Steven Kirkpatrick - Mortgage Loan Originator
Can I Afford to Buy a Home?
For most home purchases, you will ideally have at least 5% of the purchase price saved up for a down payment. For example, 5% down on a purchase price of $160,000 is $8,000. Some loan programs allow for smaller down payments, such as an FHA (Federal Housing Authority) loan, where you can buy a home for as little as 3.5% down.
There are even some programs that require no down payment at all, such as USDA (U.S. Dept of Agriculture) rural home loans. That’s right – zero dollars down payment. However, a traditional 20% down payment would result in a better interest rate and a stronger long-term financial solution.
Owning a home requires paying property taxes and homeowner’s insurance. When you buy a home, you will be required to pay up to seven or eight months of property taxes in advance, and about 14 months of homeowner’s insurance in advance. How much of this will be required?
Figure approximately 1.25% to 1.4% of the home purchase price. For a $160,000 home in Newport News, for example, your escrow account might be about $2,100. That’s in addition to your down payment.
These are the charges you incur when you buy a home. It includes things like Title Insurance, Recording Fees, Transfer Taxes, Loan Origination Fees, Appraisal Fees, etc. If you hire an attorney (a good idea), you will have to pay for legal services as well. Depending on the loan program you use, and the amount of your down payment, you may also have to pay additional fees.
This might include, for example, a “Funding Fee” for VA (Veterans Administration) loans, or an “Up Front Mortgage Insurance Premium” (for FHA loans), an “Upfront Guarantee Fee” (USDA loans) or some other form of a lump sum mortgage insurance fee. Many of these fees can be added to the cost of the loan, so you don’t need more cash to pay for them at closing.
Closing costs can vary widely; they can range from below 2.5% to over 5.0% of the loan amount. For that $160,000 home in Newport News, with a 5% down payment, your closing costs could be (very roughly) in the range of 3.5% to 4.0% of the loan amount. That would be in the range of about $6,000, give or take.
So, as you can see, it can take a lot more than just the down payment to buy a home. However, there are some bright spots, so don’t despair just yet. There is still hope. For example, you might be able to get the seller to pay some, or even all, of your closing costs.
Typically, this becomes part of the negotiation process, which is why you need a really good real estate agent representing you as the buyer. A good agent might convince the seller to pay your closing costs. Typically this might work if you offer to pay the seller a slightly higher purchase price.
There are also some government sponsored programs that can help you with a down payment – either as a grant (gift) or a “forgivable loan.” Some of these programs can be quite generous – often 2% or more of your home purchase price. Ask me for more details. These programs are almost always limited to “first time” home buyers – which typically means that you have not owned a home in the past three years.
Another important factor, however, involves your other monthly payment obligations. If you have obligations for things like car payments, student loans, credit cards, child support, etc., we will consider these payment obligations as a factor in your ability to repay your mortgage loan. As a guideline, we like to see your total payment obligations at no more than 36% to 40% of your pre-tax income. Thus, the more debts you have, the less you can borrow to buy a home (DTI – Debt to Income Ratio).
Let’s go back to our borrower earning $70,000 per year. If that borrower has more than $500 in monthly payments to creditors (such as car payments, student loans, and credit cards), then they could no longer afford that $1,600 monthly payment.
The borrowing ability is reduced dollar for dollar for any monthly payments beyond that $500 threshold. So, if they have monthly payment obligations of $900 instead of $500, they could only afford a monthly housing payment of $1,200 per month instead of $1,600 per month. This might lower their purchasing power for a new home from about $200,000 to somewhere around $170,000.
Don’t despair, there are loans available that allow you to spend up to 45% (or even 50%) of your pretax income on housing costs. That’s a conversation to have with me.
Another factor to consider is the “quality” of your income. Ideally, you have been at your job for at least two years, and you are a regular wage earner who receives a Form W-2 every year. If you have been at your job less than two years, I will need more details about your employment history.
What if you receive a Form 1099 instead of a W-2? Well, for one thing, it means you are treated as being “self-employed,” and the standards of income verification are tougher. This is what I mean by “How reliable is your income?”
It is much easier to get W-2 wage earners through underwriting over the more entrepreneurial Form 1099 income earner. Why? Because it’s not how much money you take in on a Form 1099 that matters – it’s your net taxable income that matters.
For example, suppose you work as an Uber or Lyft driver and take in gross receipts of $70,000 per year, and you have a Form 1099 to prove it. Sorry, but we can’t use your gross receipts – only your taxable income as reported to the IRS.
For example, if you drive for Uber and Lyft, you might take in $70,000 in a year, but you are more than likely going to deduct expenses from your income (as permitted by tax laws, of course). This might include things like gasoline, vehicle maintenance, insurance, mileage deductions, and even your cell phone bill.
Suppose these costs amount to $25,000 per year. In that case, your actual earnings (according to both the IRS and any mortgage lender) is $45,000 per year instead of $70,000. Ouch!
But wait, there’s much more that goes into the underwriting process! If you are a 1099 earner instead of a W-2 earner, the rules to determine your income are a bit tougher. Generally, we rely on your average net earnings over the past two years as reported on your tax returns as your income.
Did your income go up or down from last year, or is it about the same? A drop in income from one year to the next might require us to use your lower net income on your loan application.
This helps explain what I mean by “Reliable” income. Is it steady, and is it predictable? Will it continue into the future? You get the idea.
As a 1099 earner, you have yet another challenge. We are required to calculate your income based on your tax returns in most cases. This might cause a delay in terms of your timing. Suppose, for example, your income is going up – you’re having a great year – it’s only August, yet you’ve already earned more in eight months than you did for all of last year.
That’s great, but we can’t use that income until you have filed your tax return for the current year. So, even if you file your tax return in January, that’s still five months away from August.
If you are a 1099 earner instead of a W-2 earner, the rules to determine your income are a bit tougher. Generally, we rely on your average net earnings over the past two years as reported on your tax returns as your income.
Your credit score is very important, and could cost or save you a lot of money. It’s a major factor in determining the interest rate on your loan, and it has a significant impact on the cost of mortgage insurance (MI) for most loans. If your score is below certain thresholds, you won’t even qualify for some loans. Indeed, if your score is below 580, we won’t be able to offer you a loan at all until your score is raised.
But, once again, don’t despair if your credit isn’t where it needs to be, we can help! By the way, we love telling people that Fairway is a fantastic, wonderful company!
We offer an incredible, free service called “CrediTool” that helps you raise your credit score. You are assigned a personal Credit Analyst – a Fairway employee – who will work one-on-one with you to build a strategy to raise your credit score.
No other mortgage company in the country does this – only Fairway. You have no obligations to us, and there is never a cost. By the way this is NOT “credit repair.”
In our experience, many so-called “credit repair” companies engage in business practices (including false advertising claims) that are not entirely honest and ethical, and sometimes even fraudulent. In fact, anything that they do to improve your credit, you can do yourself. Indeed, according to the U.S. Federal Trade Commission: “Anything a credit repair company can do legally, you can do for yourself at little or no cost.”
Please don’t worry, if you feel confused, intimidated, or overwhelmed about fixing your credit, don’t freak out. My team and I are here to help.
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