Checks and Balances
When you purchase a home, particularly in what may be the biggest financial transaction of your life, there are many ways to cost or save you money. Make your financial decisions carefully. Consider the following:
How much down payment?
If you can, make a 20% down payment. At that point, the mortgage insurance premium (usually about 0.5% of your payment) is not charged. That also is the point where you can hold your own escrow (savings for insurance and taxes), but see later for pros and cons.
Should you pay cash?
Probably not, for a couple of reasons.
1) If you pay cash, you will be unable to access your money in case of medical problems, tuition, etc.,
2) You can make more money by investing in a good mutual fund than you save on your interest (see below), and
3) You can double your principal payments anyway and still save the interest while ensuring access to the funds if you need them. Your money will be under your control, not the mortgage company.
What type of loan?
* Most people move in 5-7 years. If you are one of these, consider an ARM (adjustable rate). The lower initial interest rate will likely save you thousands of dollars over a 15 or 30 year fixed rate. But get a stable base on which the rate is calculated. Check the alternatives with different mortgage companies and compare. Have them show you at least a 5 year history.
* A fixed rate is recommended for those who plan to be in the home for an indeterminate period, and those who don't like the uncertainty of an ARM.
* Use an FHA loan at 3% down if you can't make the down payment requirements of a 5% down conventional. Be advised though, that you will likely be paying more due to higher upfront mortgage insurance premium and sometimes higher rates.
* If you are eligible for a VA loan, you don't need any money for a down payment; you can even finance closing costs. Interest rates could be higher than conventional, but check on this. Be sure to apply for your Certificate of Eligibility before looking for a home. It takes a while to get this.
How much can I borrow?
Monthly Payment
* For a conventional loan, your monthly payment of principal, interest, taxes, and insurance (called PITI) usually cannot exceed 28% of your income. Another consideration is your debts. Adding them to your PITI shouldn't exceed 36% of your income. There are exceptions, so check with your REALTOR® or loan officer.
* For a government loan (FHA or VA), the PITI usually can't exceed 32% of your income and the debt ratio isn't supposed to exceed 42%.
Maximum Dollars
* The maximum dollar amount for a government loan on a single family home is set by the agency. VA is approximately $203,000 and FHA is determined by the metropolitan area. This is changed periodically, so check.
* There is no maximum amount for a conventional loan but there is something called a Jumbo loan that has a higher (~1/4%) interest rate. Currently a Jumbo is above $214,599.
When should you hold your own escrow?
* If you have the discipline to put the amount of your taxes and insurance in an account each month.
* If your escrow account is separate from your savings or checking.
* If your account pays at least 5% interest and it's no risk.
* If the risk is worth the $6-7 a month you will be saving, considering taxes and fees. (based on a $130,000 home)
Remember, the tax man has the ultimate control and the mortgage company is not far behind. They can get nasty.
Let's compare Cash vs Borrowing.
Assume $100,000 home, cash versus 20% down; 10 year period; 8% loan at 30 yrs; 8% investment return; 28% tax rate.
Pay Cash: $100,000 invested in home. No interest paid. At the end of 10 years you still have $100,000 equity.
Pay 20%, Borrow 80% and Invest the $80,000:
* At the end of 10 years, you've paid approximately $60,600 interest on your loan. After tax deduction the interest is really $43,645. Additional equity in the home due to your payment is $9,820, for a total equity of $29,820 (original $20,000 + $9820).
* Investing your $80,000 at 8% will yield $172,714, which after tax is worth $146,754.
Now your original $100,000 is worth $29,820(equity) + $146,754(investment) - $43,645 (loan interest) = $132,929. Plus you have your home and access to your money if needed.
You're $32,929 richer than if you paid cash for your home, even though you paid all that interest!
It's not without risk so let me point out the following:
1. You can't do this by putting your money in a bank savings account at 4-5% interest so there's a higher risk associated with investments like mutual funds.
2. If you don't like to be in debt, don't do this.
3. Of course, you've got to have the cash first.
4. If recent history is any indication, you should be able to obtain a greater return than 8% on investments. 10-15% would not be unusual, but the higher returns carry a greater risk of loss.
5. Definitely contact your financial advisor before doing this.
Homebuyer Decisions
- Know Your Neighborhood. Think about whether or not this neighborhood will make you as happy as the house does. Do your homework. Drive the neighborhood when school let's out and when the barbecue gets fired up.
- Affordable Homes. You might find that when you compare your affordable home to a higher-price home, you're disappointed. Get pre-qualified for a loan (usually free) and then stick within your budget. Ask your REALTOR® or loan officer what kind of loan options you have.
- Buy the Right Home. Consider how long you plan on being in the property and plan for any lifestyle changes that could happen. This also can affect the type of loan you should have.
- Knowing Your Next Home. If you see a home that is just what you want and is within your price range, after consultation with your buyer's agent, make an offer immediately! If the property is nice and attractive and fairly priced, others will also know it. Hesitation breeds disappointment.
- Property Resale. Walk yourself through all the positives and negatives to the property. Most home buyers sell within five to seven years. Think long and hard about how you would sell the home prior to buying.
- Down Payment. Consider a 20% down payment if you can afford it. At that point, the mortgage insurance premium of approximately 0.5% of your payment is eliminated. That dollar amount saving allows you to qualify for a higher priced home and some mortgage companies will also allow you to hold your own escrow (don't hold your escrow if you're not disciplined).
- Timing Problems. Make sure your closing/possession dates coincide for your present home and new home. For renters, plan your move to coincide with the end of your lease because of deposits and advance payments. Check with your landlord about an early release clause if you are considering buying a home.
- Choose the Right Mortgage. The thirty-year fixed rate is not the only or necessarily the best answer. Remember, most people change homes every 5-7 years. Have your lender show you on paper how much each program will cost you and how they compare with each other. You could save thousands of dollars.
- Make Your Offer. Make sure you use a Buyer's Agent. They owe a fiduciary responsibility to you. Your agent should prepare a Comparative Market Analysis to help you determine a fair price for the home. Don't lowball; you're starting off on the wrong foot. Have your agent explain the pros and cons from the sellers' standpoint of price, escrow, financing, closing, contingencies, etc. Start out fair and reasonable and it can be a pleasant experience for all concerned.
- Home Inspection. Strongly consider a home inspection. Your agent probably is not qualified as a home inspector and unless you know what to look for and where to look, you may overlook some problems. Be aware that maintenance items are normally not included as repair items. That goes also for building codes that have been changed and are grandfathered.
Make a change of address here!
Overland Park South
Teresa Hugunin
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