Using a mortgage loan to buy a house has historically been a wise decision. Unlike other types of debt such as credit card debt, a mortgage is a ‘good’ use of debt since you are buying something that has the potential to appreciate over time (unlike clothing and cars which usually lose value). In addition, you can save money since the interest on home loans is generally tax deductible.
So what are some of the basics we need to understand regarding mortgages and saving money to buy a house?
Mortgages and Home Buying
To purchase a house, you don’t need to save the entire price of the house. You can get a loan called a home mortgage. A mortgage is a type of loan for buying a house.
How Much Home can you Afford?
Banks and financial institutions that lend money will normally lend two and a half to three times your annual gross income (income before taxes, adjusted for your other debts and credit history.
Another way they look at it is that your total housing costs, including mortgage payments, property taxes, and insurance should not be greater than 28% of your gross monthly income. If you include your other debt payments, then it should not exceed 36%.
When borrowing money for a house, you will normally need to pay at least part of the purchase price of the home. This is known as the down payment. The normal down payment is 20% of the purchase price of the house. Down payments are required to protect the lender in case of default (if you fail to pay back your loan).
If you can’t afford the full 20%, then you may be able to still get a mortgage, but will be required to pay for private mortgage insurance, or PMI. Another option is that many lenders offer double loans, one for the normal mortgage, and a higher rate loan to cover the down payment.
In general, you don’t want to buy more home than you can afford. Along with the down payment, you will likely have closing costs and fees that may run 2% to 5% of the amount of the loan. Also, owning a house brings many additional costs, such as insurance, home repair, etc that you may not be currently paying, and will need to budget for.
Fixed and Adjustable Rate Loans
One big difference between mortgage loans, is fixed rate loans, and adjustable rate loans (also known as ARMs). Adjustable rate loans are usually less expensive in the beginning, since the interest rate you pay will be less than fixed rate loans. However, if interest rates rise suddenly, you may be required to make much higher monthly mortgage payments.
Nevertheless, if you plan on staying in your house for only a short period of time, then an adjustable rate loan probably makes more sense. For longer periods of time, consider a fixed rate loan. Also, be aware that some lenders often make ARMs look better by offering a ‘teaser’ rate. However, these low rates are only for a short time, so beware, and fully understand the terms of your loan.
Other Financing Options
Today’s mortgage market is very different from the past. Today, there are many more loan choices, and loans are much more available then before. Check out different lenders to learn about their different loan programs to see what works best for you.
Buying Now – Housing Bubble?
There is often a debate and controversy if we are in a housing bubble, and the question of should we be buying a home at all. There are valid arguments on both side, and since no one can completely predict the future, no one knows for sure. Though, we would say to consider how much housing in your particular area has appreciated recently, and if price appreciation is much greater than average, then consider it a possible risk that housing prices may decline.
However, on the flip side there is also a risk of not buying a house, and having housing prices further increase. If population continues to increase, and the economy continues to grow, then housing prices will then also likely increase in the future.