You could call this chapter, 'How Big A Step Should We Take?' In many ways, this step is the most important step in the entire process of selecting your next home.
SPEND TOO MUCH:
Spend too much and you end up house rich and cash poor. If any unexpected expenses pop up, and they will, you may find yourself under a great deal of pressure just to make ends meet. Professional lenders are very friendly and accommodating when they are looking for your business. Miss a few mortgage payments and your friendly lender can become a very firm collection agent with the full power of the law behind them.
SPEND TOO LITTLE:Spend too little and you end up with a home that is just too small or just not right. Now it becomes an expensive proposition to find another home, sell your current 'too small, not just right' home and move your family and all your belongings to another home.
This step is a very important one and you should take as much time as necessary to work through the amount of money to spend in order to acquire the right home, at the right price, for you. This issue is a very personal one. It requires careful thought well before you even look at your first home.
The real issue is how much home should you buy relative to your current income?
Once we walk through the 'Afford-ability check list', you will have a much better idea as to how much you should invest in your next home. You can then begin your search knowing what price range is right for you.
We can take all the mystery out of the game and remove as much uncertainty as possible by using the measuring tools that professional lenders use in evaluating your credit worthiness.
Essential areas to research when determining what you can spend on a home are as follows:
This on-line portion of the chapter will cover mortgages, prequalification and monthly payment. To obtain a copy of the book for yourself please contact Joan Manuel
Of all four costs, the mortgage is obviously the biggest and the most important. The size of your mortgage will determine your monthly carrying costs. Because of its importance, the mortgage is the first cost we are going to consider.
Professional lenders will look at three factors in making a decision on how much mortgage they will finance. Their major concern is your current income and how much of that income is available to keep your monthly payments up to date. A buyer with a high income may not qualify, if they have other monthly commitments such as a large car payment or large commitments on credit cards, charge accounts, college loans, etc.
The three factors that the professional lenders will consider are as follows:The first thing we are going to address is how you can pre-qualify yourself for a mortgage. This step is an important step for two reasons:
First
By going through the pre-qualification check list together, we will be able to make a well informed, logical decision on the price range of homes that will be comfortable for you to handle relative to you current income. Once we have gone though this pre-qualificaiton check list together, you will know just what price range is right for you.
Second
Your pre-qualification check list will have every bit of information you will need to apply for a pre-approved mortgage
Why is this so important? First, it will confirm that your pre-qualification calculations are the same as those of a professional lender. Second, it will put you in a much better position when it comes to making as offer on the home of your choice.
Your GDSR is the first thing that most lenders will look at as they consider your application for a mortgage. As a general rule, your GDSR should not exceed 30% of your gross monthly family income.
Couple A has a gross monthly family income of $6000. Their monthly carrying cost for a home should not exceed 30% of $6,000 or $1,800 per month.
The $1,800 must cover the mortgage payment including principal and interest plus real estate taxes. If Couple A assumes that their monthly real estate taxes will be $200 a month, this expense leaves $1,600 available to cover their mortgage cost.
We will take the conservative route and assume that their lender will use the 30% ratio which means that couple A will have $1,600 to cover their monthly mortgage payment after they have paid their monthly real estate taxes.
After consulting their mortgage specialist and assuming an 8.5%, 25 year mortgage, Couple A is able to conclude that their $1,600 will carry (approximately) a $197,000 mortgage with a monthly payment of about $1,599.*
| Couple A: | Gross Debt Service Ratio (GDSR) |
| Gross Monthly Income | $6,000 |
| 30% of Gross Monthly Income | $1,800 |
| Assuming Monthly Real Estate Taxes | $200 |
| Income Available for Mortgage Payments | $1,600 |
| Will qualify for a mortgage of (at 8.5%) | $197,000 |
*Please note: For illustrative purposes, several examples appear throughout this chapter which indicate mortgage payments and mortgage balances at various stages under certain conditions. These figures are approximate. The numbers have been rounded in order that they be easier to read and understand. For exact calculations, visit your mortgage specialist.
Your TDSR is the next item that a professional lender will look at as they consider your financial situation relative to your application for a mortgage. Your TDSR should not exceed 40% of your gross monthly family income. Your Total Debt Service (TDSR) is the percentage of your monthly income that is committed to fixed monthly expenses. Your TDSR includes your monthly carrying costs for your home PLUS any other monthly commitments such as car payments, personal loans and credit card payments..
Couple A has a gross monthly family income of $6000. They have no other monthly commitments. If they assume a monthly mortgage cost of $1,800 including taxes, their TDSR ratio will be a comfortable 30% which is well within the 40% that a professional lender will require.
They would still be in a comfortable financial position if they calculated that 40% of their monthly income could be used to carry their new home. At 40% of $6,000 they could carry a monthly payment of $2,400. If they assume real estate taxes of $200 per month, they will have the resources to carry a monthly payment of $2,200.
After consulting their mortgage specialist and assuming an 8.5% mortgage over 25 years, Couple A is able to conclude that their $2,200 will carry (approximately) a $271,000 mortgage with monthly payments of $2,169. However, lenders will lend only on the lesser of a 30% GDSR or a 40% TDSR. In this example, the maximum mortgage available to Couple A would be $197,000.
| Couple A: | Total Debt Service Ratio (TDSR) |
| Gross Monthly Income | $6,000 |
| 40% of Gross Monthly Income | $2,400 |
| Current Monthly commitments | $0 |
| Assuming Monthly Real Estate Taxes | $200 |
| Income Available for Mortgage Payments | $2,200 (TDSR) |
Couple B has a $7,000 gross monthly family income.
Their GDSR: By using a GDSR calculation, Couple B assumes they can handle a monthly payment of $2,100 per month. They subtract $200 per month in real estate taxes from this $2,100 and assume that with a monthly mortgage payment of $1,900 they will qualify for a mortgage of about $257,000 at an 8.5% interest rate.
| Couple B: | Gross Debt Service Ratio (GDSR) |
| Gross Monthly Income | $7,000 |
| 30% of Gross Monthly Income | $2,100 |
| Assuming Monthly Real Estate Taxes | $200 |
| Income Available for Mortgage Payments | $1,900 |
Their TDSR: Couple B has a $500 per month car payment. They are still paying off college loans at $450 per month. They have credit card monthly payments of $325 per month and their charge accounts require $300 per month.
In order to qualify for a mortgage, their TDSR cannot exceed 40% of their gross monthly income. In their case, 40% of $7,000 is $2,800. However, they have monthly commitments of $1,575 which leaves only $1,225 to apply toward their monthly mortgage costs. If $200 of this goes toward taxes, this couple can only manage a monthly mortgage payment (principal and interest) of $1,025. Assuming a 8.5% interest rate, they will only qualify for about a $127,000 mortgage and not the $257,000 they calculated using their GDSR.
Professional lenders would be reluctant to advance funds to Couple B. Their monthly commitments are very high relative to their gross monthly family income.
| Couple B: | Total Debt Service Ratio (TDSR) | |
| Gross Monthly Income | $7,000 | |
| 40% of Gross Monthly Income | $2,800 | |
| Current Monthly Obligations: | ||
| Car payment | $500 | |
| College loan | $450 | |
| Credit cards | $325 | |
| Charge accounts | $300 | |
| Total Monthly Obligations | $1,575 | |
| Assuming Monthly Real Estate Taxes | $200 | $1,775 |
| Income Available for Mortgage Payments | $1,025 | |
If you have the right GDSR and TDSR but you have a poor credit record, you will often find professional lenders turning you down. Your credit history contains a detailed record of every charge account, credit card or credit purchase that you have made in the last seven years and in many cases even beyond seven years. Your credit record will show your high balance, your current balance and your payment record for every charge account or credit purchase in your name.
|
| Note: These events will stay on your credit record for seven years or more and, in most cases, there is absolutely nothing you can do to remove them. |
Even with negative information on your credit file, you may still be able to arrange for a mortgage. However, you may have to pay a higher interest rate. A higher interest rate will be very expensive over the long run; therefore, if there is any negative information on your credit file, you should know about it and take appropriate action.
If you have any questions about your credit record, it would be a good idea to get a better understanding of your credit record before you apply for a mortgage.
The steps to check your credit rating are as follows:There are three other evaluation methods you can use in approximating the price range of the home you should be considering.
1.Two And A Half Times Your Annual Gross Family Income
Some lenders will make a quick assessment of the size of mortgage you can handle by multiplying your annual gross family income by 2.5. In the case of Couple A, their annual gross family income of $72,000 would qualify them for a $180,000 mortgage. Assuming that they have $50,000 for a down payment, approval on a $180,000 mortgage, means that they should be looking at homes in the $200,000 to $230,000 range with the intention of not spending more than $230,000.
2.Four Times Your Down Payment
If you are applying for a conventional mortgage with a 25% down payment, then the price range you should be looking in will be four times the amount of your down payment. If you have $50,000 set aside for your down payment, then the price range you should be looking in is $200,000.
The size of your down payment will not necessarily qualify you for a mortgage. A professional lender will not advance funds beyond their estimation of your ability to pay, regardless of the size of your down payment.
3.Be Conservative
These qualification methods are useful in giving you a good idea of the price range of homes you should consider. Always take the most conservative approach, because a professional lender will take the most conservative calculation and use it as the basis for their decision.
The advantage of using several pre-qualification methods is that it gives you a lower and upper range of home prices for you to consider.
MORTGAGES For most home owners, a mortgage is a way of life: It takes a huge piece of our take home pay; It costs us mega dollars in interest; It takes forever and ever to pay off; BUT, It buys us a roof over our heads; It gives our family a warm and secure home; It builds equity in an appreciating asset; AND, The alternative is to continue to pay rent, which does not build equity and leaves us with nothing more than a large pile of rent receipts.
Before we look at the specifics of a mortgage, we will review the terminology associated with this financial instrument. In reality a mortgage is a financial instrument. It is an investment made by an individual or corporation or lending institution. They will invest in a mortgage, if they believe that it will give them a good solid return on their investment.
Financial professionals, like professionals in every industry, have their own language and their own terminology. We are going to review the terminology used to describe a mortgage so that when the time comes for you to sit across the table from that professional lender, you will know the language.
The mortgage principal is the total amount of the mortgage. It decreases (slowly) over the full life of the mortgage. When you apply and are approved for a $150,000 mortgage, the $150,000 is the principal. As you continue to make your monthly payments, the principal will gradually decrease.
Here is a forecast of what a $150,000 mortgage at 8.5% interest, compounded semi-annually, with a 25 year amortization will look like over time (see chart on following page).
Note: For ease of use, the figures in the above illustration have been rounded to the nearest $1000. For exact calculations, see your mortgage specialist.(Principal Balance remaining at Year End)
The interest you pay is the investor's return on their investment. Interest rates fluctuate based on many other economic factors including the return on investment a lender can receive from other sources. Your interest rate is usually fixed for the term of the mortgage, unless you have negotiated a variable rate mortgage.
When you make your monthly payment, you will be paying both principal and interest. Your first monthly payments will be mostly interest. However, as you continue to make those payments, the equation changes and gradually more of your monthly payment goes toward principal.
The interest rate you negotiate is very important to the overall process of buying a home. A high interest rate will increase your monthly payment and may force you to consider a smaller, less expensive home. A lower interest rate will reduce your monthly payment or allow you to buy more home with the same payments you would have to make with a higher interest rate.
The following is a comparison of the difference that your interest rate will make to your monthly payment. These examples assume a $150,000 mortgage with payments amortized over 25 years, with interest compounded semi-annually.
Note: For simplicity, the figures in the above illustration have been rounded to the nearest $10. For exact calculations, see your mortgage specialist.
As you can see, the interest rate you negotiate is very important:
the lower the interest rate,
the lower your monthly payment,
the higher the mortgage you can qualify for,
the bigger or better the home you can acquire.
Using the 30%
Your mortgage payments will be made up of a principal payment and an interest payment. This combination is called a `blended' payment. Every payment reduces the principal owed on the home. Interest is always calculated by multiplying the interest rate by the remaining principal due on the mortgage. Because every payment reduces the principal, the interest allocation gradually decreases and the amount applied to principal increases.
The following chart shows how interest payments decrease and the dollars applied to principal increase over the life of the mortgage ($150,000 mortgage at 8.5% for 25 years, compounded semi-annually).
| Year | Payment Number |
Monthly Payment |
Payment Applied to Interest |
Payment Applied to Principal |
Principal Balance |
| 1 | 12 | $1,200 | $1,050 | $150 | $148,000 |
| 5 | 60 | $1,200 | $990 | $210 | $139,000 |
| 10 | 120 | $1,200 | $870 | $330 | $122,000 |
| 15 | 180 | $1,200 | $700 | $500 | $97,000 |
| 20 | 240 | $1,200 | $420 | $780 | $59,000 |
| 25 | 300 | $1,200 | $10 | $1,190 | $0 |
Note: For simplicity, the payment figures in the above illustration have been rounded to the nearest $10. Mortgage balances are rounded to the nearest $1000. For exact calculations, see your mortgage specialist.
The mortgage term can be a confusing expression. London Life mortgages are from 6 months to 10 year terms.
The term of the mortgage is the length of time for which the lender is prepared to loan the money. At the end of the term, the principal still owing must be paid back to the lender or renewed for another term.
For example, the lender may specify that this is a mortgage for 5 years at a fixed rate of interest. At the end of the 5 years, the principal still outstanding must be paid back to the lender unless the lender is willing to renew the mortgage for another term.
"HOT TIP FROM ALAN FRAMPTON AT LONDON LIFE"
| Mortgage interest rates can vary by 5% or more over a five year period. A long term, fixed rate mortgage guarantees that your monthly mortgage payments will remain constant through the term of the mortgage. A sudden increase in mortgage interest rates could have a major impact on your monthly mortgage payment. A long term, fixed rate mortgage protects you against the volatility of the interest rate fluctuations. |
The amortization of a mortgage is the length of time it would take you to pay off the mortgage. A mortgage with a 25 year amortization would take 25 years to pay off, at the set monthly payment.
A mortgage may be renewed several times through its amortization period. A mortgage could have a number of terms of different length through the 25 year amortization that it takes to pay off the mortgage.
With a shorter amortization period, you will pay less interest, but your monthly payment will be higher. A longer amortization will reduce your monthly payment, but you will pay more interest over the full life of the mortgage.
The following example illustrates a $150,000 mortgage at 8.5% and compares the total amount paid and the interest paid over the full life of the mortgage.
A 30 year amortization more than doubles the interest cost of a 15 year amortization.
COMPARING AMORTIZATION PERIODS
(With a $150,000 mortgage at 8.5% compounded semi-annually)
| AMORTIZATION PERIOD | MONTHLY PAYMENT($) | TOTAL PAID($) | TOTAL INTEREST($) |
| 15 years | 1,470 | 265,000 | 115,000 |
| 20 years | 1,290 | 310,000 | 160,000 |
| 25 years | 1,200 | 360,000 | 210,000 |
| 30 years | 1,140 | 410,000 | 260,000 |
Note: For simplicity, the monthly payment figure in the above illustration has been rounded to the nearest $10. Total paid and total interest are rounded to the nearest $1000. For exact calculations, see your mortgage specialist.
This Monthly Mortgage Payment Calculation Chart will help you determine what your monthly mortgage payments will be given various interest rates and amortization periods.
| Interest Rates (%) |
Amortization Periods | ||||
| 5 years | 10 years | 15 years | 20 years | 25 years | |
| 7 | 19.75407 | 11.55940 | 8.93249 | 7.69311 | 7.00416 |
| 7¼ | 19.86867 | 11.68461 | 9.06834 | 7.83897 | 7.15919 |
| 7½ | 19.98355 | 11.81047 | 9.20514 | 7.98602 | 7.31555 |
| 7¾ | 20.09871 | 11.93696 | 9.34287 | 8.13423 | 7.47321 |
| 8 | 20.21416 | 12.06409 | 9.48153 | 8.28357 | 7.63213 |
| 8¼ | 20.32988 | 12.19185 | 9.62110 | 8.43404 | 7.79229 |
| 8½ | 20.44589 | 12.32023 | 9.76158 | 8.88590 | 7.95364 |
| 8¾ | 20.56217 | 12.44924 | 9.90294 | 8.73822 | 8.11614 |
| 9 | 20.67873 | 12.57886 | 10.04519 | 8.89190 | 8.27978 |
| 9¼ | 20.79557 | 12.70909 | 10.18830 | 9.04660 | 8.44450 |
| 9½ | 20.91267 | 12.83992 | 10.33227 | 9.20231 | 8.61028 |
| 9¾ | 21.03005 | 12.97135 | 10.47707 | 9.35900 | 8.77708 |
| 10 | 21.14770 | 13.10337 | 10.62270 | 9.51665 | 8.94488 |
| 10¼ | 21.26562 | 13.23598 | 10.76915 | 9.67523 | 9.11362 |
| 10½ | 21.38380 | 13.36917 | 10.91640 | 9.83473 | 9.28330 |
| 10¾ | 21.50226 | 13.50294 | 11.06445 | 9.99513 | 9.45386 |
| 11 | 21.62097 | 13.63729 | 11.21327 | 10.15640 | 9.62529 |
For example, the monthly mortgage payment for a $125,000 mortgage with a 25-year amortization period at 8% is : ($125,000 ÷ 1,000) X 7.63213 = $954.02.
NOTE:To obtain a copy of the book for yourself please do not hesitate to contact Joan Manuel.
return to Joan's chapter introduction.