Buying Analysis
– How Much House I Can Afford
– How to Avoiding Predatory Lending

Purchasing a Home – Are You Truly Ready?
This is the most important question you need to ask yourself before purchasing the biggest investment in your life. Whenever we ask someone who does not currently own a piece of property if they are thinking about buying a home, the usual response is, “Yes.” There is nothing wrong with this response. If you have a desire to own a home, then confidence and diligence are two of your most important assets (besides money).

The next question we ask is the time frame within which the person would like to purchase your home. The usual response is, “Within a year.” Now there is something wrong with that if they haven’t done the appropriate research on whether or not a year is feasible to achieve their goal. Before setting a time to reach your home ownership goal, conduct your own rent vs. buy analysis:

RENT VS. BUY ANALYSIS

A. Total Cost to Rent

  • a. Annual Renting Costs (12 x monthly rent of $_________)
  • b. Renter’s Insurance ___________

Total Annual Rent Cost = A.a. + A.b. = ______________


B. Total Cost to Buy

  • a. Annual Mortgage Payments (12 x monthly mortgage of $________)
  • b. Property Taxes (__________% of price of home)
  • c. Homeowner’s Insurance (___________% of price of home)
  • d. Maintenance (__________% of price of home)
  • e. After-Tax Cost of Interest on Down Payment and Closing Costs
    ($_________ x _________% After-Tax Rate of Return)
  • f. Total Cost (Add Lines B.a. through B.e.)

MINUS:

  • g. Principal Reduction in Loan Balance
  • h. Total Savings in Taxes Due to Property Tax Deductions
    (Line B.b. x Tax Rate of __________%)
  • i. Total Savings Due to Interest Rate Deductions
    (Interest Portion of Mortgage Payments $ ________ x Tax Rate of ________%)

If completing this form is too complicated, use our “Should I rent or buy a home” calculator

Self-Reflection Time: Outside of the numbers, you need to do some serious self-reflection before you purchase a home. Here are a few questions that you should be asking yourself:

  • Is your income steady enough to afford a monthly mortgage?
  • Have you been in and out of work for the past few years?
  • Do you expect any major life changes in the next few years that will significantly change your income (children, going back to school, career change, retirement, etc.)?
  • Do you have a lot of outstanding loans that are troubling you now?
  • Do you have enough for a down payment or would you have to get a “specialty” loan just to be able to purchase a piece of property?
  • Do you pay your bills on time?
  • If you calculate the mortgage plus all of the additional costs, can you really afford it (maintenance, insurance, gas, electricity, etc.)?
  • Is your FICO score above a 720?

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HOW MUCH CAN I AFFORD?

The rule of thumb for purchasing a home: the property shouldn’t be more than two or three times your income level. Assuming you have a $50,000 per year income you should be looking at homes around the $150,000 range. This is assuming you can afford the 20% down payment and have a manageable amount of long-term debts, such as school loans, car loans, and credit card bills. If you have no debt, you might be able to afford a home that is as much as four to five times your income. Another rule of thumb: your monthly mortgage payment shouldn’t be more than 30% of your monthly gross income. To make sure you are purchasing a home that is within this limit, follow this three-step process.

Step One: Determine Monthly Net Income or Estimate.
Let’s assume your salary is $75,000 and your estimated monthly net pay for this level of income is $4,026.78.

Step Two: Determine Maximum Mortgage Payment
Take your calculated monthly net pay and multiply by 30 percent. In this example, this equals $1,208.03 ($4,026.78 x 30%), which means the estimated maximum mortgage that an earner of $75,000 could afford is $1,208.03 per month.

Step Three: Determine Mortgage Amount
To determine the mortgage amount, we used a financial calculator, which you can find under “Home” and “Mortgage Calculators” on our calculator page. With a good FICO score of 750 and a $75,000 salary, a good estimate of a home that you can afford is $212,765 at 5.5 percent interest. With a lower FICO score of 650 and a salary of $75,000, a good estimate of a home that you can afford is $172,769 at 7.5 percent interest). Those two percentage points in interest (7.5 versus 5.5 percent) equates to $40,000 in home-value difference just for paying your bills on time (i.e having a good FICO score)!

Now that you have all of your numbers together, the best way to see if you are able to afford a house is to pretend you bought it. If your rent is $800 per month, but your calculated mortgage on your dream home is $1,200, start putting the $400 difference into high-yield savings account every month. If you have to call the plumber to fix a leaky pipe and the landlord picks up the bill, act as if you had to pay the bill yourself and put the billed amount into your savings account. When the end of the year comes and the landlord has to pay property taxes, act as if you have to pay property taxes and deposit the amount of the property taxes into your savings account as well. Every time your landlord makes a payment towards your apartment take the same amount and deposit it in your account without fail for 6 -12 months; or until you have the 20% down payment that you will need for your imaginary home. If you find that you are able to make these payments and still live comfortably without over-extending your budget, then you are on your way to having that new house.

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SHOPPING FOR A LENDER

Before you apply for a loan, you must first shop for lenders. If you are able to get pre-approved for a loan through a lender-meaning a lender approves you to purchase a home up to a certain amount-the home shopping process becomes that much easier. Within 3-4 weeks you should compare loans with at least 6 lenders and compare the loans and their fees. This process might save you thousands of dollars.

While shopping for a lender, be sure that you choose a company that is accommodating. When you go into discuss their loan programs, you should feel comfortable enough to ask questions and ask for explanations of those things you don’t understand. Having a company that can approve your loan locally could be a plus, because local lenders are familiar with the home values and conditions within your state. Lastly, ask for recommendations. Many of your friends who own homes in the area may have had a great experience and can give you a good referral. If you get a recommendation from your real estate agent, be sure to ask if the lender has a paid broker fee for referrals-any opinion that you get should be free from conflict of interest.

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APPLYING FOR A LOAN

Below is a list of all of the paperwork that you should have with you when applying for a loan:

  • Recent addresses in the past two years
  • List of debt and assets
  • Divorce papers
  • Child support agreements
  • Paperwork proving extra income
  • Foreclosure and bankruptcy status
  • Social security number
  • Gift letters of all of those giving you money
  • Tax returns, check stubs, income, and employment record

Choosing the Right Loan
Choosing the right loan is critical in purchasing your new home. The mortgage industry has evolved and created many different types of loans to encourage home ownership. Here are some basic questions that need to be addressed when discerning what type of loan is right for you:

  • Is your financial situation going to be changing in the near or long term?
  • How long do you think you will be living in this new residence?
  • How comfortable are you in dealing with fluctuating interest rates?
  • What are your long-term financial goals and desires?
  • How much down payment savings do you have?
Loan Types & Descriptions
Loan Type Description/Comments
Traditional Fixed Loan – 30-Year
  • Conventional
  • Not government issue or guaranteed
  • Usually allow LTV (Loan to Value) ratio of 80%
  • Designed to last 30 years and is very predictable
Traditional Fixed Loan – 15 Year
  • Conventional
  • Not government issue or guaranteed
  • Usually allow LTV (Loan to Value) ratio of 80%
  • Designed to last 15 years and is very predictable
  • Monthly payment increases 30-40% more than that of a 30 year loan
  • Less total interest paid than a 30 year loan
Balloon Mortgage
  • Borrower pays a fixed amount originally and agrees that after a certain period of time (usually 3-7 years) he/she will pay off the remaining debt or apply for another loan
  • Uncertain financial future of the refinancing option
  • Do you have the funds to cover the entire loan and will your score be good enough to refinance?
Adjustable Rate Mortgage
  • Interest rates change during the life of the loan
Interest-Only Loan
  • Borrower is responsible for payment of only interest of loan for initial period making mortgage payments much cheaper than payments of interest + principal in traditional loans.
  • After period of time principal becomes due and payment requirement increases dramatically.

It is important that you learn as much as possible about the loan that you are considering. Many Americans are duped into purchasing loans like Interest-Only mortgages. Under these mortgages the borrower is only obligated to pay the interest portion of the loan as opposed to the interest plus the principal. This, obviously, makes the loan more inexpensive for a period of time. However, because many borrowers are not properly educated about these loans, they don’t realize that the introductory period has an expiration date. Upon expiration, the borrower is obligated to begin repayment of principal of the loan making the mortgage payments increase, over 500% in many cases. It is not an uncommon scenario to see a mortgage increase from $500/month (which the borrower could afford) to $2,500/month (which was unaffordable by the borrower). A few hours of research can avoid millions of foreclosures.

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AVOIDING PREDATORY LOANS

Before you sign on the dotted line on any loan, The Money Movement wants you to get three outside opinions to be sure that you are making the best decision on the mortgage. This will help you avoid being a victim of predatory loans that were a major cause of economic downturn in the mid 2000’s.

  • Mortgage professional
  • Knowledgeable friend/financial adviser (unbiased party)
  • You-if you spent irresponsibly, borrowed to much or got into products you didn’t understand
Here are 13 Tips to Avoiding Predatory Lending:

1. Read everything carefully before you sign.
2. Hire a qualified real estate attorney to help you understand the documents that you sign.
3. Do not sign any blank documents.
4. Hire a qualified financial adviser to help you calculate how much you can afford.
5. Do not purchase property for another party.
6. Be honest about your employment status.
7. Do not exaggerate your assets.
8. Report all of your debts.
9. Do not alter your tax returns.
10. Tell the truth about all gifts and financial help.
11. Be truthful about credit difficulties.
12. Do not provide any false documentation.
13. Do not mislead.

Didn’t find what you were looking for in Money Guide:Home Ownership? Send us an email at info@moneymovement.org and one of our experts will get back to you.



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