Mortgage Loans For Smarties

“How much house can I afford?”

This is a critical question that every homebuyer faces, particularly first-timers. If you are in the market for a house, you must assess your personal borrowing limits very seriously with a financial professional (accountant, financial advisor, or attorney) who can take a close look at your finances before you zoom in on your dream home. Champagne Wishes vs. Beer Pockets, you know the drill. From a lender’s perspective, loan eligibility is commonly based on a 30% formula, namely, the monthly mortgage payment should not exceed 30% of one’s gross income. Be mindful, however–this calculation includes more than just the loan and also necessarily covers the four major components of a mortgage: principal, interest, taxes and insurance. This is often referred to as “PITI”. As in, “Oh, what a pity, it isn’t cheap to buy a home!”

Another Reality check: Although mortgage eligibility is based on gross income, your monthly payments are paid from your net income. Hence, your $50,000 paycheck is reduced to $36,000 net, after the typical 28% income tax hit.

Taking $20,000 out of that to pay the mortgage leaves you $16,000 to live on for the year. On a monthly basis, that’s $1,333.33. Factor in a car payment, credit cards bills, student loans, child expenses and there won’t be much left over at the end of the month. You may be one emergency away from disaster, (i.e. car needs breaks, oil burner on the fritz) and you could really be in hot water. What comes next are late payment notices, the lender’s endless collection activities, even losing your home to foreclosure, or bankruptcy. The Lesson? Choose your loan wisely. Don’t adopt Mortgage Loans for Dummies!

Now the Good News: Owning a home can be a powerful financial tool and often an individual’s single largest source of wealth! Even if you don’t have enough money left at the end of the month to invest in traditional wealth-building vehicles like stocks and bonds, simply making your housing payment (mortgage not rent) can help you amass a substantial net worth. It is entirely possible that in 30 years, your nest can double or triple in value into a bona fide nest egg. Now, let’s discuss the mortgage. There are several types: Fixed-Rate, Interest-only and Adjustable Rate.

A fixed-rate mortgage is a loan whose interest does not change throughout the life of the loan. If you have a steady source of predictable income and intend to own the home for an extended period of time (7-20 years at least), Fixed-rate loans are generally recommended. Because the interest rate does not change, homebuyers are protected from sudden and potentially significant increases in monthly mortgage payments as with adjustable rate loans. Most Fixed-rate loans also permit borrowers to make extra payments in order to shorten the term of the loan or to make lump-sum payments to payoff the loan. Non-traditional versions of the fixed-rate mortgage offer the option to pay only the interest for a set period of years before making a one-time change to the payment schedule to incorporate the interest payments as well as repayment on the loan’s principal. They enable homeowners to purchase expensive homes with relatively small payments during the initial period of time in which the interest-only portion of the loan is in effect. Notably however, fixed rate loans have a downside, mainly, that the rate wont change unless you refinance. This is problematic in that it is costly to do so, in most cases.

An Adjustable-rate mortgage is a loan that has varying interest rates, usually low to high. When such a change occurs, the monthly payment is “adjusted” to reflect the new interest rate. After the initial teaser rate period, interest rates increase, this causes the monthly mortgage payment to increase. Adjustable rate loans are suitable for those who anticipate declining interest rates, only plan to own the premises for 3-5 years, or anticipate being able to pay off their mortgages before the interest rate adjustment period is reached. Beware: One of the biggest risks for a homebuyer with a variable-rate mortgage is sudden and sizable increase in the monthly payments, which creates serious problems in household budgeting. This is typically not the financially prudent way to borrow money.

Need more info? A Trusted Advisor at your side? Call us or email us. Let’s meet and discuss how we can help you achieve your goals.