Part IV: Loans and Credit Options for New Families

This is Part IV of the guide, Understanding Loans and Credit At Every Stage of Life.

After committing to partnership with someone, the next step for many couples is to select housing together. Factors such as income, job stability, future education plans or the location of extended families may all come into play in this decision. Choosing an area to settle down in is difficult enough, and you must also choose whether to rent or buy property.

Renting vs. Owning Property

Some questions you might ask yourselves when making this choice:

How long do we expect to stay here?

  • In some cases couples find themselves in a new city because a job brought them there. Alternatively, some couples may still live in their hometown but are thinking of expanding their horizons before enlarging their family. You may want to consider whether renting is a wiser choice if you are unsure where you will plant your roots. Ditto to the young family who wants to see the world a bit: mortgages are not as easy to unload as an annual lease, and it may be a better short-term option to rent if your future is uncertain. If you can commit to spending 5 years in one area, a mortgage may be a better option for you.

Is renting or owning more affordable here?

  • The real estate market where you live may make this choice for you. In some areas it can be cheaper to rent than to buy, though smart couples will consider the tax advantages that accompany home ownership. To investigate this, start by checking the websites of some large realtors in your area. When you find homes that meet your criteria, estimate your mortgage payment by using a payment calculator, and add property taxes and homeowners insurance to the total. Compare this against the cost of renting a similar space (check Apartments.Com or a similar site), and factor in the costs of doing your own repairs.

Are we both finished with school?

  • If either of you are considering pursuing further education, think twice before settling down. Due to record unemployment rates graduate schools’ admissions have shot up, making entrance requirements more competitive than ever. You may find yourself attending grad school somewhere else than you first hoped, necessitating a move.

Can we afford the extra expenses of home ownership?

  • Homeowners sometimes face expensive surprises. Unexpected replacement of major appliances, furnaces or air conditioners is costly, and regular home maintenance is not free. After you have managed a down payment for a mortgage, ensure that you have adequate savings to cover these expenses.Consider establishing a separate savings account and contribute to it monthly so you are able to fund unexpected home repairs. As with most savings slush funds, the equivalent of six months’ income is recommended.

How soon would we like to add to our family?

  • Couples who live in metropolitan areas may consider when they’d like to bring children into the fold, as suburban life may be more attractive to many families than raising children in a city. If you are thinking of making a home purchase, research school districts and other educational opportunities for your future children, and look into family-friendly environments that offer park services, preschools or a range of extra-curricular activities.

The Basics of Home Mortgage Loans

If you decide to purchase a home, you are in good company; nearly 70% of homes in the U.S. are owned or mortgaged. The positive sides of a mortgage include the mortgage interest tax deduction, a payment that will not change unexpectedly and an investment (see Part V: Financial Management in the Retirement Years) in home equity. The process of obtaining a mortgage can be daunting, but research and preparation go a long way.

The Process

The paperwork requirements of mortgage applications are legendary. You begin with an application from your lender that asks you to detail information about yourself, your employment history and earnings, your monthly expenses and any debt you may have. You are also asked to provide supporting documentation such as W-2 forms, tax returns and financial statements that list your assets. Unless you are shopping for a pre-approved mortgage before you choose a home, the contract information on your dream house must also be provided.

When your lender is satisfied with your financial information, the underwriting department will first check your credit score (see Part I: The Basics Behind Loans and Credit Scores) to determine whether you are a good loan risk.  The amount that your lender chooses to lend you is based on the market value of the home, not the sale price; at this stage a real estate appraiser will evaluate the current market value of the home. The down payment that you are offering is considered, and a potential mortgage payment is calculated by the lender. Your debt-to-income ratio is scrutinized by the lender; ideally, you will spend less than 36% of your monthly budget towards debt. Debt-to-income ratios of 37% to 42% are likely to be considered risky, and 43% to 49% may indicate that you are struggling with too much debt. If your potential mortgage payment creates a satisfactory percentage and you meet all other requirements of the lender, you will be offered a mortgage loan. This process usually takes about 30 days after your loan goes into underwriting.

The Providers

Choosing a mortgage lender may be one of the most important choices you make in life. Research available interest rates and investigate lenders’ closing fees and commissions. Consider your down payment: conventional mortgages are offered to buyers with a 25% down payment; most banks require that applicants with less than a 25% deposit purchase mortgage insurance. Mortgage insurance ensures that the lender doesn’t lose money if you default on your mortgage. Determine whether you are more comfortable with a fixed-rate mortgage, which assures that your interest rate does not change due to fluctuating markets, or an adjustable-rate mortgage that may equate to a larger loan but carries a risk of increased payments. Inquire about options like prepayment (or penalties if applicable) or whether you can transfer the mortgage to a different home at a future date. Some lenders also allow you to transfer the mortgage to a future buyer of your home, or allow you to purchase a home and assume the previous homeowner’s mortgage.

The Pitfalls

The crash of the housing market in the mid-2000s still has an enormous impact on today’s lenders. Easy-to-obtain loans and risky lending practices led to this crash; today’s lenders may be difficult to work with, but honest providers who practice fair business do exist. Be wary of any lender that pressures you to sign a contract, particularly if your questions have not been adequately answered. You have no liability if you haven’t signed; if you have, the federal Truth in Lending Act provides you and the seller with a 72-hour window within which you may cancel the contract. If you feel that your lender may be operating unethically, consult with a mortgage attorney.

Determine the going interest rate and shop around among several lenders. An unstable market can mean wildly fluctuating interest rates, so be aware of the risks before you commit to a variable-interest mortgage. Pay close attention to closing fees; lenders are legally required to disclose all fees in a Good Faith Estimate when you apply for a loan. Nearly every step in the process has a cost attached, so ask your lenders for specifics to avoid a nasty surprise at closing. Also, be sure to investigate any hidden costs that are associated with the new property, such as association fees, unpaid property taxes or liens against the property.

Federal and state government laws exist to protect consumers from unscrupulous mortgage lenders, particularly since the predatory lending practices that led to the housing bubble from 2000-2006. The Truth in Lending Act, the Fair Credit Reporting Act and the Real Estate Settlement Procedures Act have all been put in place to protect consumers. Additionally, most states have lender-specific requirements that prevent fraudulent practices such as hidden fees, repeat mortgage sales and improper income valuation. Check your state’s particular law before you begin seeking a mortgage.

Continue to Part V: Financial Management in the Retirement Years.
Back to Table of Contents.