Borrowing more money than you’ve ever seen in your life is definitely a memorable experience. There are smart ways to get there and dumb ways too.
Figuring Out How Much Home You Can Afford
When people think about buying a home for the first time, only careful study and advice keeps them from overpaying. Generally, a housing payment shouldn’t be more than 25 to 30 percent of a family’s gross income. The housing payment includes the actual mortgage payment (principal and interest), property taxes, and homeowners’ insurance; commonly referred to as PITI. So, if your gross income is $4,000 a month, your monthly housing payment shouldn’t be more than $1,200.
These days, most lenders will tell you that you can easily go 30 percent or more, and when housing prices were going up at a steady gallop, that might have been true because equity was following at a similarly brisk pace. But you have to consider the weight of a mortgage payment in good markets and bad. You also have to consider whether you could carry the payment if:
- You or your spouse lost your job.
- You suddenly had to replace a car and needed to take on a car payment.
- Your income and property truces rose.
- That doesn’t include paying expenses for yourself, your kids, and of course, saving for retirement.
When the Time Comes to Refinance
In a rising interest rate environment, thoughts turn to refinancing. Many people try to go for fixed-rate mortgages or long-term adjustables to keep their payments from rising out of control. Some tips on doing it right:
Dispose of as much debt as you can. Obviously, getting the best rates is based in part on the debt level you’re carrying now. Try to pay off as much high-rate debt as you can before you begin the process. Make sure your credit reports are clean. Before you start applying to refinance, make sure your credit reports are free of errors. This will take at least a month, so the best strategy is to plan the process ahead of time.
Questions to Ask Loan Officers Before You Borrow
- If you’re planning to buy an investment property with this new crop of low down payment loans, you should ask your loan officer:
- How much will I have to pay each month?
- How much will I pay when (or if) this loan converts?
- Is this a negative amortization loan, and if so, how much will I owe on the loan balance when the super-low interest rate expires?
- What happens if rates rise?
- Start with your goals. If you plan to stay in a home for a lifetime, steer toward fixed-rate loan options so you’re not squeezed by rate increases.
As for the credit reports, those are pretty easy-see what TransUnion (www.transunion.com), Experian (www.experian.com), and Equifax (www.equifax.com) charge for more than one credit report in a year. Then ask your lender where those fees are on your statement to see bow closely they match.
Fixing the Damage
During that floating cocktail party that was the 1990s, people weren’t all that worried about tapping their home equity to pay off bills or do home improvements. Inflation was in check, investments and wages were still on the rise, and recession hadn’t yet dampened the job picture.
The new century has brought new realities, and for many, a new view of the reality of borrowing against their homes. As the prime rate has risen since 2004 from a rate around 4 percent, the interest debt from home equity borrowings has sliced the cash flow of many households.
There are two primary kinds of home equity debt. Add that combination to rising rates, and you see an increasingly large group of homeowners facing the risk of foreclosure, being forced to sell or downsize, or at best, staying in debt well into their senior years.
Ways to cope with the threat of rising debt:
- Refinance into a fixed-rate first loan. If you have a good credit rating, are planning to stay in your home for awhile and otherwise have low debt, make every attempt to combine your first and second mortgages into a fixed-rate first mortgage and attempt to pay a little more than the minimum balance each month.
- Start tracking spending. lf you’ve never bought a personal accounting program for your computer, now might be the time. Even if you total up your expenses the old-fashioned way (with boxes of receipts and sheets of paper), computerized tracking allows you to categorize your spending in ways where you can immediately see changes in spending patterns that you can correct. It makes it easier for year-end tax preparation too.
- Make shopping lists for everything. Impulse buying is fine on birthdays, but not the rest of the year. Start creating lists not only for the grocery, but for necessary trips to the mall, drugstore, and discount store. Forcing yourself to list what you’ll be buying gets you thinking about what you really need-soon, you’ll be scratching things off.
- Add to minimum payments. Get in the habit of paying amounts above the stated payment on mortgages, car loans, or any remaining credit card balances. You’ll eliminate debt faster with minimal pain.
- Set a budget. It may be the $4 trip for your mid-morning coffee or those extra cable channels, but once you make a decision to cut debt, it is also necessary to cut spending. Take a cold, hard look at everything nonessential in your daily spending, write down what you plan to live without, and stick to it.
- Re-evaluate energy use. Cut back on the car trips, turn off the lights when you leave the room, and get used to wearing a sweater around the house. Current energy crises should build lifelong conservation habits that will save you money.
Home Financing: The Good, The Bad, and The Ugly by Ben Dallas
