Increasing your purchase power
Maybe you can see that your house-buying options will be fairly limited. While you may indeed need to lower your sights, and simply recognize that you'll have to buy a less expensive home, there are other ways to help increase your borrowing power.
Reduce your existing long-term debt
This process relies upon your commitment to credit-building. We have already seen that if your existing debt is too high, in relation to your income, you will have to settle for a smaller mortgage. You can qualify for a larger mortgage by paying off some of this debt before you apply. When you start thinking about buying a home, you should look to reduce your other outstanding loans: your car loan, the boat loan, and your student loan payment. Remember, student loan debt is unique when it comes to qualifying for a mortgage; it does not matter the student loan balance (the total amount you need to repay), what matters is the amount of the monthly payment. When preparing to look for a home, try to reduce your monthly payment on your student loan debt.
Apply when your income increases
If you find that what is limiting your borrowing capacity is not the amount of debt that you owe, but rather the amount of income that you make, you may want to wait to apply for a mortgage until your income increases. Is it possible for you to put in some extra hours on the job until your pay goes up? Does your spouse or co-borrower expect a raise in the near future? You may want to wait a bit so you can qualify for a higher mortgage.
Find a financing option that results in a lower down payment and a lower monthly
If increasing your income is not a realistic alternative in the near future, you will have to consider a financing option that makes it easier for you to obtain affordable housing at your present income. Some of the ways you can "stretch" your buying power include private and government insured loans, mortgages for first-time homebuyers, and special financing options for low- to medium-income homebuyers.
Choosing mortgage insurance options
Unless you have sufficient funds to make a 20% down payment, the lender will almost always require mortgage insurance. Mortgage insurance helps protect the lender in the event the buyer fails to repay the loan. Loans that are insured, either by the government or by a private mortgage insurer, enable the homebuyer to purchase a home with a lower down payment that would otherwise be unacceptable to the lender. The mortgage insurance on government loans is known as a Mortgage Insurance Premium (MIP), and for all other loans the term is known as Private Mortgage Insurance (PMI).
We have already discussed how, with PMI, lenders will reduce the down payment requirement from 20-percent to as low as 3-percent of the purchase price. On a $120,000 home, instead of putting down $24,000, you might be able to make a down payment as low as $3,600. The cost of your PMI will be added to your monthly mortgage payments and your closing costs.
This may help
The U.S. Department of Housing and Urban Development has published an informative brochure regarding mortgage insurance that is provided through the federal government.
PMI - HUD PDF
Mortgage insurance also is available through three programs of the federal government: the Federal Housing Administration (FHA) mortgage insurance program operated by the U.S. Department of Housing and Urban Development (HUD), the Veterans Administration's (VA) loan guarantee program, and the Rural Housing Service (RHS) loan program. Let's look briefly at each.
With FHA insurance, you can purchase a home with a very low down payment (from 3 to 5 percent of the FHA appraisal value or the purchase price, whichever is lower). FHA mortgages have a maximum loan limit that varies depending on the average cost of housing.
The VA guarantee allows qualified veterans to buy a house costing up to $203,000 with no down payment. Moreover, the qualification guidelines for VA loans are less strict than for either FHA or conventional loans. If you are a qualified veteran, this can be an attractive mortgage program for you. To determine whether you are eligible, check with the VA regional office.
Rural Housing Service loans
The Rural Housing Service, (a branch of the U.S. Department of Agriculture, formerly known as the Farmers Home Administration), offers low interest rate homeownership loans with no down payment to low- and moderate-income persons who live in rural areas. Generally, "rural areas" include settled places having a population not in excess of 10,000, or not in excess of 20,000 if outside a Metropolitan Statistical Area (MSA). While this may not be an option for persons moving into Pinellas County, it may be of benefit to those who plan on moving into the outlying areas.
State and Local loan programs
A number of State and Local programs are available to help first-time homebuyers qualify for mortgages. These and other housing agencies offer attractive loan terms to eligible homebuyers in some areas. These loan terms often include low down payments or low interest rates to first-time homebuyers that meet specified income guidelines.
Many lenders offer a wide variety of mortgage types, some specifically geared toward helping first-time homebuyers.
Adjustable-rate mortgages (ARM)
Unlike a fixed-rate mortgage, in which the homeowner's monthly principal and interest payments never change, (because the interest rate is fixed for the life of the loan), with an adjustable-rate mortgage the interest rate that is paid by the borrower is adjusted from time to time to bring it in line with changing market rates.
With an ARM, when interest rates go up, your monthly mortgage payments go up as well, sometimes significantly. On the other hand, when interest rates go down, your monthly mortgage payment should also go down. ARMs are attractive to some borrowers because they may offer a lower interest rate than fixed-rate mortgages — initially. Since the monthly payments on an ARM start out lower than a fixed-rate mortgage of the same amount, the homebuyer qualifies for a larger loan.
The chief drawback is, of course, that your monthly payments will increase when interest rates go up. How much your payments will increase will depend on the terms of your mortgage. Before deciding on an ARM, you should be confident that you know how high your monthly payments could possibly increase — the "worst case scenario." Most mortgage lending institutions are required by law to provide you with this worst case scenario. You may want to consider an ARM if this loan is the only way you can afford to buy a house, and that your are confident that your income will increase enough in the coming years to comfortably handle any increase in payments.
The various protective features you should look for when you shop for an ARM, and they are discussed here. If you are not confident that your income will increase in the coming years (self-honesty is required), you should consider buying a house you can afford at a traditional fixed rate.
Seller take-back mortgage
If you assume an existing low-interest rate mortgage, the balance on the mortgage will usually be far less than the purchase price of the house. This means you must come up with a very large down payment, unless you can get the owner to finance part of the difference. Sometimes sellers are willing to "take back" a second mortgage, sometimes at a below-market rate. Just be sure you can afford both mortgages. Please feel free to talk with us some more about seller take-back mortgages.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac offer low- and moderate-income households financing options that are designed to overcome the most common barriers to homeownership. For households of modest means, these barriers can include coming up with the down payment and closing costs, and managing housing expenses that are often higher than the qualifying guidelines permitted in traditional mortgage lending.
Fannie Mae and Freddie Mac also allow borrowers to use a non-traditional credit history. For example, if you do not have a credit history (one that is reflected in a credit report), you may document your demonstrated willingness and ability to repay a bill on a timely basis by getting verifications from utility companies, collecting receipts from current and previous landlords, and tallying other sources of credit or service where you were (or are) required to meet a regular financial obligation.
To be eligible for Fannie Mae and Freddie Mac, often your income must be no more than the median income for the area in which you wish to purchase. Such flexibility is usually only possible because of the homebuyer education provided to the borrower by the lender or non-profit organization that deals with Fannie Mae and Freddie Mac loans. You may be required to participate in a formal homebuyer education class in order to be eligible for non-traditional mortgage options.
Our community also has subsidized (financially assisted) second mortgages. The funds for subsidized second mortgages are provided by the City of St. Petersburg, City of Clearwater, City of Largo, County of Pinellas, and State of Florida housing agencies, as well as by foundations and non-profit organizations.
The typical financing for a second mortgage includes a down payment from your own funds — usually 3 to 5 percent of the purchase price — then a first mortgage, which provides most of the financing for the home purchase, and then a subsidized second mortgage covering the remainder of the down payment and/or closing costs. (This allows the limited public or non-profit funds that are earmarked for homeownership to be used to help the greatest number of home buyers possible).
Subsidized second mortgages offer several features that can help you close the affordability gap on a home purchase:
- Their payment is often deferred
- They carry no or very low interest rates
- Part of the debt may be forgiven for each year that you remain in the home
Lease-purchase mortgage loans help you overcome another obstacle: insufficient savings for a down payment. With a lease-purchase mortgage loan, a non-profit organization purchases (and often rehabilitates) a home they can then lease to a prospective home buyer, with an option to buy.
The non-profit group will charge you a "rent" that consists of the monthly principle, interest, tax, and insurance (PITI) payments on the first mortgage, plus an extra amount that is earmarked for a savings account where the money for a down payment will accumulate. Through regular, scheduled savings, you will normally be able to purchase the home after a lease period of three to five years. The assumption, or sales price, of the home generally is established when you begin renting, thereby assuring you an affordable home when you have accumulated sufficient funds for the down payment.
The lease-purchase agreement is negotiated and signed by you and the non-profit organization after you have been qualified for their mortgage. This assures the likelihood that you will be able to make the timely "rent" or lease payments to the non-profit, and the non-profit is able to make their monthly mortgage payments, as well as assuring everyone involved that you will be able to make timely payments when you assume the mortgage.
Lenders with strong rehabilitation lending experience may offer Community Home Improvement mortgage loans. With this type of loan, you can usually obtain 95% financing for the purchase and improvement of a home that is in need of modest repairs. The amount of the mortgage is based on the appraised value of the home "as completed" (either the sales price plus rehabilitation costs or the appraised "as completed" value, whichever is lower). In addition, you must have cash reserves equal to two months mortgage payments at the time of closing.
The repair work to be completed may represent up to 30-percent of the property's appraised value after the repairs are made. The cost of rehabilitation is determined by rehabilitation plans, specifications, and an itemized estimate of from a licensed contractor for all rehabilitation work. The rehabilitation must be performed by a licensed contractor.
Rehabilitation escrow account
The funds needed for the rehabilitation are held by the lender in an insured, interest-bearing special deposit (escrow) account. With the lender's approval, you may withdraw funds from the rehabilitation escrow account as needed to pay for the work. The lender is responsible for administering the account and assuring that the repairs and rehabilitation are completed according to the set plans and specifications.