Because hardly anybody has a couple hundred thousand dollars available to hand over for a home, we rely heavily on mortgages when purchasing homes.
A mortgage is a loan you get from a bank or other lender. You borrow the difference between the cost of the house and the money you have for a down payment and agree to pay it back over a specified period of time and at a specified rate of interest.
On one hand, mortgages are great because they provide a means for buying a house. On the other hand, they can be financially crippling if they’re not managed properly.
A mortgage is a loan for the purpose of property. The loan is secured by a lien on the property and comes with conditions regarding the length of time over which it will be repaid, the amount of interest you’ll pay on the loan, and other factors.
Foreclosure is the legal process in which ownership of a home transfers from the homeowner to the mortgage lender. This occurs when the homeowner does not make the agreed-upon payments on the mortgage.
To determine how much you’d be able to get for a mortgage, you need to consider a few things. First, think about how much money you have available to put down. Then consider how much you earn and what your expenses are. These factors will help you figure out how much you can afford to borrow.
The Down Payment
Generally, a lender such as a bank or a mortgage company requires that you have about 20 percent of the selling price of the home you want to buy to use as a down payment. This makes it difficult for many younger people today because wage growth has been slow, the cost of renting is high, and the average student loan debt is $30,000.
The real estate research firm RealtyTrac estimated that a typical millennial would need 12½ years to save enough money for a 20 percent down payment on a home.
There’s good news, however. In 2015, the federal government reduced the cost of mortgage insurance and the minimum amount of money needed for a down payment for first-time homeowners who qualify for a government-backed mortgage such as through the Federal Housing Administration or from the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac).
Fannie Mae and Freddie Mac are publicly chartered corporations that buy mortgage loans from lenders. This ensures that mortgage money is available at all times, everywhere across the country. In September 2008, the federal government took over both of these corporations as they teetered on the brink of failure. The takeover was meant to keep the companies afloat and mortgage money available.
If you qualify for a Fannie Mae or Freddie Mac mortgage, you may be able to get a minimum down payment of only 3 percent, down from 5 percent previously. Not everyone supports these home-buying incentives, but they are the government’s response to the lowest rate of home ownership in the United States in 20 years. Only about 65 percent of all Americans owned homes in 2015, and only about 36 percent of people under 35 owned.
If you don’t qualify for a government-backed mortgage, you’ll probably need a larger down payment. The bigger the down payment you make, the less your monthly mortgage payment will be. This can work in your favor in two ways: you can lower your monthly payments and have more money to invest or for other purposes, or you could afford a more expensive house with a bigger down payment because you’ll be financing less of the cost of the home. For example, if you buy a $175,000 home and make a $10,000 down payment, you have to finance $165,000. But if you have $35,000 for a down payment, you could buy a $200,000 home and only have to finance the same amount as you would have on the less-expensive home with a smaller down payment.
Your Income and Expenses
To determine how big a mortgage you probably can get, look at how much money you make before taxes. This amount is your gross income. The recommended guideline is that you should spend no more than 28 percent of your gross monthly income on your mortgage payment.
The mortgage payment includes the principal, interest, real estate taxes, homeowner’s insurance, and PMI if applicable. The principal of a mortgage is the amount loaned. If you borrow $200,000, that amount is the principal, and you are obligated to repay a portion of that mortgage amount each month. You pay principal every month based on the unpaid balance of the mortgage. The interest is the fee the lender charges you to use its money.
Your gross income is your income before taxes are deducted. The principal of a mortgage is the amount of money loaned to you. The interest is the fee you are charged to use the principal.
When you’re thinking about applying for a mortgage, you must pay close attention to all your expenses as they relate to your income. Although the recommended maximum for your mortgage payment is 28 percent of your gross monthly income, the historical maximum for your total monthly debt is 36 percent of your income. That means all your debt other than a mortgage—such as your car payment, credit card bills, student loans, child support payments, and other bills—should total no more than 8 percent of your gross income.
You need to take a realistic look at your gross income and all the expenses you’ll be faced with once you’ve bought a house. Then consider your down payment, and you’ll be able to determine how much you can afford to borrow. Many good mortgage calculators are available online, or you can get an app such as Quicken Loans’ Mortgage Calculator to help you.