your guide to
buying and
financing a home
Whether you’re a first-time homebuyer or you’re a seasoned pro, purchasing
a house is a big step that can be stressful and overwhelming.
First there’s the matter of finding the perfect home for you and your family.
And after that, there are countless steps that have to be completed: getting
finances in order, setting a budget, selecting a mortgage, preparing for the
hidden costs and much, much more.
In this booklet you’ll find a collection of our most useful tips from
MidWestOne mortgage bankers and the Hands On Financial Advice
website. These simple and actionable articles are designed to help you make
the home-buying process as enjoyable as possible.
Happy reading!
Hands On
Financial Advice Team
HandsOn
Advice.com
and financing a home
5 questions to ask when deciding whether to rent or buy a home 3 Getting your finances in order 4 - 5 How to set your budget 6 Mortgage 101 7 Hidden costs of a buying a home 8 Pay off mortgage early or invest? 9 Does it make sense to refinance your home? 10 What you should know about a HELOC 11 Reverse mortgages – get the facts first 12 - 13
After saying “I do…” many newlyweds start the home buying process. Owning a home has always been a part of the American Dream and one that many people are willing to work hard for.
This year, first-time homebuyers have a lot to consider when making the decision to rent or buy a home: interest rates are still relatively low, there’s still plenty of housing stock and prices are at or near their lowest in years.
Nonetheless, deciding whether to buy a home or rent an apartment can be a complicated decision. How do you know what’s right for you? Potential buyers should ask themselves several key questions before making this important decision.
1. What will monthly costs be, and
can I afford the payments?
Keeping your home-related payments under 30 percent of your monthly income is a good rule of thumb. This includes your mortgage payments as well as principal, interest, taxes, insurance and private mortgage insurance, if required. If you can’t keep mortgage payments below that, you may be better off renting for awhile.
2. What other debt do I have?
Total rent or mortgage payments plus credit obligations (such as car loans, student loans or credit card payments) should not exceed 42 percent of your gross monthly income.
3. What is my credit score?
Can I qualify for a good interest rate?
A high credit score indicates strong creditworthiness, and that qualifies you for better interest rates on a mortgage. For example, someone with a credit score of 740 and above is going to have less in closing costs. Lower interest rates also mean lower monthly payments. If your credit score is low, you may want to delay buying a home until you can improve your score.
4. How much will taxes, monthly
maintenance, or other fees cost?
Owning a home means you’ll have to pay real estate taxes and other costs like insurance and maintenance. Most lenders will require an escrow account for taxes, insurance and other costs.
5. How many years will I stay here?
Generally, the longer you plan to live in one location, the more it makes sense to buy. You’ll build equity in your house and its value may increase over the years.
These are just a few of the many important questions to consider before deciding to purchase a home. You can also refer to the Rent vs. Buy Calculator developed by the American Bankers Association. The calculator compares the cost of renting versus the real cost of buying a home. If you have additional questions about the home buying process, contact your local banker for more information.
your guide to buying and financing a home
Whether you’re a first-time homebuyer, or you’re a seasoned pro, purchasing a house is a big step that can be stressful and overwhelming.
One of the best ways to reduce the anxiety that often comes with making such a big purchase is to be organized and prepared.
Follow our five simple steps and you’ll be fully prepared to start the home buying process.
Request and review your credit
report.
Your credit history will not only dictate whether you will receive a loan – it will also determine the interest rate for the loan. As a result, it’s important to review your credit before you begin the home buying process so you are able to address any potential issues as quickly as possible. The Fair and Accurate Credit Transaction (FACT) Act allows you to get one free copy of your credit report every 12 months from each of the three nationwide credit reporting agencies –Equifax, Experian and Trans Union. To get your free annual credit report, go through the FTC’s website at www.annualcreditreport.com, call (877) 322-8228 or write: Annual Credit Report Request Service, PO Box 105281, Atlanta, GA, 30348-5281.
Once you have your report, review the information and ensure it is accurate. If there are any issues, take the steps to fix them immediately.
Reduce your debt.
When you apply for a mortgage, one of the things the lender will look at is the amount of debt you are carrying and how that compares to your gross work income. This is referred to as your debt ratio. In other words, the lender will want to make sure your debt does not exceed a certain percent of your income. (This percentage is typically around 38 percent.)
As you prepare to purchase a home, focus on reducing your debt as much as possible. Continue to make loan payments on time, pay down large balances on your credit cards and avoid taking on any additional debts.
Review your budget.
Your lender will want to have a clear picture of your monthly income and expenses to help them determine exactly how much money they will be able to loan you. More importantly – a budget will help you determine how much you can afford on a monthly mortgage cost.
Review your budget and get a concise picture of how much money you have coming in and going out. If you haven’t created a budget, now’s the time. Here’s how you set one up:
• Determine your income. • Determine your fixed expenses. • Determine your variable expenses. • Compare your income to your expenses. • Adjust as needed.
• Evaluate your budget.
getting your finances in order
Get your down payment together.
The more money you are able to put down when you buy a home, the better your interest rate and the lower your overall monthly payment. Using your budget, determine how much money you will be able to use as a down payment for your new home.
Many experts recommend a down payment of 20 percent of the purchase price. However, not everyone has that much cash available. Don’t worry; your lender may be able to identify other options for you.
Nevertheless, the fact remains that the more you put down, the lower the mortgage. Low mortgage balances carry low mortgage payments.
As you’re going through this process remember that you don’t want to utilize all your savings towards a down payment. In addition to money for every day expenses, make sure you have at least 2 months’ worth of living expenses remaining to cover emergencies that may arise.
Gather financial documents.
Start pulling together the documents your lender will want to review during the loan pre-approval process. These include:
• 2 years of Federal tax returns. • Most recent 2 years of W-2’s.
• 2 months worth of bank and 401(k) statements and other assets.
• Most recent 30 days of pay stubs.
With these five steps completed you’ll be ready to schedule an appointment with your lender to get the credit approval process started.
Once you’ve made the decision to purchase a home, the next big step is figuring out exactly how much you can afford. This is extremely important, because the dream of home ownership can quickly turn into a nightmare if you buy a home you cannot truly afford.
Establishing a budget for your mortgage helps protect your financial interests down the road. Take the time to consider the following steps:
Evaluate your financial situation.
Take stock of your finances and determine how much money you’d like to provide as a down payment on your home. Make sure you are not completely depleting your savings. In addition to money for every day expenses, it is recommend you have at least 2 months’ worth of living expenses remaining to cover emergencies that may arise.
Consider the future.
Taking your current financial situation into consideration is important – but there’s more to it. Your future goals and potential life changes also play a large role in budgeting for a mortgage. Do you plan to start a family soon? Do you have children leaving for college? Do you plan on replacing a car in the years to come? Do you anticipate any changes in your employment situation?
Also, consider potential future maintenance costs when evaluating a home. Will you need to fix the roof in a few years? Will you need to replace the windows, the heating and air conditioning system, kitchen appliances? Those are some major cost factors in owning a home, and if you need to do any of the major projects within a few years of buying the house, this could impact your monthly budget.
Give yourself a safe buffer by choosing to take out a mortgage that will accommodate potential changes in your future.
Review your monthly budget.
Calculate your gross monthly income, which is your income before taxes and deductions. For example, if your salary is $40,000, your gross monthly income is roughly
$3,333. Bankers will use this amount as part of qualifying you for a mortgage.
Next, figure out what your income is after taxes and deductions. Then, add your debt commitments, including loans and credit card debt, and subtract it from your net income. Also, subtract your down payment and the amount of money you will retain in your savings for living expenses and an emergency fund. Divide this number by 12 to determine the amount that is available for your mortgage payment.
Factor in additional costs.
Once you actually begin looking at properties, keep in mind that your monthly mortgage payment consists of more than just the principal and interest charges. In addition, you must factor the following into your monthly mortgage payments:
• Real estate taxes – If you have your eye on a certain home, divide the home’s annual property tax amount by 12 to estimate the amount you need to pay or set aside each month. For example, if the property taxes are $4,200 per year, the monthly amount is $350. • Homeowners insurance – talk to your real estate agent
or call an insurance agent to receive an estimate on this cost.
• Private mortgage insurance, often referred to as PMI. PMI kicks in when you put down less than 20 percent of the home’s value towards your home purchase and is designed to protect the lender.
It’s important to keep all these factors in mind when you are determining your monthly mortgage budget. To help you with these calculations, take a look at the “monthly payment” calculator on the MidWestOne website.
Compare your estimated monthly
cost with your income.
Once you have determined a monthly cost for home ownership, divide that amount by your monthly gross income. This will result in the percentage of your income. Many lenders will require that percentage to be no more than 28 percent.
how to set your budget
Selecting a mortgage can be confusing, frustrating and time-consuming. Nonetheless, picking a mortgage may be the most important financial decision you will make. Mortgage lenders offer a variety of loans under different names with different interest rates, up-front costs, and fine print terms. Take your time to learn about all your options to ensure you receive a mortgage that best fits your needs at a competitive price.
What is a mortgage?
Likely the largest debt you’ll ever take on, a mortgage is a loan to finance the purchase of your home.
Your mortgage consists of a “life” of the mortgage and a “term” for the interest rate that you choose. The life of the home mortgage is commonly 15, 20, or 30 years. This represents the length of time in which your home will be paid off (if you pay regularly and with the specified amount). You will also have a term for the interest rate that you pay on your home mortgage. In effect, this is the time period over which you’ve agreed to pay at a particular rate of home mortgage interest (either locked in or floating).
There are many different types of mortgages available on the market, including, fixed rate, adjustable rate, combination, graduated payment, and others.
Fixed rate mortgages
The fixed rate mortgage (FRM) is considered by many as the “traditional” mortgage. Its advantage is that neither the interest rate nor the monthly payment (principal and interest) changes over the life of the loan.
There are two main types of fixed rate mortgages: • 30 Year Fixed Rate Mortgages and
• 15 Year Fixed Rate Mortgages
Other terms (such as 10 or 20 Year Fixed Rate Mortgages) exist but they are not as commonly used.
The beauty of fixed rate mortgages is that they allow you to predict what your loan payments will be in the future. No matter what happens with interest rates, your payments won’t change. Because these are fixed payments over a long period of time, the interest rate may be a bit higher.
Adjustable rate mortgage
If you plan to move or refinance in 3 to 5 years, an adjustable rate mortgage (ARM) might be the better choice for you. With an ARM, the interest rate can – and probably will – change periodically during the life of the loan, depending on interest rates in financial markets. It’s a trade-off. You get a lower rate with an ARM in exchange for assuming more risk.
You should review how long you intend on living in this particular property and weigh the advantage of the lower payment at the beginning of the loan against the risk that an increase in interest rates would lead to higher monthly payments in the future, assuming you still own the property. With most ARMs, the interest rate and monthly payment are fixed for an initial time period such as 1 year, 3 years, 5 years, 7 years or 10 years. After the initial fixed period, the interest rate can change every year. One of the most popular mortgages is 5/1 ARM. The interest rate will remain fixed, at the initial rate for the first 5 years, but has the ability to change every year after the first 5 years.
mortgage 101
your guide to buying and financing a home
Most ARM interest rate changes are tied to changes in an index rate. This provides you with assurance that rate adjustments will be based on actual market conditions at the time of the adjustment. If the index rate rises, your mortgage interest rate may as well, and you will probably have to make a higher monthly payment. On the other hand, if the index rate goes down your monthly payment may decrease.
One feature of ARM that can help protect the borrower is interest rate caps.
An interest-rate cap places a limit on the amount your interest rate can increase or decrease, at any adjustment period. As you can imagine, interest rate caps are very important since no one can predict what will happen in the future.
While there are numerous mortgage products available these are two of the most common ones. Don’t hesitate to work closely with your loan officer to learn about all your options.
As if the home-buying process isn’t overwhelming enough, there are many hidden costs of purchasing a home that you should account for in your overall mortgage budget. We’ve pulled together a quick overview to help you ensure you don’t overlook any hidden costs.
Closing costs
Closing costs are the various fees charged by those involved with the home sale. As a rule of thumb, closing costs run about 2 to 4 percent of the purchase price. They typically include:
• Appraisal – Your lender will typically expect you to pay for an appraisal to ensure the purchase price of the property is equal to or less than the value of other homes in the marketplace of the same size and type. • Credit report – you’ll be expected to pay for the
costs associated with pulling your credit report (and potentially your partner’s report) so the lender can identify the liabilities that you have and pay on a monthly basis, which in turn will aid in determining the interest rate for your loan.
• Title fees and searches – In order to determine the legal ownership of a property and the liens or judgments that may be attached to the property, a title search is performed by a third party. An attorney identifies any items that must be resolved in order to convey a clear and clean title to you. The lender will then have the title guaranteed by the State of Iowa to insure against errors and omissions. As the buyer, you may be responsible for both of these costs.
• Attorney fees – In most states, including Iowa, attorneys are required to be part of the home buying process. • Recording fees- These are the costs for recording the
deed to the property with the county, showing you as the new owner and the mortgage, showing that there is a lien against the property for the mortgage loan.
Inspections
A home inspection is a complete and detailed inspection that examines and evaluates the mechanical and structural condition of a property. As a buyer you’ll want to make sure you complete an inspection before you move into escrow. In Iowa, you should estimate roughly $400-$500 for a thorough home inspection.
Adjustment costs
Depending on when your purchase actually closes, the seller may owe you for taxes that you will be paying in the future on this home. In Iowa, the property taxes are paid in arrears. When the seller sells their home to you, they need to pay their proportionate share of the upcoming tax bill, which reflects the taxes that were incurred while they were living in the property.
Private mortgage insurance (PMI)
If your down payment is less than 20 percent, you will likely have to pay PMI. This added cost is usually rolled into your monthly mortgage payment and may remain even after 20 percent equity is reached unless you choose to refinance.
Insurance
Don’t forget about your homeowners insurance. Also, depending on the location of your new home, you may also be required to purchase flood insurance.
Maintenance costs
Many people don’t think about short-term maintenance costs when buying a home, but they should. Whether buying an older home or a newly constructed home, major home systems like furnaces or hot water heaters can break down. By adding this into your monthly budget upfront, you will be able to address these costs when they occur.
New furnishings and other
related expenses
This is a hidden cost that many people overlook – especially if it’s your first time buying a home. Will you need to purchase new furniture, appliances, window coverings or other items for the home? Make sure you take these into account in your budgeting process.
your guide to buying and financing a home
As you begin to count down the years (or months) to retirement, you may be one of the many people who wonder if you should just knock off the remainder of your mortgage balance so you can live debt free.
This is a question many empty nesters struggle with: Should you pay off your mortgage early? Or should you use those extra funds and invest them instead?
Let’s begin by looking at the advantages of paying off your mortgage early.
The case FOR paying off your
mortgage early
The first and most obvious reason for paying off your mortgage early is that it will save you money. For every dollar you pay early, you’re “earning” the interest you would have otherwise paid over the balance of the loan period. This means that you’ll end up saving a good amount of money on interest payments. In addition, the money saved is risk-free and guaranteed, as opposed to other investment tools. Another big advantage of paying off your mortgage early is the peace of mind you will have in knowing you are mortgage free and your home is entirely yours.
With the lower cost of living, the prospect of unemployment or underemployment is no longer so daunting. You can now imagine retiring or taking a job that pays a whole lot less than your previous position without any concerns about losing your home.
To see how long it might take you to pay off your mortgage, check out MidWestOne’s mortgage calculator.
The case AGAINST paying off your
mortgage early
On the other hand, by paying off your mortgage early you may be giving up on investment returns that might outweigh your mortgage interest rate. For example, why pay off a 5% mortgage early when you could be earning 8-10% (or more) on that money? (Keep in mind that these types of returns are never guaranteed, while mortgage savings are.)
Also, for many people, their home is a significant portion of their assets. By prepaying, you are adding more stock into property, which could result in too much investment in real estate. By instead investing your money into other financial tools, you are reducing your overall financial risk through diversification.
Another important thing to consider when making this decision is tax deductions. Your tax savings decline the further you get into the loan, as more money is applied toward principal.
Nonetheless, if you pre-pay, you are also reducing the amount of money you could use for tax deductions. Meet with your CPA to ensure you understand the tax ramifications of paying off the mortgage in advance. There are both advantages and disadvantages to paying off your mortgage early. Make sure you meet with a financial planner before you decide to prepay your mortgage so you can determine if it is indeed the best approach for you.
As a homeowner, there will more than likely come a time when you will feel like it is a good idea to refinance your home. However, it’s important to keep in mind that refinancing a home isn’t a decision that should be taken lightly.
There are costs involved with refinancing a home, and it’s important to consider your long-term plans for the house before you embark on the refinancing process.
Determining the best time to refinance your home mortgage can take some time and effort, but if you educate yourself on market trends, your research might help you save a lot of money on your mortgage. We’ve put together some things to consider:
Determine why you want to
refinance
Do you currently have a variable interest rate, and you’d prefer a fixed interest rate? Do you want to switch from a 30-year mortgage to one that is shorter? Or do you want to refinance so you can take out equity to pay off debts? Understanding your end goal is important to determine if it makes financial sense. Remember – refinancing doesn’t eliminate debts – it simply restructures them.
Educate yourself
Educate yourself about the different types of mortgage loans that are available. Different loans are used for different purposes, such as repaying your mortgage faster, flexibility, etc.
Seek out a mortgage lender
Find a reliable mortgage lender who you trust and has your best interest at heart. Your lender should spend time with you discussing your long-term plans and determining the best financing options based on those plans. For example, one of the things to think about is how long you will be staying in the property.
Check your credit
Seek out your credit report from the three main credit reporting agencies and check it for accuracy. If you find inaccuracies, immediately begin the process to correct them. Your credit report impacts your credit score, which in turn will influence your refinancing.
Stop applying for credit
If you plan on refinancing your home don’t open new credit cards or department store cards. New lines of credit can drive down your credit score and negatively impact your interest rates.
Crunch the numbers
Determine if refinancing is really going to benefit you. If you’re switching from a variable rate loan to a fixed loan, estimate how much you will likely save. Do the same thing if you’re opting for a shorter-term loan. Talk to your lender, discuss your options and calculate whether the numbers will result in an honest benefit. Not a numbers person? Let us do those calculations for you!
Refinancing a home is a big decision. While it takes time to determine the best options for you, it can be well worth the effort.
does it make sense
If you own a home, you may have heard of Home Equity Loans and Home Equity Lines of Credit (HELOC). Because a home often is a family’s most valuable asset, many homeowners use home equity credit lines to finance major items, such as education, home improvements, or medical bills.
If you are in the market for credit, a home equity plan is one option that might be right for you. Before making a decision, however, you should carefully weigh the costs of a home equity line against the benefits. Shop around to ensure you are utilizing the best credit terms without posing undue financial risks. And remember, if you are unable to repay the amounts you’ve borrowed, plus interest, you could potentially lose your home.
What is a home equity loan?
A home equity loan is different from your original mortgage loan. It’s a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower’s equity in his/ her home. Your equity is the amount you would receive after selling a property and paying off the mortgage. A home equity loan provides a one-time advance and has a specific monthly payment with a specified repayment time frame. Flexible terms and competitive rates make this a convenient way to borrow money.
What is a HELOC?
HELOCs are similar to Home Equity Loans in that they use your “equity” in your home for you to use for many purposes. The difference with a HELOC is the way the loan works.
A HELOC has a maximum dollar amount that you are qualified for. This allows you to advance up to your qualified amount whenever you want. Many banks have both fixed rate and variable rate HELOCs. The payments are determined on how much you owe at the time of billing and there are even interest only HELOCs.
Advantages of HELOCs
One advantage of a HELOC is that you are able to pay down your loan, advance again, and pay down again as you have the funds to do so. This allows you to simply write a check to access your line of credit. Only borrow what you need, when you need it.
Some banks also offer fixed rate repayment options for HELOCs. This allows you to lock the rate, time period and payment of your loan. The advantage of this is that you will have predictable monthly payments that stay the same for the life of your loan. Also, even though you lock in a certain amount, you still have the remaining amount on your HELOC available to you.
The Risks of a HELOC
Some financial institutions promote a feature on a HELOC that allows the minimum monthly payment need only cover interest costs. A loan amount of $30,000, for example, might only require a minimum payment of $200. This allows you to float the balance from month to month. This can create issues over the long run. If you make only the minimum payment, you’ll never pay off any principal, and the loan will never go away.
Also – unless your rate is locked, interest rates on HELOCs are usually based on the prime rate, which tends to hover in the single-digit range. A HELOC’s loan rate is variable, however, and usually rises when the Federal Reserve increases rates to stem inflation. These increases can come quickly and may climb 2 percent or more.
Finally, your home may decrease in value while you’re borrowing more money. When it comes time to sell the house or refinance the loan, you may find that the equity that you had counted on has suddenly disappeared. Avoid this problem by making sure that the total amount of your home loans doesn’t equal more than 80 percent of the house’s market value.
As an empty nester, it’s likely you’ve heard the term “reverse mortgage” pop up more frequently among your circle of acquaintances.
Although we at MidWestOne Bank do not offer reverse mortgages, it is important to understand this type of mortgage option, to see if it is a viable option for you. If you’re 62 or older and looking for money to finance a home improvement, pay off your current mortgage, supplement your retirement income, or other expenses – it’s important that you fully understand how this financial tool works before you pursue it.
What is a reverse mortgage?
With a “normal” mortgage you make regular payments of principal and interest, to the lender. With a reverse mortgage, you can receive money from the loan or line of credit, and are not required to pay it back for as long as you live in your home, as your primary residence. In other words – it lets you convert a portion of the equity in your home into cash, for when you need it.
Unlike a traditional home equity loan or second mortgage, with a reverse mortgage you are not required to make regular monthly payments and won’t have to repay the loan until you no longer use the home as your principal residence or fail to meet the obligations of the mortgage. The reverse mortgage is an FHA, federally insured loan program and is repaid when you pass away, sell your home, or when your home is no longer your primary residence. The proceeds of a reverse mortgage generally are tax-free, and many reverse mortgages have no income restrictions.
Who is eligible for a reverse
mortgage?
To qualify for a reverse loan, you must: • Be 62 years or older.
• Own your home, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan.
• Live in your home, as your primary residence.
Due to the complexity of these loans, FHA also requires you receive financial counseling prior to obtaining this type of loan.
How much money can you receive?
The amount that is accessible to you depends on a variety of factors, including:
• The age of the youngest borrower on title. • The current interest rate.
• The appraised value of the property. • The cost of the mortgage insurance.
Your lender will use a formula to calculate the exact amount based on these variables.
How do you receive the payments?
If you determine that a reverse mortgage is the right choice for you, you will be able to choose from a number of different payment options.
• Tenure - equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
• Term - equal monthly payments for a fixed period of months selected.
• Line of Credit - unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted.
• Modified Tenure - combination of line of credit and scheduled monthly payments for as long as you remain in the home.
• Modified Term - combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.
reverse mortgages – get the facts first
your guide to buying and financing a home
Benefits of a reverse mortgage
A reverse mortgage can be a powerful financial tool for retirees:
• Receive cash or pay off debts without having to make any payments on your loan.
• You will not need cash to cover closing costs. You can use the money you receive to pay the loan’s closing costs. • It’s easy to qualify for a reverse mortgage because your
credit score or income stream is not considered. • Reverse mortgages allow you to stay in the property
for as long as you continue to pay the property taxes and insurance and live in the property as your primary residence, even if the outstanding loan and interest grow to exceed the property’s value.
• Reverse mortgages can be used as an estate planning tool. For more information on this, consult your tax planner.
Disadvantages of a reverse mortgage
While reverse mortgages have benefits, they also have some disadvantages:
• When you take out a reverse mortgage you are losing equity in your home.
• The money you receive from the loan is not free money – it has to be repaid to the lender.
• Reverse mortgages can often be more expensive than “normal” home loans. That is because lenders may have to wait many years for repayment of any kind. • It’s a complicated process that can be confusing and
overwhelming. Be wary of people who do not have your best interest at heart.
As with any other financial product, it’s important you educate yourself about the advantages and disadvantages of the tool before you decide if it’s the right choice for you.
