How To Afford A Mortgage
Minimum Cash Requirement
The main deterrent in buying a home today is not income or credit requirements but rather finding the
necessary funds to cover the initial costs and down-payment. Traditionally, a 20% down-payment is
required and in many instances the related closing costs and escrow funds can run another 10%. In today’s
market of high prices for even modest homes, upfront fees of 30% present more of a barrier than credit
history or mortgage payment ratios. Funds for the purchase of a home can include obtaining a cash gift
from a relative, cashing in an insurance policy, or retirement account. Fortunately there are more available
methods to lower the initial costs of obtaining a mortgage.
Conventional loans offer low or no down-payments with PMI Private Mortgage Insurance). PMI is not life
or accident insurance, but rather insures the mortgage itself and covers the lender in the event of a
foreclosure on the property. Generally, lenders will require PMI when there is less than a 20% down-
payment. Many lenders offer conventional loans with as little as 5% down and a few offer loans with no
down-payment at all. Conventional loans with PMI are subject to relatively restrictive credit and income
guidelines. Interest rates among most types of prime loans are roughly equal.
The key in using the minimum in up-front funds is to have the seller pay most or all of your closing costs.
Depending on the down-payment you make, the seller may be permitted to absorb all of your closing costs.
The seller can also pay the tax and insurance escrow allowing the buyer to get in the home with little or no
funds. Most conventional programs allow the seller to pay up to 6% of the sales price to the closing costs;
conventional loans at 95% LTV (Loan to Value) allow the seller to pay only 3% of the sales price toward
closing costs. You may have to make the seller a full price offer to have him absorb the closing costs, but
any offer can be presented. If the seller does agree to pay the closing costs, ask your lender if you can
obtain a loan without escrowing for taxes and insurance. This means that you would have to come up with
hefty payments when the property taxes and insurance are due periodically throughout the year, but you
will have avoided establishing a fat escrow fund at closing. Beware, however, finding money to pay taxes
and insurance in a lump sum can be difficult and most lenders won’t allow it unless you have a large (20%)
down-payment. Also, try to set up your closing to occur towards the end of the month because you will
have less pre-paid interest due at settlement for the month of closing.
Many times a 5% cushion is built into the sales price of a home to allow negotiation of a sales offer. Just
remember that in a hot real estate market, the seller may not be anxious to accept a low offer and may reject
the agreement on a home that you really want due to small differences. If you play the game, you must be
must be prepared to lose and go on to the next property.
You should call American Heartland Mortgage for pre-approval prior to shopping for a home. A pre-
approval is a strong marketing tool when making an offer that may contain seller concessions. Telling a
seller that you are already approved for a loan makes the acceptance of a low offer or one where he may be
paying the closing costs much more palatable.
Most lenders will require that you disclose your income from the previous two years and use this income to
qualify you for a mortgage. They will ask for W-2 forms, tax returns, or bank statements to verify income.
The requirement is that the mortgage payment cannot be greater than 28% of the borrows gross monthly
income, and the mortgage payment plus all other monthly obligations cannot exceed 36% of the gross
One way to expand your purchasing power is to obtain a low, low rate mortgage such as adjustable rate
mortgages. They may begin with an introductory rate well below market rates. The disadvantage to these
types of loans is that these rates are subject to change as frequently as every 6 months. Payments are
permitted at an artificially low rate but these may result in “reverse amortization” that is, the mortgage
balance may be higher at the end of the year than when you started! This may not always be bad,
particularly if you are buying in an area of high appreciation or if you only intend to live in the home a few
years. Not all adjustable rate mortgages are negatively amortizing and lenders are required to give you a
program description. Get in and review it until you are sure you understand all of the terms. This type of
loan can, add thousands to your purchasing power due to the low initial rate.
If you don’t have the stomach for an adjustable rate mortgage, explore 5/1 or 7/1 type loans. The rate will
stay the same for the first 5 to 7 years and then it changes to a 1-year ARM for the remainder of the term.
The initial rate is lower than a fixed 30-year mortgage, and by the time the rate is due to change in 5 years,
you may be ready to move or refinance.
Take a look at your monthly installment payments. It could be to your advantage to use some of your
down-payment money to pay off high interest rate for short-term debt to ease your qualifying ratio. Paying
off a car loan with a few years to run may erase a high dollar monthly payment for only a few thousand
dollars. The result may be a higher mortgage due to a less down payment, but monthly you will be
spending less and mortgage payments only increase by a few dollars per thousands due to longer
In general, always try to obtain a 30-year amortization loan and try not to pay discount points (fees for a
lower rate) on a loan. Shorter-terms loans do save interests over the long run but decrease buying power up
front. You can always make extra payments later if you want to shorten the term of the mortgage. Forget
about by-weekly mortgages, they force you to make extra payment whether you want to or not. It may be
smarter to save money in a mutual fund or another vehicle that can offer a better return and easier access to
funds when needed than a mortgage. Owning a home with a mortgage could allow you to itemize your
taxes for the first time and save some money on April 15.
Finding a Bargain Home
One cliché of the real estate world is that old saying, “location, location, location.” That also applies when
trying to find a bargain in a home. Generally, it is better to buy a fixer-upper in a terrific neighborhood
rather than a great but bargain priced home in a less desirable neighborhood. There are always bargains in
run-down areas, but while these houses may offer a lot of houses for the dollar, they will be difficult to sell
and may have little or no appreciation despite the time, energy, and money you have invested.
Forget about buying a home from the newspaper foreclosure notices, they are difficult to purchase and
better left to the pros. Instead foster a relationship with a real estate agent and remain loyal to that agent.
You want to find a home that may need cosmetic work but is basically sound. Estate sales are probably
the best area you want to explore, and try to investigate listings that have been on the market a while, but
keep in mind the reason a property has been on the market a while is because it is less desirable for some
Remember, every property has its price and will ultimately sell when the price/value ratio becomes
attractive. Multi-family homes can offer some additional income if you are willing to put up with the
headaches of being a landlord with tenants in close proximity. It can be financially profitable to live in the
multi-family for a few years and then keep the property as an investment after you move to a single family
If financially able, look to buy a home during periods of high interest rates or economic recession. During
those times home prices may drop or the seller may be more open to accepting low offers. High interest
rate periods do not last forever, and when rates come down or the economy improves you can refinance for
a lower rate and even take out some excess cash from appreciation.
Credit Scores and Sub-Prime Loans
Prior to the early 1990’s home-buyers had to have a very good credit history to qualify for a loan. Those
who had foreclosures, repossessions, or bankruptcies in their history were told to wait 7 years and to walk
the straight and narrow credit path in the meantime. During the 1990’s a new type of financing became
available called “sub-prime” lending. Those who could not previously obtain a loan were eligible for a
sub-prime loan where the interest rate charged may be 2% to 5% higher than the prevailing prime rate.
Basically there is a trade off by the lender for receiving a higher interest rate in return for accepting a
perceived higher risk loan. The good news is that now many more people are eligible to obtain a mortgage.
During the 1990’s credit scoring also came into effect. Credit scores attempt to classify a person’s credit
history into one three-digit number ranging from 350 to 850. A credit score of 650 or above is deemed to
be a “good” credit risk by many lenders, the higher the better. In fact, a credit score of 700 or above can
allow for a 100% LTV loan at only a little higher interest rate. A score of 625 may be acceptable, but
scores from 525 to 625 usually fit into the sub-prime loan category. A score under 500 makes it very
difficult or even impossible to obtain financing of any sort. There are three credit repositories in the United
States and their method of determining a person’s credit score is somewhat a secret but mainly based on
past payment history and overall amount of debt.
Correcting Past Credit Problems
Contrary to what you may have heard, credit reports are for the most part accurate.
Common last names and a “Jr.” in the family can cause a few problems but credit reports identify people by
social security number, address, and name. If you have an issue with your credit report, credit-reporting
agencies are required to attempt to resolve the problem. Most of the information has to be provided by the
individual and they should stay in touch for as long as it takes, frustrating or not. There are three main
credit repositories in the United States: Equifax, Trans Union, and Experian. These companies hold a
database of information and provide it to a more local credit-reporting agency that may actually be issuing
the report. If you have a dispute, you can go direct to the three repositories to attempt to clear the issue.
Their addresses are listed below.
As mentioned before, credit scores in the 500 range can cause problems when attempting to obtain new
credit. You can raise your score if the original information was incorrect, or you can over time improve
your payment history, but it may take a few years of diligent pay history to appreciably raise your credit
score. If unfortunately you are unable to work your way out of debt on your own you can turn to credit
counseling agencies such as Consumer Credit Counseling Service (CCCS) a non-profit that has offices in
many cities that will work with your creditors to reduce your installment payments. There too it will take a
while to improve your credit history and score.
If worse comes to worse declaring bankruptcy may be your only answer. I recommend it only as a very last
resort. A bankruptcy will stay on your record for years and make obtaining credit difficult. There are two
methods to declare bankruptcy: Chapter 13 and Chapter 11. Chapter 13 is where an individual attempts to
restructure his debts and pay them off over time. Chapter 11 is where an individual is relived of his
obligations included in the bankruptcy petition. The descriptions above are overly simple and general, but
the bankruptcy option is a poor one and you should explore your options with an attorney before making
that decision. After a bankruptcy is discharged (finalized) a new mortgage can be obtained usually on a
sub-prime loan arrangement. Most lenders state that at least a year must pass after Chapter 11 bankruptcy
discharge and a new good credit history must be established. Make sure that rent or mortgage payments
have no late payments for at least the previous 12 months. Avoiding paying in cash; make all payments by
check or credit card so that your payment history can later be verified. It will also help to explain to your
lender that the situation that originally caused the problem…a job loss, illness, etc. has now been resolved.