April is National Financial Literacy Month! Since the spring market is going full steam, it's a good time to discuss mortgages. If you're a first time buyer or haven't purchased in awhile, the lending process can be confusing. We're going to break down the basics of financing a home.

preapprovals

It's vital to get preapproved before starting your home search. A lot of buyers have a price range in mind before applying with a lending institution, but there are many factors that determine how much you can afford. You need the help of a loan officer to nail down a realistic budget. Your loan eligibility will be based on your debt-to-income ratio, credit score, and assets. Here are some of the financial documents you can expect to provide your loan officer:

debt-to-income ratio

Debt-to-income (DTI) is the percentage of your income that goes toward paying down debts each month. To calculate your DTI, add all of your debt payments per month. Include minimum credit card and loan payments (not the account balance), child support, and alimony payments. (Note: if you currently rent, your lender will likely check that rent payments have been made on time. However, your current rental costs will not be included in your DTI as they are not payments that will continue after you buy.) Subtract that by your gross monthly income. For example, if you have a gross monthly income of $4,000 and the following debts:
$250 car payment
$150 minimum credit card payment
$300 student loans
= $700 total recurring debts

Not including your future house payment, your back-end DTI is rounded up to 18% because $700 is 17.5% of $4,000. If you're looking at a home with a mortgage payment of $800/month, your total back-end DTI is 38% ($700 in recurring debts + $800 mortgage = $1,500 which is 37.5% of your $4,000 monthly income).

Conforming loans have maximum DTI limits, however, lending institutions also set their own standards. Generally, a DTI below 36% is considered ideal while the closer you are to 50%, the harder it will be to obtain financing.

purchase price isn't the only thing to consider

Don't simply focus on the price you want; monthly payments have a more immediate impact than the purchase price. In fact, some lenders give a max budget simply to help guide your search. The monthly payments will actually determine whether or not you can afford a home. Mortgage payments are a combination of *Principal + Interest + Taxes + Insurance* (PITI).

different types of financing

CONVENTIONAL
A conventional loan is not secured by the government and instead is guaranteed by a private lender or the government-sponsored enterprises Fannie Mae and Freddie Mac. To conform to Freddie Mac and Fannie Mae requirements, borrowers need a credit score of at least 620, a down payment of at least 3%, DTI below 50%, and the loan must be below $647,200 in most areas. Conventional loans are typically looked at more favorably by sellers compared to other loan types because they don't require more extensive FHA/VA inspections and they typically close faster. Sellers can contribute toward the buyer's closing costs with a conventional loan, but the amount depends on the down payment. With a down payment of 10%, the seller can contribute up to 3% of the purchase price. With a down payment of 10-25%, the seller can contribute up to 6%. With a down payment more than 25%, the seller can contribute up to 9%. A seller can only contribute up to 2% on any investment property regardless of the down payment. 

FHA
FHA loans are backed by the Federal Housing Administration and have lower credit requirements than conventional. The minimum credit score as set by the FHA is 500 with a 10% down payment. With a score above 580, the minimum down payment is 3.5%. The home being purchased must be the borrower's primary residence. FHA loans require more in-depth inspections and, in addition to verifying the market value, FHA appraisers must make sure that the home meets minimum property standards. Any issues that do not meet these standards must be repaired or the home will not qualify for FHA financing. A seller can contribute up to 6% for closing costs.

VA
A VA loan is guaranteed by the US Department of Veterans Affairs and is offered to veterans, active military members, reservists, and select surviving spouses. These loans do not require down payments and they do not have PMI. The VA also does not set specific credit score requirements. The home you purchase must be your primary residence within 60 days of closing. Pest inspections are required for VA loans in most states, including Ohio and Michigan, and must be paid for by the seller. The seller can contribute up to 4% of the buyer's closing costs. 

USDA
USDA loans are backed by the US Department of Agriculture and eligibility is based on the buyer and property. The home must be in an eligible rural area and the buyer can't make more than 15% above the local median income. USDA loans are only available for primary residences. DTI requirements are usually 41% or less and a credit score of at least 640 is required by the USDA. These loans do not require a down payment, have lower mortgage insurance than FHA, and often have better interest rates than other loan types. Sellers can contribute up to 6% of the buyer's loan amount. 

Keep in mind, you will have to pay private mortgage insurance (PMI) on any conventional loan with a down payment of less than 20%. PMI falls off a conventional loan after you pay it down to 20% equity. With an FHA loan, you'll have a mortgage insurance premium (MIP). If you put down more than 10%, MIP can be removed after 11 years. If you put down less than 10%, you'll need to refinance after you have 20% equity to remove MIP. 

what can buyers expect to pay at closing?

On top of your down payment, closing costs are generally around 3-6% of the purchase price of the home. These fees may include:

- Prorated taxes
- Prorated HOA fees
- Lender fees
- Appraisal
- Recording/title company fees
- Homeowners insurance premium

If you are escrowing taxes and insurance, lenders typically require 2-3 months worth of taxes and insurance upfront for your escrow account.

Some lenders require you to pay for the appraisal at the time it is ordered. If your appraisal is included in your closing costs but you back out of the deal, you will still be charged for the appraisal. Remember that asking a seller to contribute toward your closing costs depends on the percentage of your down payment and loan type. Seller concessions can only go toward closing costs and prepaids— they cannot help pay for your down payment and you are responsible for home inspection fees (with the exception of VA pest inspections).

before closing on a home, do not:

1. Open new lines of credit or obtain new loans
2. Quit your job
3. Make large cash deposits without consulting your loan officer
4. Transfer large amounts of money between bank accounts

As you can see, there's a lot to consider during the mortgage process. The loan products available to you will depend on your specific circumstances which is why it's so important to consult with a loan officer before beginning your home search. Realtors can connect you with knowledgeable loan officers, so they're a great place to start! Get in touch with a Danberry agent here.