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The Top 5 Tips for Shopping for a Mortgage

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As you shop for a mortgage, it’s easy to get overwhelmed. There are so many terms and numbers thrown around, not to mention the decisions you must make. Before you set out to get a mortgage, learn the top things you should know to make it a success.

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Know Your Credit Score and Credit History

Before you shop for a mortgage, you should be an educated borrower. That includes being educated about yourself. Do you know your credit score? Do you know what your credit history looks like? If not, now is the time to look.

You can get a free copy of your credit report from www.annualcreditreport.com. This will give you your credit history, not your score. Go over the report. Look for any inaccuracies. Do all of the accounts belong to you? Is all of the payment information correct? If anything is incorrect, address it with the reporting credit bureau and reporting creditor right away. It may take some time to get it fixed.

Also, look at your trade lines. Do you have late payments? Take the time to bring the accounts current. Do you have too much credit outstanding? Try to pay your balances down. The more you improve your credit history, the higher your credit score will get. If you want to know your actual credit score, check with your credit card companies or bank, they usually offer free access to your credit score.

Get Pre-Approved

All buyers, whether first-time buyers or not, should get pre-approved before shopping for a home. The pre-approval lets you know a few things:

  • How much loan you can borrow
  • The maximum purchase price you can afford
  • The loan program you qualify for
  • The loan’s terms

A pre-approval also helps when dealing with sellers. Many sellers won’t show you their home unless you are pre-approved. It’s the only way to know that you are a serious buyer. Without the pre-approval, you could be a nosy neighbor or someone that thinks they can buy a home, but may not be able to afford it.

We suggest getting quotes from at least three lenders when you get pre-approved. This way you have at least three loans to compare to one another and decide which one is right for you.

Know All of Your Options

Today you have many options when taking out a mortgage. Government-backed loans, such as FHA, VA, and USDA loans are all flexible options. You also have conventional loans, which have slightly stricter guidelines as well as subprime loans, which vary by lender.

Ask about all loans that you qualify for based on your credit score, down payment, and debt-to-income ratio. This way you can weigh all of your options. Government-backed loans typically have flexible guidelines and require little down payments (some don’t even require a down payment). You may pay a funding fee or annual mortgage insurance for the life of the loan, though.

If you have great credit, low debt ratios, and at least five percent to put down on the home, you may qualify for conventional financing. These loans don’t have a funding fee and only require Private Mortgage Insurance until you owe less than 80% of the home’s value.

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Knowing your options gives you a chance to determine which loan costs the least now, as well as over the life of the loan. Don’t just take the loan with the lowest interest rate – look at the big picture to decide which loan is right.

Don’t Take Out New Credit

The last thing you should do is apply for new accounts when you are ready to shop for a mortgage. Lenders look at your credit history, your current outstanding credit, and any current inquiries. They’ll know if you took out new credit. Even if you have a lot of inquiries, but no new credit, they’ll be hesitant to give you a loan.

A flurry of new inquiries means that you are desperate for money. If the inquiries are less than 60 days old, there could be new loans out there that aren’t reporting on the credit report yet. It’s best to keep your credit as stable as possible before taking out a mortgage. This is even true after you get pre-approved. Lenders will pull your credit again just before the closing. Avoid opening any new accounts, closing old accounts, or even using your current credit card accounts to keep your approval.

Think About the Future

Most people take the first loan that comes to mind – usually the 30-year fixed loan. What if you could afford more, though? What if you could pay your loan off in half the time? A 15-year fixed loan means you pay a lot less interest because you pay the loan off much faster.

Think about your goals. Do you plan to be debt-free before you retire? Plan your term around that time. Do you plan to go from one income to two or two to one in the future? This could also affect the size of the mortgage payment that you take. While you can refinance your mortgage in the future, it’s best to choose the mortgage now that will still work in the long run.

Shopping for a mortgage doesn’t have to be stressful. Set yourself up with the right mortgage the first time by educating yourself on the process. Go into the mortgage process knowing what you want and the best way to get it. This will give you the best outcome for one of the largest investments of your life.

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Mortgage Down Payment Gift Rules

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Did you know that you can accept gift funds for many loan programs? Gift funds help you come up with a down payment on a home. Before you accept money from just anyone and throw it in your account, though, you should know the rules.

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Each loan program has the same requirements regarding accept gifts for down payments. Yes, you can accept them, but you must follow the tips below.

How Much Money Can you Receive?

First, let’s discuss the amount you can receive. This varies by loan program.

  • FHA loans – If you have at least a 580 credit score, the entire down payment can be a gift. If you have a credit score between 500 – 579, you must contribute 3.5% of your own funds. The remaining 7.5% (for a total 10% down payment) can be from a gift. You can also use gift funds to help with closing costs.
  • Conventional loans – The entire down payment can be a gift as long as you buy a single-family property. If you buy a 2-4 unit property, at least 5% of the down payment must be from your own funds. Gift funds may also help you pay your closing costs.
  • VA and USDA loans – Neither VA or USDA loans require a down payment; you can get 100% financing, but you can use gift funds to cover the cost of closing the loan.

Who Can Gift you Money?

All loan programs have the same guidelines. You can accept gift funds from family, your employer, or a charitable organization. In some cases, you can accept funds from a friend, but you must be able to document your relationship, showing that you’ve been friends for a long time. If you are unsure if someone qualifies, ask your loan officer. When it comes to family, though, all family counts including relatives by blood, marriage, and step-family members.

Documenting the Gift Funds

Here’s where you really need to pay attention. All lenders require you to properly document the gift funds. Don’t just accept money from someone and think you can use it for your loan. You must follow the proper steps, which first includes a gift letter.

The gift letter should be from the donor. It should state all of the following:

  • The amount of the gift
  • The reason for the gift (buy a home)
  • The property address
  • A statement that this is not a loan and no repayment is expected
  • Signed and dated by the donor

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Once you have the gift letter, the donor can transfer the funds to you. They should transfer the funds in a way that the lender can track, such as via check, electronic transfer, or wire transfer. The lender will need to see the funds leave the donor’s account and get deposited into your account. You can provide the deposit ticket or your asset statement showing the deposit.

In some cases, lenders need to track the funds provided by the donor. In other words, they need to see where the donor got the funds, to ensure there isn’t a loan in the works. If the donor sold an asset, received a windfall, or used his or her income, they should be able to document the origination of the funds.

Make sure you deposit the funds in the account you’ll use to fund the down payment and closing costs. Don’t combine accounts or use more than one account. Keep it simple from the start so that the lender can effectively transfer the funds.

Who Can’t Provide Gift Funds?

Something you should also note is who cannot give you gift funds. While the list is long regarding who can, it’s just as lengthy regarding who can’t help. Basically anyone that’s involved in the transaction can’t give gift funds. This includes the builder, seller, realtor, and lender. Anyone that has an interest in the transaction is ineligible.

This doesn’t mean the seller can’t help with the closing costs – he or she just cannot give any money for the down payment. When a seller helps with closing costs, it’s called a seller’s concession. The seller concedes some of his or her proceeds from the sale to help you with your loan costs.

Mortgage down payment funds must come from either you or an approved gift source. Lenders are very careful about who provides the down payment funds to make sure there isn’t any ‘bribing’ to buy the home. You should buy the home of your own free will and because you are financially capable of doing so. If that means getting gift funds for the down payment, it is possible, you just have to follow the rules.

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How to Use Mortgage Comparison Sites

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The internet makes everything easier, right? You can buy just about anything from the comfort of your own home. You can also do your research or ‘window shop’ before you head out. Many people do this with cars or appliances. But what about mortgages, can the internet help you compare loans?

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You can with mortgage comparison sites. These helpful sites give you an idea of what to look for in a loan before you ever talk to someone. Keep reading to learn how they work.

The Required Information

A quick search online will turn up hundreds of mortgage comparison sites. Each one works a little differently. The idea, however, is to provide you with quotes from several lenders that help you choose the right loan for you.

Some sites require you to disclose your personal identifying information. This way they can contact you and talk with you directly about your loan needs. Other sites, however, keep everything anonymous. You just enter basic information such as:

  • Your estimated credit score or credit rating
  • The type of transaction (purchase or refinance)
  • The down payment range
  • The state the property is in
  • The type of property

With this information, mortgage comparison sites can give you links or information to mortgage companies that have programs that match your criteria.

Other companies require all information including the actual sales price, real estate tax amount, and homeowner’s insurance payment. They provide the same results, though, links or referrals to lenders that may offer a program that suits your needs.

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Comparing the Offers

Once you have several offers – typically three to five, you should compare them. This could get tricky, though. Don’t just compare interest rates or just compare closing fees. You have to look at the big picture.

Look at what the loan costs over the entire lifetime. For example, a loan with a 4% interest rate sounds a lot better than a loan with a 5% interest rate, right? But what if that 4% rate came with double the closing costs? You may want that 5% interest rate after all.

The loan that works for you should be the one that costs you the least amount over the entire term. Think about how long you’ll stay in the home. If you take out a 30-year term, but will only stay in the home for 3 years, it doesn’t make sense to pay higher closing costs just to get a lower interest rate. You won’t be in the home long enough to enjoy the lower rate.

If, however, this is your home until you can’t live there any longer, keeping the interest rate as low as possible may be a good choice. Calculate how much you would save in interest with the lower interest rate over the loan’s term. If it exceeds the extra closing costs you’d pay for the lower rate, then it’s worth taking the lower interest rate loan.

Mortgage Comparison Sites Have Reviews

There’s a lot that goes into a mortgage that has nothing to do with the numbers. Your house is probably one of the largest investments you’ll make in your lifetime. You want to work with a company that is customer friendly and accommodating.

Use the reviews on the mortgage comparison sites to your benefit. Of course, read through as many as you can, not just one or two as some people have skewed opinions. But knowing what others have to say can help you make a decision. If one company is hard to get a hold of on the phone and you prefer phone contact, check other lenders. Or if a lender has a reputation of selling loans often and you want to remain with one lender, look elsewhere.

The mortgage comparison sites help you find the best deal as well as the right mortgage company for you. Take your time when choosing your mortgage company. Look at everything that the company is about as well as the terms of the mortgage they offer. Make your decision only after comparing it to at least two or more other loans so that you know you’ve got the best option for you.

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How to Pay Your Mortgage Off Faster

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You took out a mortgage with a specific term, but now you want to pay it off faster. Fortunately, you don’t have to refinance to pay your loan off sooner. There are ways that you can make larger payments, getting your principal paid down faster, which pays your loan off early.

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Pay a Little Extra Every Month

Most lenders allow you to pay extra money toward your principal balance. How much you pay depends on what you can afford. Whether you send an addition $50, $100, or $500 – it’s up to you. Just make sure you mark your mortgage coupon accordingly. There should be a spot to mark the extra principal. This ensures that the extra funds get allocated correctly.

While $50 or $100 a month doesn’t sound like a big deal, it adds up. Even this little amount can knock some interest off the life of the loan and a few months off your loan’s term. The key is to keep the extra payments consistent for the greatest results.

Make an Extra Payment Every Year

It’s easy to make an extra payment every year. You have two options:

  • Make one lump sum payment – If you get a bonus, tax refund, or have some other way that you get a windfall, you may want to make the extra payment all at once. You can do this at any time of year. Again, make sure you mark the coupon accordingly so it directly pays down your principal.
  • Pay 1/12th of the mortgage payment each month – If you can’t afford a lump sum payment, divide the payment by 12, and pay that amount in addition to your regular mortgage payment each month. After 12 months, you’ll have made an extra payment that year.

Making 13 payments a year can knock a few years and several thousand dollars of interest off the life of your loan.

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Make an Extra Payment Every Quarter

If you have the funds, make an extra payment more frequently than once a year. If you make an extra payment every three months, you’ll have made four extra payments each year. This could easily knock off several years and a lot of interest off your loan.

Apply a Windfall to Your Mortgage

If you receive a work bonus, work on commission and have a large sale, or get a tax refund, consider applying the funds to your mortgage. You can send any amount that you want to knock your principal down. If you do this regularly, you can knock plenty of time and interest off the life of your loan.

Pay Your Mortgage Every Other Week

This may sound strange, but if you make half of your mortgage payment every other week, you’ll naturally make 13 payments every year. Since there are 52 weeks in the year, you make 26 payments without having to budget extra money. At the end of the year, you’ll have made one full extra payment. If you do this continually, you’ll save yourself money on interest in the long run.

Calculate 15-Year Payments

If you can afford 15-year payments, but don’t want to spend the money on refinancing, here’s a simple tip. Use a mortgage calculator to figure out how much a 15-year payment would be given your interest rate and loan amount. Then make those payments. Make sure you let the lender know that the extra money is for your principal balance. You can then pay your loan in half the time, saving yourself thousands of dollars in interest and being mortgage-free in half the time.

Paying your mortgage off faster is possible. Whether you pay a little or a lot, your efforts pay off in the end. Always check with your lender to make sure they don’t charge a penalty for paying your loan off early, but most don’t today. Also, make sure you don’t pay the lender to set up bi-weekly payments for you. Many will do that as a service, but then charge you a fee for each payment. This takes away from the amount you pay toward your principal balance. You can do it on your own just as easily.

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Does a Garage Add Home Value?

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You may not think of your garage as adding value to your home since it’s not living space, but it can help. Adding a garage adds storage space, which is of high value to many buyers. Where your home is located and the type of garage you add will determine how much value it adds to your home, but know that you’ll see some type of return on your investment.

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Why Garages Matter

You still may be wondering why a garage would add value. Let’s look at it from the buyer’s point of view. Garages can:

  • Provide storage space for your vehicle
  • Provide storage space for items you don’t need on a regular basis
  • Great place to conduct hobbies, like woodworking or mechanics
  • Serve as a ‘man cave’

The uses for the garage are literally endless. There isn’t a specific use you must use it for in order for it to affect your home’s value. Just having a garage will help increase it.

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The Type of Garage Matters

There are two types of garages you can choose – attached or detached. Typically, attached garages provide the most value. This is mostly for convenience purposes. Detached garages are harder to access, especially in areas of bad weather, but that’s not to say that they won’t add any value to your home, because they do.

Believe it or not, attached garages cost less to construct. If your property isn’t set up to accept an attached garage, however, a detached garage can add value. This is especially true if detached garages are the ‘norm’ for the area.

The Style Matters

Even though it may be tempting to construct a garage that looks nothing like your own, but suits your personal preference, you may not see the increase in value that you desire. Homebuyers love a uniform look. Choosing to make the garage look just like the rest of the home will keep your neighbors happy and your home value up.

How Much Do Garages Increase a Home’s Value?

How much of a return on your investment you’ll see when adding a garage depends on the area. Do you live in an area where parking is a hot commodity? Maybe it’s hard to find street parking in your neighborhood. If that’s the case, a garage will add incredible value. If you live in an area where garages aren’t the ‘norm,’ though, you may not see as large of an improvement in the home’s value.

If you already have a garage, but it’s in less than optimal condition, renovating it can greatly increase your home’s value. A large part of your home’s value has to do with its curb appeal. Since the garage is one of the first things people see on your home, an ill-fitting garage could really hamper your home’s value.

On average, homeowners see between a 75% and 80% return on their investment when adding or renovating a garage. Before you decide to do so, talk with a local appraiser to see how a garage will affect your home’s value. If you won’t see that much of an improvement, you may want to find other ways to fix up your home to improve its value.

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Can you Deduct the Closing Costs to Refinance?

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It costs money to refinance, just like it did when you bought a home. The lender and appropriate third parties provide their services, for which they need to be paid. The costs add up, so many people want to know if they can deduct the closing costs on their tax returns.

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We help you explore the answer below.

Deducting Closing Costs

In general, you can’t deduct your closing costs when you refinance a loan. The same is true when you purchase a home. But, the good news is that there are a few expenses you can write off during the year that you refinance as well as the years you own the home.

Whether or not you can deduct closing costs depends on if your deductions exceed the standard deduction. The Tax Cuts and Jobs Act increased the standard deduction to $12,400 and $24,800 for singles and couples respectively. The higher standard deduction makes it the most common way to take tax deductions today since many people don’t have itemized deductions that exceed that amount.

If you do have deductions exceeding this amount, though, you can include the following deductions.

Mortgage Interest

Everyone pays interest on their mortgage. No matter your rate or type of mortgage, you can deduct these expenses on your tax returns. You must meet the following requirements to qualify:

  • The home must be your primary or secondary home
  • The refinance must be to improve your home
  • The loan must be for $750,000 or less

If you have a loan amount higher than $750,000, you may only deduct the interest on the first $750,000. For example, if you have an $850,000 loan, you can’t deduct the interest on the last $100,000.

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Mortgage Points

If you pay points to buy down your interest rate or as a part of your closing fees, you may deduct the points. Remember, points are prepaid interest. The lender collects the points at the closing, rather than over the life of your loan.

Unlike when you buy a home, you can’t deduct the full amount of the points during the year you paid them. With a refinance, you must deduct a portion of the points over the loan’s term. If you took a 30-year term, you can deduct 1/30th of the points each year. If you took a 15-year term, you can deduct 1/15th of the points paid each year.

Real Estate Taxes

Just as when you bought your home, you can write off at least a portion of your real estate taxes. The Tax Cuts and Jobs Act states that you can write off up to $10,000 in real estate taxes paid per year. This continues to be possible even after you refinance your mortgage.

Other Closing Fees

Any other closing fees you pay to refinance your loan cannot be deducted. This includes any fees paid to lenders or third parties, such as appraisers, attorneys, or title companies. Keep this in mind as you shop for a lender. Try to find a loan with the least amount of fees to help keep your costs down and to make refinancing make sense.

Always talk to your tax advisor when deciding whether you can write off certain expenses on your tax returns. Typically, just the interest and points get deducted, and as usual, you can still write off your property taxes.

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Understanding the Turnkey Home

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Shopping for a home can be exhausting. As you look at home after home, you start to feel frustrated at the amount of work the homes require. Wouldn’t it be great if you could find a move-in ready home? Fortunately, they do exist – they’re called turnkey homes.

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What are Turnkey Homes?

Homes in great condition, ready to live in and that don’t need repairs are turnkey homes. These homes have no structural issues, look cosmetically pleasing, and don’t need minor repairs. If you chose to, you could literally move right into the home as-is.

Typically, turnkey homes were recently fully renovated. The sellers make the necessary repairs and renovations, hoping to recoup their investment within the sales price. Turnkey homes are great for busy families as well as investors that want a home they can rent out right away.

The Pros of Turnkey Homes

Turnkey homes have several obvious benefits:

  • You may not need to make any renovations to the home
  • You may love the cosmetic appeal and won’t even need to paint the walls
  • Investors can rent the home out right away rather than putting more money into it and wasting time
  • You don’t have to worry about meeting building codes or failing the appraisal

The Cons of Turnkey Homes

Turnkey homes sound amazing, but they do have their downsides:

  • Turnkey homes cost more since the seller invested his/her money to make it move-in ready
  • You don’t have a say in the home’s cosmetic appearance
  • Real estate taxes could soar once the assessor figures in the new renovations
  • You should still pay for an inspection to ensure that all work was done well

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Use Caution With Turnkey Homes

Don’t fall for the label on the packaging, so to speak. Anyone can slap the term ‘turnkey homes’ on a home. But is it really? The term is rather subjective.

Do your own due diligence. Hire an inspector to make sure the home doesn’t just look pretty on the outside, but really has major internal flaws. Also, ask for a list of the recently done repairs. Pay close attention to those areas. Are they up to your standards? Does the work look like it was done by a professional? Do you see any issues?

Do you like the look of the home or would you make changes anyway? It’s not worth paying the inflated price if you will invest more in the home’s appearance anyway. Really look at what the seller claims they did and decide if it’s something you like and will keep or will change in the near future.

The turnkey home can be a great option for investors – it allows you to rent the home out almost instantly. But does it? Is the price worth it? Are there still things you may need to fix? Do you like the appearance of the house and does it meet the needs of your target audience? These are all factors you should consider before buying a move-in ready home.

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Understanding the Patio Home

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The name sounds deceiving. You’d assume a patio home has a patio, right? That has nothing to do with it. Instead, patio houses are attached homes, similar to a townhouse or condo, but they’re different. They typically only have one story, whereas condos and townhomes have two or more stories.

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Keep reading to learn more about patio homes.

Defining the Patio Home

Patio homes are typically smaller. Not only are they on one story, they have less square footage too. They may or may not have a yard. If they do, it’s a small one. The homes are generally very close together, if not attached. The idea is to save land/space and provide a large number of homes for first-time homebuyers as well as empty nesters.

Most patio homes are part of a homeowner’s association. Many developments have common areas for recreation, increasing the cost of the HOA dues. The HOA typically takes care of the external maintenance on the property too, making it an attractive option for those nearing or in retirement.

What Should you Consider When Buying a Patio Home?

Just like buying any home, you should consider a few factors including:

  • How much are the HOA dues?
  • What does the HOA do/cover?
  • What common areas/recreational activities are included?
  • How large is the lot?
  • How close are your neighbors?
  • What is the layout of the home?
  • What is the size of the home?

Just like buying any other home, you need to be sure the patio home will suit your needs. Just because it costs less doesn’t mean it’s the right answer. Make sure you are comfortable with the closeness to your neighbors or the cost of the HOA dues, for example.

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The Pros and Cons of the Patio Home

All home purchases have pros and cons. The patio home’s pros include:

  • Low maintenance – Typically the HOA handles the exterior maintenance, which decreases the work you must do year-round. This can be good for first-time homebuyers as well as retired homeowners.
  • Low cost – Compared to single-family homes and larger townhomes, patio homes are typically much more affordable (depends on the location)
  • Access to a community – Homeowners of adjoined homes with common areas often have a larger sense of community and togetherness.

Patio homes do have some cons including:

  • Less space – Patio homes are compact. You won’t find large versions as that defeats the purpose of the type of home.
  • Less yard space – Some patio homes have no yard space and those that do have little space available. It’s typically enough for a small slab of concrete or small grassy area in the backyard.
  • Homeowner’s association dues – You’ll usually have HOA dues, which increase the cost of homeownership.

Fortunately, getting a loan for a patio home is the same as getting a home for a single-family home. It’s no more difficult than securing financing on a townhome or condo. If the HOA is in a secure financial position and most of the homeowners are on time with their association dues and not in foreclosure, you should have an easy time securing financing.

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Can a Friend Provide Gift Funds for a Down Payment?

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The down payment is the largest obstacle when buying a home. First-time homebuyers struggle the most, because they don’t have equity in a home to sell. All money they put down comes from their own liquid assets.

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What if you don’t have the liquid assets? Can you get a gift from a friend? Technically the rules state that only family, your employer, or a charitable organization may provide gift funds. There are exceptions to the rule, though.

Proving the Friendship

Accepting money from a friend is different from accepting money from a family member or employer. What if the friend demands repayment? You may end up in a financially difficult situation. Will you default on your mortgage as a result? These are the issues lenders have with friends supplying gift funds.

However, that doesn’t mean you can’t accept gift funds from a friend. You will need to prove the friendship though. Family is easy to prove, whether a blood or marriage relationship. Friendship is a bit harder.

Lenders want to know how long you have known the friend and the depth of your friendship. Lenders want to know the friend is ‘close.’ Just how you prove this will vary by lender.

Proving the Gift Funds

No matter how you prove the friendship, you must prove the gift funds and their origination. You need a gift letter from the donor. Also, the donor must prove the origination of the funds. Just like you would have to do to use your own funds, lenders need to know there isn’t a loan lurking somewhere deep in the trenches here.

Let’s start with the gift letter. The donor must write a simple letter that states the amount of the gift, the reason/address of the property, and the date. The donor must also state that the funds are a gift and not a loan. They must state that no repayment is expected. This one sentence makes or breaks a gift letter.

Next, donors must provide proof of the funds. Are the funds in his/her bank account? The lender may source the funds with their income. If there are large deposits on the donor’s bank statements recently, the lender may ask about them. Basically, the lender needs to know if they are a loan from anywhere else.

If the donor sold a car, stocks, or any other asset, he or she must provide the bill of sale or any other proof of the sale. The lender needs solid proof that the funds aren’t a loan. Any funds the donor can’t prove may not be able to be gifted.

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What is the Maximum Amount you Can Gift?

Lenders typically allow 100% of the down payment to be a gift. Certain loan programs, like the FHA loan for borrowers with credit scores lower than 580 have different rules. The FHA requires the borrower to come up with at least 3.5% of the purchase price for the down payment. The remaining 6.5% may come from gift funds, though.

Aside from lender/loan restrictions, the IRS limits how much one person can gift you too. As of 2019, the IRS allows gifts of up to $15,000 without tax implications. If you receive any more than $15,000 from one person, you and the donor may have to report it at tax time.

Should a Friend Provide Gift Funds?

Before you accept gift funds, think about what it means. You shouldn’t be repaying the money, but how does the friend feel? Will the friend expect equity in the home? Will the friend expect to be on the title of the home? Working out these questions, no matter how difficult they may be to ask, is important.

You may even want to consult with your attorney before accepting gift funds. Make sure everything is on the up and up before you accept anything. Your lender isn’t the only person you have to face – you’ll face your friend for a much longer time in the future. Know his or her expectations before accepting the funds.

Gift funds are a great way to become a homeowner when you don’t have the money for a down payment. Many loan programs allow them, but exercise caution when accepting them. If they are from a friend, work out the fine details to avoid any issues in the future.

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5 Ways to Tell if You Can Afford Your Dream House

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Before buying a home, you need to know how much you can afford. You may have the perfect number in your head, but does the lender agree? Knowing what you can afford before you look at homes saves time and frustration.

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Use the simple steps below to see how much home you can afford.

Know Your Monthly Debts

Chances are you have debts now. They won’t disappear just because you buy a home. Credit cards, installment loans, and student loans are a few examples. Lenders use these payments to calculate your total debt ratio.

Don’t worry, lenders don’t include utility bills, grocery spending, or insurance payments. They only consider the payments on your credit report.

If you notice you have too many debts, consider paying them down now. The fewer monthly debts you have, the easier it is to qualify for a mortgage.

Know Your Gross Monthly Income

Lenders look at your income before taxes. Do you earn an annual salary? Divide it by 12 – that’s your gross monthly income. You need this number to figure out your debt ratios. Lenders have different debt ratio requirements for each program.

If you work hourly or on commission, use your year-end W-2s to figure out your gross monthly income. Divide the annual income by 12. This gives you an average over the course of the year. This is important, especially with variable income.

Know Your Front-End Ratio

Lenders use your gross monthly income to determine an affordable mortgage payment. Each loan program has its own guidelines, for example:

  • Conventional loans – 28% housing ratio
  • FHA loans – 31% housing ratio
  • USDA loans – 29% housing ratio

Once you know your gross monthly income multiply it by the appropriate front-end percentage. For example, if you make $5,000 per month, your maximum mortgage payment on a conventional loan is $1,400 and $1,550 for an FHA loan.

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Use these numbers as a guide. Your total mortgage payment can’t exceed these amounts. Your total mortgage payment includes:

  • Principal
  • Interest
  • Real estate taxes
  • Homeowners insurance
  • Mortgage insurance (if applicable)
  • Calculate your Back-End Ratio

Your back-end or total debt ratio could reduce how much mortgage you can afford. This is where your total monthly debts affect things. Your back-end ratio is the maximum amount of your gross monthly income you can commit to your monthly obligations. This includes the new mortgage.

The back-end ratios are as follows:

  • Conventional loans – 36%
  • FHA loans – 41%
  • USDA loans – 41%
  • VA loans – 41%

Calculate your back-end ratio by adding up the new mortgage payment with your current monthly debts. Next, you should figure out your max total debt ratio. Do this by multiplying your gross monthly income by the appropriate percentage.

Using the $5,000 monthly income, you could have maximum debts of $1,800 for a conventional loan and $2,050 for government loans. If you want a $1,400 conventional mortgage payment, your other debts can’t be more than $400.

Does your income and debts fit this requirement?

Put the Number Into Your Budget

Thus far you have a fictitious number. Sure, it looks good on paper to have a $1,400 mortgage payment, but does it fit into your budget?

If you use a computer program or app to keep track of your budget, toss that $1,400 payment in there. How does your bottom line look? Do you still have money for your ‘other expenses?’ Can you still live the life you’re used to? Do you need to sacrifice? Are you willing to sacrifice?

If you don’t use a program or app, physically take $1,400 out of your bank account. What’s left? Can you cover your other bills? Do you have the cash to do the other things you want to do? Try this for a few months and see how it feels. Practicing before you own the home is a lot less risky than taking a chance on late payments and foreclosed homes.

Knowing how much mortgage you can afford before you shop for a home helps avoid delays. You can shop for a home within your budget. If you have the necessary qualifications for the loan, you’ll have fewer issues getting approved.

Looking for Current Mortgage Interest Rates? Click Here.