3 Steps to Figure Out How Much Mortgage You Can Afford

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Generally, the amount a lender will allow you to borrow for a mortgage is the amount at which the monthly loan payments (including principal, interest, property taxes, and homeowners insurance) equal no more than 28% of your gross monthly income. If you have excellent credit, some lenders may allow room for leniency. Additionally, your total debt payments (including the mortgage payment and all other debt) typically cannot exceed 36% of your monthly income.

While many borrowers use this as a guideline for the mortgage they can afford, it is really meant to be a lending guideline for how much you can borrow. However, the amount you should borrow is not necessarily the same as the amount you can borrow.

Follow this three-step process to help you determine how much you should spend on a home.

1. Prepare a Budget

In order to determine the mortgage payment you can afford, you need to first prepare a budget. It is critical to include the proper short-term savings and long-term investing in your budget before you establish the amount to allocate toward a mortgage payment. While owning a home can help build your net worth, it is an extremely illiquid asset that is not easily converted to cash. You should make certain that you have enough in short-term savings to pay your mortgage for at least six months in the event of an unforeseen financial setback. Also, make certain not to reduce your long-term savings goals for things such as retirement or your children’s future college education expenses.

2. Account for Increased Expenses

The good news is many of your budgeted items will not change with the purchase of a new home. For example, dining, food, clothing, and travel expenses will likely remain as they were before the move. However, some items like homeowners insurance, lawn care, pool maintenance, HOA dues, and utilities may increase when you purchase a residence. Property taxes will also likely increase, so just plugging in the amount the current owner pays may result in errors. If your purchase price is higher than the value listed on the tax rolls (as is commonly the case), you should recalculate the property tax based on the purchase price you will pay. It may take up to a year for the taxing authority to update the tax rolls, but eventually the purchase price will be used to determine your property tax due.

3. Determine Your Optimal Mortgage Payment

Once you have prepared a new budget, it will become apparent how much of a mortgage payment you can afford. If the amount you can afford is less than the amount you want to borrow, it may be necessary to adjust other budget items. Focus on reducing discretionary (non-essential) expenses. For example, you might consider reducing the amount you spend on vacations, entertainment, dining out, hobbies, and even your monthly television subscription so you can allocate more toward your new home. It is also a good idea to shop around for your auto insurance policy at the same time you are getting new homeowner insurance. Bundling these two policies with the same insurance company can often reduce your monthly premium by as much as 20%. All of these little changes to your budget can add up to a tidy sum that can help you purchase the home of your dreams.

Buying a home is no small feat, and there are many financial ins and outs to navigate as you prepare for this step in your life. As parting tips, don’t forget that you’ll need cash for your down payment (which will also influence the amount of your loan), and it’s helpful for you to check your credit report before speaking to a lender so you understand whether your lender will view you as a high-risk or low-risk borrower. Planning is key, and the more thought and energy you put into the process ahead of time, the more smoothly the home-buying process will go.

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Freelancers: Here’s What You Need to Know About Getting a Mortgage

When it comes to mortgage loans, there’s a special exception for freelancers, business owners, and even Realtors.

When my husband (then fiancé) and I began preparing to purchase our first home, I was a burden.

I know what you’re thinking — my writing career as a freelancer simply must not have been generating enough money to allow me to contribute, and I needed to ride on the coattails of my fiancé’s full-time job and steady paycheck to get the home of my dreams.

Given the reputation of a freelancer’s income, I don’t blame you. And having started on this new career just months before house hunting, I actually was a little strapped for cash.

However, it wasn’t my uncertain income that excluded me from the mortgage-qualifying round. Despite my limited pennies, I was more than willing to be an equal partner in the house-buying process.

The bank? They had different ideas — ideas I didn’t even know existed until I was in the thick of it all. They told me my income would not be considered when pre-approving us for a mortgage loan amount. Instead, the loan would be based on my fiancé’s income alone.

This came as a surprise, to say the least. So I’ve made it my mission to spread the word to others who might find themselves in the same boat. Let’s break this down, shall we?

What Freelancers Need to Know

When it comes to mortgage loans, there’s a special exception for freelancers, business owners and even real estate agents — basically, it’s a rule for people who are self-employed with a sporadic income.

So, what exactly is this rule? Well, the bank told me I needed two full years of freelancing income history for them to consider for our loan amount. (Shopping for home loans? Be sure to check your credit first. You can view two of your free credit scores, with updates every two weeks, on Credit.com.)

Be warned: These specific restrictions might vary from bank to bank, so you’ll want to talk to your own lender to determine what you need.

The general rule is that you’ll need to share 24 months’ worth of income history in the form of your personal and business tax returns. They average those two years to get a general idea of how much you make during a typical year, which they can then use to determine what size loan you could realistically handle. (You can see how much house you can afford here.)

Since I had only been freelancing for a handful of months, I had next-to-no information to share with them. My business was just getting off the ground — I barely had two months of income to report, let alone two full years.

So we were left with a choice: Either we could wait for two years until I had built up a solid enough income history as a freelancer for them to consider, or we could qualify for a loan using just my husband’s income.

The latter option was a little demoralizing. I was making money, so why couldn’t I be an active part of the purchasing process? Why was I being punished by having to take a backseat and watch my fiancé sign his name on that pile of paperwork? Starting my own business as a freelancer was a scary enough leap without being made to feel like a lesser half of our partnership.

However, it didn’t take me long to begin to understand where the bank was coming from. It’s a risk to lend money to a freelancer — someone who might make $7,000 one month and $700 the next. But just because I could understand it, didn’t mean I liked it.

So my fiancé and I worked out an arrangement so I could still feel like I was involved in our home purchase. I wrote him a check to contribute to our down payment, and we continued to shuffle money around between the two of us to cover the mortgage and other living expenses until we were married and shared joint accounts.

It was a bit of a roundabout way to involve me in the process, and it still had its frustrating moments.

As a freelancer, I still work full time — just not in the way a bank can calculate. But in the end, it was actually a good thing. The fact that we received our loan amount after reporting only my husband’s income means we took on a loan and bought a house priced well within our budget.

While the process was far from painless, knowing we’ll never be house poor? Well, that’s priceless.

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Do You Need a Jumbo Down Payment for a Big Mortgage?

Having a big chunk of cash to put down on a house is nice, but it's not always required.

Most people will say you need to have excellent credit and a big down payment in order to secure a large mortgage. The reality is that while having a big chunk of cash to put down on a house is nice, it is not always an absolute requirement. Here’s what you should know if you are looking to take on a large mortgage.

Can I Get a Large Mortgage With a Low Down Payment?

It depends on where you live and how large we’re talking. Any Federal Housing Administration or FHA loan up to the maximum county loan limit can qualify for only 3.5% equity in down payment. Bonus: Back in December 2016, the FHA approved higher loan limits beginning in January 2017 for many counties across the country.

Another program known for having low down payment requirements are VA loans. VA loans are available to veterans, active duty service members, National Guard members and reservists who meet the requirements of the Department of Veterans Affairs and have acquired a Certificate of Eligibility from the VA or their lending office. VA loans will also go up to the maximum county loan limit and can even go up to or over $1 million in home values.

The idea that you need a big down payment in order to secure a larger mortgage is simply not true. FHA loans do require mortgage insurance premiums, and VA loans have a guarantee fee, which will increase your closing costs. However, your down payment will remain minimal.

What’s a Jumbo Mortgage?

Jumbo loans exceed the maximum county loan limits and are not bought and sold every day to Fannie Mae and Freddie Mac. That said, jumbo loans do require significantly higher credit scores, typically 700 or above, and at least 10% equity in down payment. Keep in mind that any loan with less than 20% equity in the property will be subject to private mortgage insurance. (Not sure where your credit stands? You can view two of your credit scores, with updates every 14 days, for free on Credit.com.)

Jumbo mortgage requirements are particularly relevant for those looking to buy a home in high-cost areas. For example, in California’s Sonoma, Marin, San Francisco, and Alameda counties, the maximum loan limit ranges anywhere from $595,000 to $729,500, but there are home that easily go for well over that.

How Can I Put Together a Down Payment?

Acceptable sources of down payment funds can include:

  • Gift funds from a relative
  • Selling of personal property that can be documented and supported by third-party value pricing (i.e. Kelly Blue Book for a car sale)
  • Withdrawals from retirement funds

Remember, you cannot use your income as a form of assets. Banks want to see that you have the ability to save money up on your own. For example, you cannot use money from your paycheck that you deposited five minutes ago as a down payment because the funds are not considered “seasoned.” In order for these funds to be considered, they must have been in your accounts for at least 60 days to show the money was “saved.”

Struggling to put together a down payment? You can find more ways to find extra funds here.

As always, if you are looking to buy a house, be sure to do some research beforehand. Figure out how much cash you really have by working with a lender and seeing what you qualify for now. Be sure, too, to carefully research how much house you can actually afford — and what a comfortable monthly mortgage payment would be. Also, work with that lender to develop a savings plan so you can qualify for your first mortgage or improve your current mortgage and financial situation.

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How Using Your Latest Paycheck for a Down Payment Could Stall Your Mortgage

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Are you saving up a down payment to buy a home? Here’s something you need to know: Your paycheck can work against your down payment-savings plan if you aren’t careful.

Buying a home requires precision planning, good income, good credit, manageable liabilities and a healthy down payment. Having as much as 3.5% of the purchase price can be a big factor for many families looking to get their piece of the American Dream. In some areas, it can be best to put down 20% of the sales price of the home.

Not all the money you save is created equal, however, and here’s why. When you save money from your paycheck (a good idea for personal financial planning in general), that money is not automatically eligible to be put toward purchasing a house. It’s called income from assets, and income from assets in the world of mortgage lending is frowned upon.

For example, let’s say you receive your paycheck and your net earnings is $5,000. That $5,000 must be in your bank account for a period of 60 days in order for that money to be considered what’s known as seasoned. The bank wants to see you had the ability to save the money on your own volition rather than depositing your income for cash to close. If you are currently in contract to buy a home, these funds, if needed, could delay your closing date. If you are not in contract, plan on keeping these funds in your account for 60 days if you intend to use them.

Using income for a down payment may might not seem like a big deal in the grand scheme of things with all the other aspects that go into buying a home. However, it will be looked at closely by the bank’s underwriter. Your cash to close can very easily set off a bank’s radar if you’re using every last hour you can to get your foot in the door.

If cash is your obstacle to buying a home, you have options. It may mean waiting to put an offer on that house until you have enough money in your bank account or writing a longer contract. Remember, every seller has different motivations and timelines for selling. You will need to plan with your lender to have the funds ready to go, then write the contract to make your home-buying plan a reality.

Also keep in mind that mortgage lenders like to see good credit among applicants, so it pays to know where you stand before you apply. Good credit can also open the door to better rates and more affordable monthly payments. You can view two of your free credit scores, updated every 14 days, on Credit.com.

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Morty: The Startup Trying to Streamline Your Mortgage Application

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In 2005, Brian Faux was working as a client relations manager at a major bank. This was years before the mortgage crisis had set in and millions of Americans lost their homes.

“I don’t think the vast majority of us had any poor intentions,” Faux, who lives in New York, said in a phone interview. But he admits the ensuing years “were a crazy time.” He remembers when he saw federal regulators take conservatorship of Fannie Mae and Freddie Mac. “People were losing their homes [by] the tens of thousands, and that’s just a really difficult situation to be in,” he said.

One would think those haunting experiences would have pushed Faux to seek a new line of work. But the 32 year old still reveres the mortgage industry. “Owning a home is still, today, and will remain for a long time for many Americans, the best way to build wealth,” he said, “and when used properly [mortgages are] a great tool for doing so.”

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Brian Faux (image courtesy Morty)

Last January, Faux launched a Silicon Alley startup called Morty, a full-service and fully digital mortgage broker that aims to do for homebuyers what online banking has done for consumers: Streamline the paperwork.

Now that the mortgage industry is on the right track, he said, he’s putting his 17 years of industry experience to use, employing high-tech algorithms and verifiable online data to cut down the time it takes to apply for a mortgage. “Instead of things like printing and scanning and emailing your bank statements or credit, we can do it all digitally through linked data sources,” Faux said. But will it work? Credit.com took a closer look.

How Morty Works 

Similar to Quicken Loans’ online broker service, Rocket Mortgage, which touts the idea of pushing a button and getting a pre-approval, Morty gathers borrowers’ information via an online application. After syncing accounts tied to assets, employment and so on (no self-reported data here), as well as using third parties to perform a hard credit pull, Morty brings prospective borrowers to a marketplace, where they can browse different loan products based on their financial snapshot. Up to 1,000 loan options are on offer, Faux said, and the company currently works with five lenders. (Morty is licensed in five states and Washington D.C., including Colorado, Virginia, Tennessee, Florida, and Oregon, with plans to expand to 30 by June of next year.)

The company also aims to eliminate unwanted face time. After submitting your application, you may receive a prompt “telling you to ask for advice before you select,” Faux said, but in reality, “today’s consumer is interested in doing their own research” and would rather educate themselves before stepping into a sales environment. If the borrower decides that she doesn’t want help, she can select a loan and submit her materials for processing.

The company said it can take between a week to two weeks for a consumer to sign a closing disclosure. Joe Parsons, senior loan officer at PFS Financing in Dublin, California, described it this way: “What [it sounds like] Morty is doing is gathering information from the borrower, then submitting it to the Automated Underwriting Systems. If they get an Approve/Eligible or Accept outcome, the broker sends the loan package to one of the lenders they do business with. The lender will then underwrite the file as I’ve described … what they describe appears to be the same process all lenders go through.”

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Morty’s application (image courtesy Morty)

Like a traditional mortgage broker, Morty earns a commission from lenders. However, “we’re uninterested in who a borrower chooses,” Faux said, stressing the lack of fees for using the service. “There is no fee to use the application, even credit, income and asset pulling [has no fee for the borrower].” He added, “We don’t fund the loan or collect payments.”

Is Getting a Mortgage This Easy? 

“Two weeks ago, we had a borrower do the whole process in nine minutes and 18 seconds,” Faux said. “It was a Friday night, and we saw a note in the system because they thought something was broken. They thought it couldn’t be that easy to get a mortgage.”

Yet perhaps the narrative that getting a mortgage is difficult is misguided, said Parsons. “As a loan originator, what I will gather from a borrower is a month’s worth of pay stubs, at least one year’s W-2s, two months of bank statements to show assets, and that’s it,” he said. “They send me those items, and in some cases I get tax returns, depending on the type of the loan. The choice is to send those to me, or push a button and get them electronically. There really isn’t a big difference, one is not less effort than another.”

Parsons also pointed out that “loan approval happens within minutes for any of us.” It’s during the underwriting process, in which application materials are more closely scrutinized, when questions tend to arise. “That’s going to be true with any loan,” he said.

However you choose to apply for a mortgage, it’s a good idea to review all your documents carefully. You may be asked to provide more paperwork than you expected or to better explain certain aspects of your application. Last-minute changes can throw a wrench into the process as well, so it’s important to be on sure footing before you begin. You can check your credit, which can affect the type of program and terms for which you may qualify, by viewing a free snapshot of your credit report on Credit.com.

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Can Rental Income Help Me Get a Mortgage?

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You may not know this, but you can use projected rental income to qualify for a mortgage on a new property you’re looking to buy and lease out. Here’s how it works.

Some mortgage companies will give you the benefit of fair-market rents when you purchase a property with the intention of renting it out. This type of financing is called non-owner occupied and costs more than primary home financing. You can expect to receive a rate that’s 20 to 35 basis points higher than owner-occupied and secondary home transactions.

Now, let’s say you’ve had a rental property for the last few years. Your new rental agreement is higher than the rental income from previous years, which is identified on your tax return. You cannot use this new income to qualify, as there is no history of that income.

Instead, lenders will perform a rental property analysis, taking into consideration depreciation, expenses, insurance, mortgage, HOA and interest paid to banks. The net income of this lender averaging will determine how your rental with hurt or help your ability to borrow.

It’s important to keep in mind that showing big losses on your Schedule E (the tax form listing supplemental income and loss from rental real estate, royalties, partnerships, estates, trusts, etc.) can actually limit your borrowing power. Though it won’t automatically preclude you from qualifying for a mortgage, it will factor into your debt-to-income ratio, or DTI. (Your debt-to-income ratio is a benchmark percentage lenders use to assess how much debt you can carry against your income.)

How Rental Income Factors In

Here are some general lending rules for rental properties.

  • Projected rents may be used by most lenders to offset against the mortgage payment at up to 75% of projected fair market rents determined with an appraisal when buying a property.
  • If you owned a rental property for the last 12 months, the lender will average your expenses, which may impact your income ratios and ultimately how much mortgage you can handle.
  • If you bought a rental in the last year but have not yet filed your return, you can use 75% of projected fair market rents with a rental agreement, bypassing the rental averaging lenders use.

How you report your expenses on your Schedule E will make all the difference in your ability to qualify for a loan. Even if a property shows a loss, it can still make sense to borrow, as keeping the property over time might mean carrying forward losses to offset against future taxable earnings.

Alternatively, selling the property may net extra funds that allow you to purchase another property and minimize rental losses in the process. Please note, you should always consult with a licensed tax professional regarding your unique situation.

Remember, a good credit score, too, can help secure a more affordable mortgage since it helps you qualify for better rates and terms. (You can see where your credit currently stands by pulling your credit report for free each year at AnnualCreditReport.com and viewing two of your credit scores for free each month on Credit.com.) You may be able to improve your score by paying down high credit card debts, limiting new credit inquiries and waiting for negative information to age off of your credit report.

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3 Things That Will Sabotage Your Plans to Buy a House

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No one wants money to stand in the way when their heart is set on owning a home. But all too often borrowers pull last-minute moves that put their financing in jeopardy.

“The events that can endanger the transaction are the kinds that happen at the last minute,” according to Joe Parsons, senior loan officer with PFS Funding in Dublin, California, “for example, an unidentified or unsourced deposit made two days before escrow that we cannot source.”

We asked Parsons to share some common mistakes that can sabotage your mortgage approval process.

1. Changing Jobs 

“If I suddenly, at the last minute, change jobs and I don’t document it — [especially if I decide to do it between the time the loan is approved and close of escrow] — that could kill the deal,” Parsons said. That’s because lenders perform a verbal verification of employment within 24 hours of funding a loan. “We’ve had cases where the borrower decided to retire,” Parsons said, laughing. “Now I tell people not to quit their job before we finish the loan.”

2. Acquiring New, Undisclosed Debt

If your debt-to-income ratio is high and you go out and buy a new car, that could hamper the loan, Parsons said. (Your debt-to-income ratio represents the total amount of monthly debt payments, including the house payment, divided into monthly income.) Lenders perform a pre-closing credit check, known as a credit refresh, immediately before funding the loan to make sure the borrower hasn’t overextended themselves at the last minute. “They are looking to see if there’s any new debt that hasn’t been disclosed,” Parsons said.

If you decide to take on new debt before your loan closes, you’ll need to provide a letter of explanation to the lender. Hard inquiries will also appear on the credit refresh, like any request for a new line of credit.

3. Moving Money Around 

If you’re going to make a down payment of, say, $50,000 to buy a house, every dime must be documented and sourced, explained Parsons, even if it was a transfer, payroll deposit or tax refund. If the money was transferred from another account, say from savings to checking, then the lender would need to see two months’ worth of bank statements from the source. “Large deposits must be explained and documented,” Parsons said, lest the lender think the money came from an unacceptable source like a cash advance or money laundering.

Before You Apply

As with any new line of credit, it’s important to know where your credit stands long before you apply for a mortgage, as this will determine your eligibility for various rates. (You can view two of your credit scores, updated each month, for free on Credit.com.) You can learn more about why it’s important to check your credit before buying a home here.

More on Mortgages & Homebuying:

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Will Applying for a Mortgage Tank My Credit Score?

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If you are hesitant to apply for a mortgage because you think your credit score will drop dramatically each time you fill out an application, think again. Here’s what really happens when you apply for a mortgage and your credit is pulled.

When you apply for a mortgage, you must have your credit checked. It is the only way a mortgage company can really determine whether you can qualify for financing and what your rates and fees will look like.

If you are applying for multiple forms of credit at the same time, such as a credit card, a mortgage and an auto loan, such actions will negatively impact your credit score. Each of these applications will generate a hard inquiry on your credit report, which could send a signal to lenders that you are having difficulty managing credit.

But you can avoid extra damage to your credit score if you apply for one form of credit at a time, and limit the time between each credit inquiry. That’s because most credit scoring models group credit inquiries for the same type of financing (mortgage, auto or student loans) that are made within a specific timeframe to allow people to comparison-shop for competitive rates. It can vary from model to model, but, in most cases, all inquiries of one of those types will be counted as one, provided they take place within a 14- to 45-day period

A single inquiry is likely to drop your score by less than five points.

When Credit Shopping

Remember, there are lots of different credit scores out there. Different lenders use different models and there can be variations from score to score. For example, the credit score your auto lender looks at might be 740 while the score your mortgage company looks at could be 720.

And each creditor you do business with reports to the bureaus at different times of the month. So it’s normal for your credit score to be different from one month to another, too, simply because of when your creditors sent their report.

Small variances, caused by inquiries or otherwise, may not be a be big deal, given the way mortgage rates are determined.

If your credit score is higher than 700 to 740 and drops two or three points because of a credit disparity, there may be nothing to worry about. Similarly, if your credit score is anything from 660 to 699, it’s not going to cause much change in your mortgage rate and pricing on conventional and Federal Housing Administration mortgages.

Still, your credit score does set the benchmark for what type of mortgage loan program you can qualify for, especially if you’re looking for a jumbo mortgage, which across the board requires a score of at least 680. If your credit score is between 620 and 640, you are still going to be looking in the FHA mortgage loan category, as conventional loans in this category automatically hit high-cost thresholds.

So, getting rate quotes from a mortgage company without getting an idea of where your credit stands is setting yourself up for disappointment — especially if your actual scores are different than your guesstimates. (You can get an idea of what shape your credit is in by viewing your two free scores, updated each month, on Credit.com.)

More on Mortgages & Homebuying:

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