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.
Some questions you might ask yourselves when making this choice:
How long do we expect to stay here?
Is renting or owning more affordable here?
Are we both finished with school?
Can we afford the extra expenses of home ownership?
How soon would we like to add to our family?
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 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.
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 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.
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