Housewife MacGyver: Home Buying Finance with Fiscally Chic

Our guest today will knock your socks off -- not only is Cathy gorgeous, she knows stuff. About finance, of course, among other sorts of other things. She is a a full-fledged accountant who blogs regularly at Fiscally Chic and she's here with us today to talk about the basics of buying a home and the whole mortgage thing -- a process that she is in the middle of since she and her husband have found their home and had their offer accepted by the seller! Here's Cathy:

Good morning, Housewife MacGyver’s! I’m Cathy from Fiscally Chic. Generally, I share ideas for “saving money with style.” I also post recipes, talk about running, and share other random things that inspire me. We’re in the process of buying a house, so let’s discuss what’s going on in my life: the mortgage. Since that’s a pretty wide topic in itself, I figured I’d cover a natural extension of Emily’s post on budgeting – determining what you can afford when buying a house and getting preapproved for a mortgage.
If you’re like me, you may not have thought too hard about budgeting until it really mattered. We’ve been thinking about buying a house for a while, but finally got serious during fall 2010. We took a good look at our savings, income, debt, and future aspirations. Plus, the home buying market seemed pretty favorable. Low interest rates and abundant real estate listings make it a buyer’s market.

What can you afford?
When buying a home, you have to strike a balance between what you can afford and what you want and need out of your future nest. While you see your home as a place to raise your family and an investment, lenders look at you as a future investment. They are more concerned with what you can afford and if you’ll be able to make your monthly payments. This is where knowing your current financial situation is extremely important.

In general, lenders take a look at your housing expense-to-income ratio. This is your mortgage payment (principal, interest, taxes, insurance) divided by your gross monthly income (income before taxes and deductions) and should generally be 28% or less. So if your monthly gross income is $5,000, your monthly mortgage payment should be less than $1,400.

Next, lenders look at your total monthly payments relative to your gross monthly income. That calculation will factor in your other debts (credit card debt and installment loans) and must generally be under 36%. Again, if your monthly gross income is $5,000, your total monthly debt payments should be less than $1,800. Those ratios are often referred to as 28/36.

Finally, how much home you can afford will be largely based on your down payment. In the these economic times, most lenders will let you borrow no more than 80% of a home's market value--which means you must have the other 20%. This could be a down payment of 20% or a second mortgage. Otherwise you'd have to pay costly "PMI," or private mortgage insurance*.

Credit reports
Another important component of the mortgage approval process is your credit score. Do you know what yours is? Do you know what a credit score is?

Very briefly, your credit score represents your creditworthiness, or the likelihood that you will make payments as promised. Your score is based on information found in your credit report, which contains your borrowing and repaying history, type and amount debt, length of credit history, and new credit lines opened. If you’ve been diligent in paying off your credit card bill each month, your credit score should be higher. And the better your credit report and credit score, the lower your interest rate will be! You can get a free copy of your credit report once every 12 months from each of the nationwide consumer credit reporting companies (Equifax, Experian and TransUnion) here.

Tote from Etsy seller dearcolleen
Mortgage menu
Still with me? I sure hope so! Moving right along to different types of mortgages. These fall into two buckets: fixed or adjustable rate. We’re planning on going with a 30 year fixed mortgage. Interest rates are low right now (around 5%), so we’d like to lock in that rate for the long haul. Adjustable rate mortgages are fixed for a number of years (generally 3, 5, or 7) and then reset to the current interest rate annually. And then there are different mortage terms: 15, 20, or 30 years.

Ultimately, the type of mortgage you choose is based on your comfort level with interest rate fluctuations (hint: interest rates will probably be increasing in the future) and how long you plan to stay in your house.

Preapproval primer
Last, but not least, let’s quickly jump into preapproval. You’ve figured out what you can afford, now it’s time for the lender to tell you how much they’re willing to lend you. Shop your mortgage around by contacting several lenders, telling them that you are looking to buy a home and would like to get preapproved for a loan. Our realtor gave us a list of recommended lenders. We also researched options online at bankrate.com and asked for referrals from friends and family. When getting preapproved, we needed the following documents:
  1. Last 40 days of paystubs (both of us)
  2. 2008 and 2009 W-2s (both of us)
  3. 2008 and 2009 federal tax returns (both of us)
  4. If married in last 12 months, please provide a copy of marriage license
  5. Most recent asset statements, all pages, all accounts (i.e. checking, savings, and investment accounts)
  6. Copies of both of our driver’s licenses
  7. Contact for our future property insurance provider
Being preapproved is kind of a big deal and highly recommended. It tells you how much house you can afford to buy. Though take that figure with a grain of salt because the bank may think you can afford more than you’re comfortable paying. More importantly, it shows the seller that you are serious and that the lender sees you are a “qualified” buyer.

Phew! That was a long one! This was meant to be an overview on the mortgage preapproval process, so your actual journey in home buying might be a little different. Once you start the mortgage process, specific questions should be asked of your lender. If they’re unhelpful or unwilling to take the time to explain things, then maybe you should go with someone else.

Thanks for reading! To reward you for your diligence, I’d like to give you all cupcakes. And if you’re looking to crunch a few numbers, here’s a handy mortgage calculator.
*Lending rules of thumb obtained from Mint

Thanks, Cathy! You have knack for explaining things so that even a finance dunce like me can understand :) and I really MUST have those divine cupcakes. 


While you're drooling over the cupcakes, check out Cathy's Makeunder Your Finances series. It is a perfect 4-step action plan to help your budgeting meet Emily's definition of budgeting (and her suggestions): aligning your spending with your values and meeting your goals.

3 comments:

Cathy said...

Thanks again for asking me to be guest blogger! Best of luck with your eventual home buying adventures!

Gwen @ Gwenny Penny said...

This was a great guest post. I think everyone needs to be better informed when it comes to financing a home and knowing what you really can afford. We've purchased three houses over the last 10 years, and luckily my husband works in finance or I would have been clueless. You really need to educate yourself before you jump in.

Calvin Brock said...

just to raise your rate. That’s not quite accurate. While some banks are pulling full credit reports, and using the scores to re-price when applicable, that is NOT required by Fannie Mae. Your lender should be looking for only 3 things: free credit reports from all 3 bureaus

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