Nothing is more exciting than buying your first home. I love to educate first time home buyers about how loans work and all of the options available to them. You want to buy a home but you have a ton of questions. Let’s cover some of those now.
Credit: Just like mom always said “pay your bills on time”. This is the most important rule, of course. Any outstanding debts you have either revolving debt (credit cards) or student loans or car loans (both referred to as installment debt) all play into your credit worthiness. It is important to use credit, but wisely. For example, you have limits on your revolving debt, the higher your balance gets to the limit can affect your credit score. Going over your limit can also affect your credit score. In my humble opinion, the goal is to get to a place where you have credit cards with benefits (IE earned airline miles per dollar spent), but pay the balance off every month to avoid interest. FYI: the only tax deductible interest is student loans and home loan interest. The more outstanding debt you have the less of a house payment/home loan you can qualify.
Income: When you are pre-qualified for a home loan they are looking at your “gross” monthly income before any deductions (taxes, pre-tax insurance payments and retirement deductions). If you are salaried W2’d employee we will use 30 days’ worth of your most recent paystubs and your last 2 years’ worth of W2s for verification. If you are a sole proprietor/self employed (1040 schedule C) the lender uses your last 2 years (complete with all schedules) tax returns to average out your bottom line income for 24 months. You may also file your taxes as an S-Corp (1120s) or LLC or s partnership (1065) we will use this income as well.
Assets: Most every home loan requires a down payment, some as small as 3.5% of the sales price. Typically you may want to put down 5% of the sales price. (There are zero down options but they do have strict maximum income restrictions; call me we can talk about this). The more money you put down the less your mortgage insurance (see below for more on MI). The down payment usually needs to come from your own funds IE saving/paycheck. Sometimes you may receive a gift of down payment from a family member or a gift of home equity (if you are buying a home from a family member) as well.
Mortgage Insurance (MI): Is a requirement of the loan program when you do not put down at least 20% of the sales price. (IE a sales price of $300,000 would require a down payment of at least $60,000, to avoid MI). Mortgage insurance is paid to a mortgage insurance company that insures the lender that if you (God forbid) default on the loan the lender will be paid the loss.
Closing costs and pre-paid expenses: There are always costs associated with borrowing money, typical expenses with a home loan are: Origination and/or discount fees (discount fees are only charged if you decide to buy down the interest rate to a lower than current market rate); home appraisal fees; credit report fees; title and escrow fees (the cost for a clear title report and signing with escrow as well as the recording fee to the county to record the new deed of trust into your name for the property); per day (per diem) interest on your loan amount from the day of closing to the first of the next month); escrow account prorate collection (your pre-paid homeowners insurance , taxes and MI (if required) (escrow accounts are a requirement if you do not put down 20% as well) is collected sufficiently in prorate so the lender can pay your taxes and homeowners insurance for your annually. The good news is you typically 30-45 days before your first payment is due after loan closing.