If you’re in the market to buy your first home, you probably don’t have a clear sense about the costs of homeownershipand mortgage application.
Even people who presently own a home and are considering trading up often don’t have a great grasp on their current or likely future homeownership expenses.
So we include this section to help you assess your likely homeownership costs.
Making your mortgage payments (mortgage application)
A mortgage is a loan you take out to finance the purchase of a home.
Mortgage loans are generally paid in monthly installments typically over either a 15- or 30-year time span.
In the early years of repaying your mortgage, nearly all your mortgage payment goes toward paying interest on the money that you borrowed.
Not until the later years of your mortgage term do you rapidly begin to pay down your loan balance (the principal).
all that mortgage lenders can do is tell you their own criteria for approving and denying mortgage applications and calculating the maximum that you’re eligible to borrow.
A mortgage lender tallies up your monthly housing expense.
the components of which the lender considers to be the mortgage payment, property taxes, and homeowners insurance.
Understanding lenders’ ratios (mortgage application)
For a given property that you’re considering buying, a mortgage lender calculates the housing expense and normally requires that it not exceed 40 percent or so of your monthly before-tax (gross) income.
So, for example, if your monthly gross income is $5,000, your lender may not allow your expected monthly housing expense to exceed $2,000.
If you’re self-employed and complete IRS Form 1040, Schedule C, mortgage lenders use your after-expenses (net) income, from the bottom line of Schedule C.
add back non cash expenses for items such as real estate
And, in fact, add back noncash expenses for items such as real estate and equipment depreciation.
which increases a self-employed person’s net income for qualification purposes).
This housing expense ratio completely ignores almost all your other financial goals, needs, and obligations.
It also ignores property maintenance and remodeling expenses, which can suck up a lot of a homeowner’s dough.
Never assume that the amount a lender is willing to lend you is the amount you can truly afford.
In addition to your income, the only other financial considerations a lender takes into account are your debts or ongoing monthly obligations.
Specifically, mortgage lenders examine the required monthly payments for other debts you may have.
such as student loans, auto loans, and credit card bills.
They also deduct for alimony, child support, or any other required payments.
In addition to the percentage of your income that lenders allow for housing expenses.
they typically allow an additional 5 percent of your monthly income to go toward other debt repayments.
Calculating your mortgage payment amount After you know the amount you want to borrow.
calculating the size of your mortgage payment is straightforward.
The challenge is figuring out how much you can comfortably afford to borrow given your other financial goals.
This chapter should assist you in this regard, especially the previous section on analyzing your spending and goals.
SO YOU THINK YOU CAN HANDLE EXCESS BORROWING?
Some people we know believe they can handle more mortgage debt than lenders allow using their handy-dandy ratios.
Such borrowers may seek to borrow additional money from family, or they may fib about their income when filling out their mortgage applications.
Although some homeowners who stretch themselves financially do just fine, others end up in financial and emotional trouble.
You should also
You should also know that because lenders usually cross-check the information on your mortgage application with IRS Form 4506T
(the lender receives your actual tax return you filet. which certainly didn’t overstate your income).
borrowers who fib on their mortgage applications are caught and their applications denied.
So although we say that the lender’s word isn’t the gospel as to how much home you can truly afford.
Telling the truth on your mortgage application is the only way to go.
It may be painful to learn that you don’t qualify for the loan.
You need to purchase that home of your dreams, but you’re likely better off in the long run not overextending yourself with mortgage debt.
We should also note that telling the truth prevents you from committing perjury and fraud, troubles that catch even officials elected to high office.
Bankers don’t want you to get in over your head financially and default on your loan, and we don’t want you to either.
Suppose you work through your budget and determine that you can afford to spend $2,000 per month on housing.
Determining the exact size of a mortgage
Determining the exact size of a mortgage that allows you to stay within this boundary may seem daunting.
Because your overall housing cost is comprised of several components :
mortgage payments, property taxes, insurance.
and maintenance (and association dues if the property is a condominium or has community assets like a swimming pool).
You can calculate the size of your mortgage payments based on the amount you want to borrow.
the loan’s interest rate, and whether you want a 15- or 30-year mortgage.
Alternatively, you can do the same calculations by using many of the best financial calculators available for less than $50 from companies like HP and Texas Instruments (mortgage application).