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KNOW
WHAT YOU CAN AFFORD
Most lenders use a two-part qualification ratio to determine
how much money you can safely spend on living expenses and
mortgage costs: 28/36. In other words, lenders will
generally allow you to spend up to 28% of your gross monthly
income on housing expenses—principal, interest,
homeowner's insurance and taxes. If the down payment you
scrape together amounts to less than 20% of the purchase
price, your 28% allowance also needs to include the cost of
purchasing private mortgage insurance (PMI), which protects
the lender in case you default.
In terms of the second part of the equation, 36% of your
gross monthly income is the amount lenders will allow you
for a mortgage plus monthly recurring debt, such as your car
loans and credit card bills. Normally, only debts that will
take more than 10 months to pay off will matter.
IDENTIFY YOUR COMFORT LEVEL
The 28/36 qualification ratio establishes the maximum amount
you are eligible to be loaned. Using these criteria, lenders
will happily lock you into as high a level of debt as you
want. However, this number may not be within your comfort
zone.
Take a look at the past year's income and expenses. If you
commit the maximum amount to a mortgage, will you have
sufficient funds left over to meet expenses for hobbies and
activities you enjoy? Are you willing to forego such
activities to meet your mortgage commitment? And, after
making your down payment, will you have a large enough
savings buffer to enable you to sleep soundly at night?
These are some of the questions you need to ask yourself.
MAKE SURE YOU'RE CREDIT HEALTHY
To qualify for a mortgage, you must have a clean credit
record for at least two to three years. Even if you think
your borrowing history is without blemish, take advantage of
federal law and ask to inspect your credit reports; they
could contain discrepancies. And remember, though you are
entitled to request corrections, this process can be
time-consuming. To be safe, contact the credit agencies at
least six months before you plan to apply for a mortgage, to
save yourself the headache of possible closing delays.
GET
YOURSELF PRE-APPROVED
Pre-approval means the lender has checked your credit,
verified your income and other financial references. You'll
get a document that says the lender will give you a mortgage
up to a specific amount, as long as the home appraisal
justifies the price. This may help you beat out a slightly
higher bid from someone who does not have pre-approval.
WHAT
YOU SHOULD ORGANIZE
To save yourself time further down the road,
start organizing the items you will need to apply for a
mortgage. You'll be asked for income tax returns for the
previous three years, current copies of pay stubs, records
of any past negative credit history that has since been paid
off, and records of any supplemental income you may have.
If you are self-employed, you
will need all business records and tax returns for the past
three years. Also, if you're going to be receiving money as
a gift for the down payment from a friend or relative, have
that person prepare a "gift letter" for you, confirming that
the money is a gift, not a loan. This letter clarifies that
you are not going further into debt and jeopardizing your
ability to repay the lender's loan.
SHOP AROUND FOR YOUR MORTGAGE
All mortgages are not created equally. Doing a little
competitive shopping definitely can save you money. Check
newspaper ads and ask for referrals from friends and
co-workers who have recently gone through the process. Ask
each lender you're considering for a disclosure listing all
loan terms. Be cautious of referrals that come from the real
estate agent, especially if the agent receives a "referral
fee" from the lender.
DON'T
FORGET ABOUT OTHER COSTS
Even if you've decided to go with a no-points
mortgage, out-of-pocket expenses to close on your new home
can add up to a few thousand dollars. If you'll be making
your purchase with an adjustable-rate mortgage, be sure you
base your budget on what the interest rate will jump to in
the second year.
And remember those paint chips and furniture ads mentioned
at the start of this article? You probably will spend
several thousand dollars in the first year just on
appliances, furnishings and changes to the property. So, be
sure you have a few extra dollars to pay for items like
these.
Brought to you by the North Carolina
Association of Certified Public Accountants in cooperation with the AICPA.
©2007 The American Institute of Certified Public Accountants;
www.360financialliteracy.org
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