Is Now the Time to Buy A Home?
Take stock of your current financial and lifestyle situation. When do you want to buy a house—tomorrow or five years down the line? Whatever your choice, financing is crucial.
Let’s assume that you’ve looked around and decided that you’d like to buy a house in the $100,000 to $150,000 range. If we pick $125,000 as the house price, your monthly payments vary greatly based on 1) your down-payment, 2) the length of the mortgage, and 3) the interest rate.
As good scientists, we know that we can only change one variable at a time to get a sense of how that will affect the outcome. So let’s start experimenting!
First: how would your payments change if you altered your down-payment? (Keeping in mind that this doesn’t account for private mortgage insurance or any other penalties.)
As you see in the chart below, the more money you put down up front, the lower your monthly payments and the lower your total interest paid.
(example is a $125,000 home with a 30-year fixed-rate Mortgage of 7%)
|Down Payment||Monthly Payment||Remaining Principal||Total Interest||Total
Length of Your Mortgage?
Fifteen- and 30-year mortgages are the most common, but 20- and 40-year mortgages are also available. Take a look at how costs change if you shorten or lengthen your mortgage. As you see in the chart below, the shorter the loan length effect two crucial aspects of your financing: (1) more you pay each month and (2) the less total interest you pay.
So if you choose a 15-year loan, you will have a higher monthly payment but will pay a whopping $24,282.65 less in interest. You must factor in how much you can afford each month and whether the interest money saved is worth the higher monthly payments.
(example is a $125,000 home with 20% down and a fixed-rate 7% mortgage)
|Length of Mortgage||Monthy Payment||Total Interest||Total Principal
Changing an interest rate by just a quarter- or half-percent can make a huge difference in a mortgage loan. Borrowers with good credit are typically offered the best interest rates.
|Interest Rate||Monthy Payment||Total Interest||Total Principal
In an ideal situation, you would:
- put down as large a down-payment as possible
- get as short of a loan period as you can
- find the lowest possible percentage rate
In reality, your down-payment is typically determined by how much you are able to save before you get the urge to buy, your loan period is determined by how large a monthly payment you can afford, and the interest rate is set by the market and your credit score. Even so, keeping the tables above in mind during the mortgage process can help you stay on the right track to getting an affordable mortgage.
PMIs and The Magic 20%
Nowadays, the credit score is king when it comes to getting a loan of any type. If you have a low credit score, your mortgage may have a higher interest rate —which would cost you big bucks in the long run. For more on Credit Reports and Credit Scores please see the Trusty Guide to Credit. Key terms are defined below:
Credit Report: This report encompasses the history of any time you’ve ever borrowed money—through a credit card, installment loan, bank overdraft protection, or even a long-term gym membership that’s automatically deducted from your account.
Credit Score: A credit score is an attempt by lenders to calculate the likelihood you’ll be able to pay back a loan, based on your credit report.
FICO Credit Score: The FICO (Fair Isaac Corporation) credit score is the best-known and most widely accepted credit score in the U.S. Know it and love it.
High Credit Score: A FICO score of 720 and above is considered good credit and should make you eligible for most of the going interest rates.
Low Credit Score: If you score below 600 on FICO, you are considered to have poor credit.
Now that you’ve got something of a handle on how mortgage costs are affected by your downpayment, time period, and interest rate, let's throw a wrench into the simple equations and introduce you to Private Mortgage Insurance (PMI). Historically, borrowers with less than 20% to put down on a house were considered at a higher risk of defaulting on their loan. For this reason, buyers with smaller down payments are often forced to get PMI tacked onto their expenses, as well as the usual interest. PMI can add quite a chunk of change onto your monthly payments—how much depends on how far short you fall of 20%, what type of loan you get (A.R.M.s typically have higher PMI premiums), and how large the loan is. PMI is also not tax deductible.
The good news is that PMI disappears after you have reached 20% equity in your home. You crave more good news, you say? Well, a newer type of financing called 80-10-10 is available.
With this type of loan, a borrower gets a mortgage worth 80% of the home sale price. A second mortgage is taken out for 10% of the sale price and the buyer makes a 10% down payment. By ensuring that no loan is worth more than 80% of the sale price, the borrower avoids PMI. This type of financing is also available as an 80-15-5 (15% second mortgage and 5% down payment) or even as an 80-20 loan with no down payment. Of course, the more you borrow, the more interest you will be paying. In general, if you can avoid paying the additional PMI premium, that’s a good thing.
Let’s say you haven’t saved a penny and you want a house now. Is it possible?
Lenders are offering zero-percent down mortgage options. To qualify, you usually need to have an above-average credit score and a stable, pretty substantial income. A zero-down loan offers potential buyers the opportunity to buy a home today instead of waiting months or years to save up for a down payment. However, the interest rate is usually higher than a normal loan, and you would still need to deal with PMI premiums (unless it’s 80-20 financing).
So even if zero-down loans are out there, is it a good idea? A zero-down loan is a greater risk than even an A.R.M. or balloon loan because you have no equity in your home. If house prices drop slightly, you could owe more on the loan than your house is actually worth. You will also pay significantly more in interest because you will be borrowing the full amount of the sale price, instead of a portion of it. In general, if you can wait it out a little longer and save up for a down payment—even if it’s only 5%—you will be in a better position.
Now that you’re an expert on the types of mortgages available, read on to learn about potential lenders.