Financing Your Home

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When you’ve found the home that both you and your new spouse agree on, it’s time to deal with the financing. There are hundreds of brokers and lenders in the area, all offering dozens of loan programs with various options. Since the purchase of a new home is one of the largest investments you will ever make, it’s important you choose the best loan for you and your family.

There are two basic places to get a mortgage: direct lending institutions and mortgage brokers. Direct lenders such as banks, savings & loans, and credit unions lend out money and make the final decision on your mortgage application. According to one area broker, about 40% of mortgages in Wisconsin are obtained through a broker. A mortgage brokers is an intermediary between the consumer and the lender. The broker uses the consumer’s information and credit report to shop for your perfect loan. If you have special financing needs, an experienced broker might be able to help find the loan that best fits your individual needs. A mortgage broker’s fee is usually a percentage of the amount you borrow, buy you should always ask what the fee is from the beginning.

How Much Can You Afford?

This is usually one of the first questions people consider when buying or remodeling a home. It is often surprising how much one can afford with some of the longer-term loans available. For example, borrowing $150,000 at 6.0% interest with a 30-year fixed mortgage results in roughly a $900 monthly payment – not very much by today’s average housing costs.

To figure out how much you can actually afford will entail taking your income and subtracting your expenses. Most lenders have websites with financial calculators to help you estimate what you can afford.

Types of Loans

fixed rate mortgage: With a fixed rate loan, your monthly payments are easy to budget and you will continue to pay the same amount of interest even if rates rise. On the downside, if the rates drop, you will have to refinance in order to lower your rate, which can cost you money in refinancing charges. 30-year and 15-year fixed rate mortgages are most common.

adjustable rate mortgage: If you plan to move within seven years or less, an adjustable rate mortgage (ARM) may be a good option for you because of the lower initial payments and the possibility of a zero-point loan. If rates fall, your rates will fall too, but a jump in rates, will cost you. A convertible ARM will let you convert to a fixed rate if rates climb too high, but it will cost you to make the conversion. Two-step mortgages give you a fixed rate for a fixed short term, say five or seven years, before converting to an ARM.

construction loans: Depending on the type of builder you hire to construct your home, you may need a construction loan to get the project started. A construction loan is a short-term loan used to purchase land, materials, and labor. When the house is completed, the construction loan is paid off with a permanent mortgage. During construction, the builder will make several draw requests from your construction loan lender. Money for materials and labor during building comes out of the construction loan.

turn-key builder: A turn-key builder typically does not require a construction loan. The term “turn-key builder” essentially means that when this type of builder delivers a brand new home to you, all you have to do is “turn the key.” Much of the legwork, including the construction loan process, is taken care of for you. Planned community builders often fall into this category. Requirements vary, but many simply ask for a down payment when you sign a contract, with the balance due at closing. A turn-key builder will not finance your purchase, but can offer suggestions on securing a mortgage loan.

home equity loan: For remodeling projects that are too large to pay in cash, many homeowners opt for a home equity line of credit or a home equity loan. With a home equity line of credit, your bank or mortgage broker will approve you up to a certain amount of revolving credit. As your remodeling project progresses, you can draw on your credit line, often using special checks issued by the lender if you need special items, or if the contractor requires a payment. You can spend as much as you need and do not have to spend the whole amount. You are responsible for paying only the interest, then the outstanding balance is usually paid off or rolled into a traditional mortgage after the project is completed. The amount of credit you can get is based on a formula that takes a percentage of the appraised value of your home and subtracts the balance you still owe on your existing mortgage. A home equity loan might be more suitable if you know the specific amount of money you will need for a project. This type of loan will give you a fixed amount of money with a set schedule of equal repayments.

Applying for the Loan

If you have gathered all the right documents, the actual application process should be easy. The bank or broker will want to know your employment history, balances of your bank accounts, car loans, credit card debt, investments, etc. Be prepared to show paycheck stubs, bank account statements, tax returns, investment earnings reports, rental agreements, divorce decrees, proof of insurance, and other documentation that explains your current financial situation. After all the information is compiled, a credit check will be run. (Note: this is not a good time to make any big purchases or change jobs. It could have an impact on your ability to secure a loan.) If you are deemed “credit worthy,” an appraiser will be hired to appraise the value of the home you want to buy to ensure that it is worth the money you want to borrow.

Costs of the Loan

Closing costs, points, and prepaid items are part of the price of buying your new home. Depending on the market, you may be responsible for part of all these costs. Check with your lender prior to signing any agreements.

Closing costs are the expenses the lender incurs in preparing your home loan, such as obtaining credit reports, the appraisal of the property or processing your application. Closing costs typically run between two and three percent of the amount borrowed.

Loan discount “points” are a form of prepaid interest, with one discount point equaling one percent of the amount borrowed. At closing it is paid in cash to the lender as a form of interest and can help lower the interest rate on the loan you are obtaining. Sometimes new homebuilders offer to pay some of these points as an incentive to buy.

Prepaid items are costs that are always the homeowner’s responsibility. On closing day, you must have proof that you paid the first year’s insurance policy in full. If you are a first time homebuyer, lenders often require you to set up an escrow account. This is a savings account to cover property taxes and future insurance on your home. Each month, a portion of your mortgage payments goes into the escrow account.

Plan to Invest in Your Mortgage

The kind of mortgage you choose when you buy or refinance you home can make a big difference in how much interest you pay and how much you keep. By taking out a 15-year mortgage instead of a 30-year mortgage, you pay more per month, but you save thousands in interest – and your interest rate is usually lower. Let’s say you are trying to decide between two typical $100,000 home mortgages. Although the 15-year loan requires payments of $884.91 per month (compared to $665.30 with the 30-year), it would end up saving you $80,225 – just $19,775 shy of the original mortgage!

Want to save more mortgage interest? You can if you pay off your mortgage early. Sound impossible? Not really – not if you pay a set monthly amount over and above your required mortgage payment. For instance, if you have 25 year remaining on a 30-year, 8.5% mortgage, your monthly payment would total $769. Paying just $50 more every month takes four years and four months off the life of the loan and saves $27,816 in interest. Paying an extra $100 each month takes seven years and two months off the loan and saves a whopping $45,153.