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mortgages Archives - Personal Finance For Beginners In 30 Minutes

All about down payments and mortgage requirements

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It’s exciting to buy your first home, but act responsibly when it comes to making this purchase:

  • Live within your means.
  • Don’t get yourself into risky or untenable situations when it comes to choosing a home or taking out a loan.
  • Do not assume the value of the property will increase.
  • Do not assume you will be able to “flip” the home in a few years for massive profits.

Most people need to take out a mortgage to buy their first home. Typically, they’ll bring a down payment for a small percentage of the purchase price in addition to meeting the other mortgage requirements. On a $100,000 home, it might be $20,000.

Where do you get the money for the down payment? If you’ve followed my earlier advice in this guide to establish a special savings account for emergencies or other special situations, you can use this money for the down payment. A lot of people get help from relatives, or sell other liquid assets, such as stocks and bonds.

The remaining $80,000 will be paid for using a mortgage, which is essentially a large amount of money loaned to you by a bank. You pay back a small amount of money to the bank every month over many years.

Mortgages have to be paid back in monthly installments over 15, 20, or 30 years. The monthly payments are usually equal (exceptions include adjustable rate mortgages), and include principal as well as interest that the bank charges.

The size of the monthly payment depends on the amount of the loan, the length of the mortgage (also known as the “term”), and the interest rate offered by the bank at the time the mortgage started. Here’s how a $200,000, 30-year mortgage at a fixed 6% interest rate breaks down:

Monthly principal and interest payments: $1,199

Annual principal and interest: $14,389

Total interest over 30 years: $231,676

Total payments over 30 years: $231,676 + $200,000 = $431,676

The principal declines gradually over 30 years, until the mortgage is paid off:

$200,000 mortgage example - payments over 30 yearsIf you feel the interest rate is too high, you can apply points to the mortgage. Points are a method of lowering the interest rate in exchange for an upfront payment. You might pay a few thousand dollars for 1 point, which will drop the interest rate a full percentage point. This lets you lower your monthly payments, but you’ll have to deal with the upfront cost of “buying” the points at the closing.

Regardless of the interest rate and the length of the term, you’ll also need to pay so-called closing costs (translation: expensive fees) to seal the deal. Lawyers and appraisers need to be paid. There are “origination” fees, fees to make adjustments or filings relating to the deed, etc. These can vary a lot from bank to bank, from just a few thousand dollars to more than $10,000. Shop around and ask about the closing costs associated with a particular mortgage product. Some banks allow you to fold most closing costs into the mortgage, which is one way to reduce the pain.

Tips for buying your first home

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Buying your first home means dealing with bankers, real estate agents, and real estate lawyers. There are often elaborate rituals around negotiating a price, and then closing the deal. I won’t go into detail here, because there can be a tremendous amount of variation depending on the state or locality, and whether or not the market is active. But there are some basic steps that everyone should take:

  • Know the area you are moving to. Once you have narrowed down the list of communities you are interested in relocating to, find friends or colleagues who have purchased a home in the same areas in the past few years. Ask them about the pros and cons of the communities, as well as local market conditions.
  • Find a trustworthy real estate lawyer. Schedule a short meeting or phone call to introduce yourself and see if you feel comfortable with the lawyer before commissioning him or her to represent you at closing. Use the opportunity to ask some questions about the processes involved with purchasing a home and sealing the deal, such as closing costs.
  • Don’t jump at the first property you see. Attend as many open houses or showings as possible to understand what’s available and how sellers are pricing their homes.
  • Be honest with yourself (and your partner) about what you like and don’t like about each property you see. Don’t assume that you can fix something or you’ll “get used to it” later on.
  • Identify potential problems that may not be apparent during the open house. For instance, if a neighboring property operates a dog kennel on one side, and a fleet of school busses is based in the big parking lot on the other side, you can expect noise from barking, back-up alarms, and idling engines. If the property is near wetlands, mosquitoes or other critters might be an issue.
  • During the negotiation process, try to moderate or eliminate time pressures, which tend to work against your interests. In a hot market, this may be difficult, and there are some deadlines that cannot be changed (such as the closing date, the expiration of a purchase agreement, or the “lock-in” period of a mortgage rate).

Tips for buying your first homeOn this last point, time pressures can lead people to make big mistakes. As you are reading this, a real estate agent somewhere in America is telling a prospective buyer, “You better get your offer in by tomorrow, before someone else takes it! We had a lot of interest at the open house.” Regardless of whether the statement is true or false, it encourages premature bids and higher prices.

However, you can fight the pressure, and take other steps that give you more breathing room or a chance to find the right home for you and your family.

For instance, let’s say you are renting and want to buy your first home. If you have a lease that expires on May 31, don’t assume that you have to close on a new home by then. Ask your landlord to extend the lease on a monthly basis (perhaps for a slightly higher rent), or consider moving into temporary housing until you can find a great home that’s right for you.

This post was excerpted from Personal Finance For Beginners In 30 Minutes, Vol. 2, by Ian Lamont. All rights reserved.

What are assets?

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Your house, the cash you have in your checking account, the car in your driveway, the oak table in your dining room, the pair of running shoes in your closet, and the phone in your pocket are all considered “assets.”

However, when it comes to personal finances, assets typically refer to big-ticket items — houses, cars, boats, rental properties, precious metals, bank accounts, retirement accounts, etc. (the accounting definition is different.)

Your running shoes, beer steins, old Madonna albums, and a football with Tom Brady’s autograph may hold great personal value, but they may not be worth much on the open market. Indeed, they may be hard to value, much less convert to cash. Other assets may have cost tens or even hundreds of thousands of dollars (a college diploma) but cannot be converted back to cash.

Major assets such as homes, vehicles, land, savings accounts, stocks, bonds, and other equities can be used to calculate a person’s net worth. Banks and other financial institutions may use this information to determine how much you can borrow, if you’re applying for a mortgage or home equity line of credit (more on that later).

Assets example: A home or personal property

In addition, for certain assets, you may have only a partial ownership. A house is a typical example. Unless you’ve bought it outright, or until you have paid off your mortgage, you only have a limited amount of equity in the property. For instance, “I have 30% equity in my condo” or “I have $100,000 worth of equity in my house” reveals the amount you have paid for. The remainder is still owned by the bank.

What if you don’t have any assets beyond that beer stein collection or a copy of Madonna’s Vogue in mint condition? That’s OK … this book is written for people who want to build up their assets, and improve their long-term financial health.

This post was excerpted from Personal Finance For Beginners In 30 Minutes, Volume 1:
How to cut expenses, reduce debt, and better align spending & priorities
.

How credit ratings agencies “score” you

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A credit report is a document that grades you on your ability to pay your bill. The credit ratings agencies that provide the reports — Experian, TransUnion, and Equifax — gather information from the credit card companies, mortgage lenders, department stores, utilities, and other firms that have provided credit to you in the past. The information they gather is aggregated into what’s called a FICO score, a number between 350 and 850 that reflects your creditworthiness.

People with lower FICO scores are considered less likely to pay their bills. Mortgage, credit card, telecommunications companies and even some utilities may reject their applications, or may charge higher rates and fees.

Among the population at large, relatively few have terrible credit card scores. The following table shows the distribution of FICO scores among people evaluated by one of the credit rating agencies, TransUnion. More than 50% have a FICO score above 700:

Transunion credit ratings agency

How to get a free credit report

Typically, when you apply for a new credit card or mortgage, or want to rent an apartment, the bank, lender, or landlord will run a credit report on you. They want to know if you are likely to pay on time and pay off any debt that you incur.

Wouldn’t it be great to see your credit report? It would allow you to understand your credit profile from the view of banks and other issuers, and identify any potential problems that need to be addressed.

Here’s some good news: You can see your credit report, and it’s free, thanks to federal law. Go to the government-operated website usa.gov and look for the links that direct you to an external site that is the only official location to request reports from the three big agencies. Note that the free reports show many details about your credit history, but do not show your credit score — that is only available for a fee.

Once you get your report, check it carefully. If you see mistakes such as incorrect information about a dispute, unpaid accounts that you never opened, or other people (and their debt) being associated with you, there are processes for having this information removed.

Be on the lookout for situations that might indicate identity theft. You will need to resolve any case of fraud that is wrongly associated with your identity. Further, there are rights you have as a consumer — check out the ftc.gov website to learn more.

This post was excerpted from Personal Finance For Beginners In 30 Minutes, Vol. 1, by Ian Lamont. All rights reserved.

Considerations when buying your first home

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So you’ve reached that stage in your life when you are considering buying your first home. Maybe you just got married, or are ready to have kids, or have enough stability in your life where it makes sense to put down roots in a particular neighborhood.

Then there are the financial considerations. If done sensibly, purchasing a home can be a great way to strengthen your financial health while providing shelter and stability for you and your family. It’s also a way of eliminating rental payments, which generate no long-term financial value. Long-term, your home can become an important part of your retirement planning strategy.

However, buying a condo, house, or trailer doesn’t make sense for everyone. If local housing prices and/or interest rates are high, the monthly outlay for a mortgage, real estate taxes, and other costs associated with home ownership may simply be too expensive.

The New York Times has an online calculator that lets you determine whether it makes more sense to rent or buy, based on the following criteria:

  • Home price
  • Number of years you will inhabit the property
  • Mortgage rate/term
  • Home price growth rate
  • Growth in rental rates
  • Property and marginal tax rates
  • Maintenance/renovation costs
  • Utilities/common fees
  • Inflation

Plug in all of the variables and the calculator will spit out a price that shows whether buying a home makes sense.

Renting vs buying a house - NYT housing calculator

However, the calculator does not take into account other factors and intangibles, such as local school quality, location of the home relative to your place of work, environmental conditions, and whether or not there’s a decent bar or barbecue joint in the neighborhood. These things really matter, and sometimes are very hard to quantify.

Regardless, when the time comes to purchase a home, you’ll need to understand some of the basics (mortgages, fees, etc.) and be aware of some other considerations.

This post was excerpted from Personal Finance For Beginners In 30 Minutes, Vol. 2, by Ian Lamont. All rights reserved.

What is a mortgage?

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The following post was excerpted from Personal Finance For Beginners In 30 Minutes, Vol. 1, by Ian Lamont. All rights reserved.

If you’ve purchased a house or condo, you probably had to take out a mortgage. What is a mortgage? In a nutshell, mortgages are loans from banks that help homebuyers pay the difference between the cash they have available to pay for a home and the actual cost of the home.

Typically, mortgages have to be paid back in monthly installments over 15, 20, or 30 years. The monthly payments are usually equal (exceptions include adjustable rate mortgages, described below), and include principal as well as interest that the bank charges.

The size of the monthly payment depends on the amount of the principal, the length of the mortgage, and the interest rate offered by the bank at the time the mortgage started. Here’s how a $200,000, 30-year mortgage at a fixed 6% interest rate breaks down:

Monthly principal and interest payments: $1,199
Annual principal and interest: $14,389
Total interest over 30 years: $231,676
Total payments over 30 years: $231,676 + $200,000 = $431,676

The principal declines gradually over 30 years, until the mortgage is paid off:

What is a mortgage example

This is a greatly simplified view of mortgage payments. Not shown in the data above:

  • Even though the monthly payment never changes, interest payments are high during the early years of a mortgage. Toward the end of the 30 years, most of the payments will be paying back principal.
  • Local real estate taxes are not included.
  • There are fees related to setup, late payments, and other situations.
  • Lenders are required to reveal the annual percentage rate (APR), which is the mortgage rate plus fees, points, and some closing costs. If there is a big difference between the quoted rate and the APR, watch out!

Another risky situation that can lead to serious pain down the road involves monthly payments which “balloon” after a set number of years, which is typical of adjustable rate mortgages (ARMs). Here’s a typical ARM offer:

What is an ARM mortgage example
The initial rate is low, but the rate after the first 5 years is unknown. There is a real risk that the rate could more than double in the 6th year, which would greatly increase monthly payments.

You should always understand the terms of a mortgage based on the printed documents you sign as well as professional advice from an accountant, housing counselor, or experienced real estate lawyer.

This post was excerpted from Personal Finance For Beginners In 30 Minutes, Volume 1:
How to cut expenses, reduce debt, and better align spending & priorities.