A home mortgage is a loan provided to potential homebuyers that do not have the cash to pay for a house all at once. Through this medium, it is possible to purchase a dream home and pay for it slowly over years or decades. In the current economy, interest rates are low and this means that it is still possible to capture a great deal on a home mortgage.
In fact, this is not only true in the U.S. but around the world, as well. We can remember back to 2008 to see that certain types of mortgages (sub-prime mortgages) actually played a major role in the financial collapse of the world economy. Clearly, these are lessons that will need to be remembered in the future.
Knowing what you can afford
Luckily, the process of obtaining a home mortgage does not need to be a catastrophic event. The first critical task before any home mortgage applications are filed is to know how much you can afford to finance.
As a quick reference, this chart outlines some of the limitations that homebuyers should set for themselves relative to gross income. Debt-to-Income ratios (DTI) tend to be based off of two key percentages: 29% and 41%. So, for example, a household with an income of $70,000 a year is often limited to monthly mortgage payments less than $2,391.
This does not necessarily mean that your lender will hold you to these limits but, in most cases, banks do not like to see homebuyers exceed these levels. Many interested buyers have no idea what size home mortgage they qualify for, so they end up trying to take out the largest loan a broker will approve. This approach to acquiring a home mortgage is not the wisest option, and it can put your family at risk of foreclosure.
Determining loan eligibility
A trusted mortgage company will often go beyond the formula of simply determining someone’s basic eligibility, and actually take into consideration the security of the homeowner’s financial future. It is important for prospective homeowners to ask questions of the mortgage broker to explain how home mortgage eligibility is determined. This can also help new homebuyers to lock-in the best possible mortgage rates in many cases.
Net income vs. gross income
When assessing whether an individual qualifies for a home mortgage, many things are taken into consideration. Normally, a monthly mortgage payment will need to remain below the DTI standards that have been developed by the bank.
It may be possible to raise lending limits in cases where credit scores are above average. However, it is essential that buyers understand that they will be paying for their loans from their net income (not gross income). Other expenses (such as car payments, taxes, credit cards and other loans) must be considered when deciding what mortgage size one capable of handling.
This can be easy to forget, given the fact that DTI ratios are determined by gross income. But this is not the way payments will be structured in practice, and it is critical that home buyers understand this before making any real estate purchase.
Mortgage Interest Rates
Over the life of a home mortgage, it may be surprising to learn that one of the largest total expenses is interest rates. This is true even in today’s low-interest rate environment because of the nature of compound interest. Of course, mortgage companies are just like any other business — they have to make money to remain viable.
In order to make money, banks charge interest on the amount of money they lend. As a homebuyer, it is important to shop around so that you can obtain a fair and competitive interest rate that puts your family in a position to achieve financial stability through retirement.
Interest rates are included as a factor in the DTI calculation because this will have an important determination on the final monthly payments. If you are able to secure a lower interest rate, it is possible to finance more through the house itself and this is one of the ways homebuyers can maximize their benefits in home mortgages.