Guest post by Betsy Fallwell
When I bought my first house in 2006, it was a different world. Lenders didn’t ask how much you made, and if they did, they didn’t bother asking for verification. You could buy a home with no money down, without having to worry about additional private mortgage insurance, or PMI, on top of it.
A lot has changed since then, thanks to the housing crisis and accompanying recession. Those changes have many would-be homeowners wondering if they’ve missed out on having their chunk of the American Dream. The fact is, if your credit is good and you do your research, you home ownership isn’t out of reach, whether you’re a first home buyer or someone returning to the housing market after getting burned.
Comparing Home Loans
The first step to figuring out if home ownership is right for you is comparing home loans. They come in a variety of shapes and sizes: fixed-rate loans come with a stable interest rate for the duration of the loan; adjustable-rate mortgages, or ARMs, start with a low introductory interest rate, which is reevaluated based on market conditions once that intro period expires; an interest-only loan lets you pay just the interest on your loan for a few years, but then adds in principal payments thereafter.
Each loan has its pros and cons. The best way to visualize this is to look at monthly payments. Let’s start with the same “sample” property: a $200,000 home with a 20% down payment, resulting in a $160,000 loan.
- Fixed-rate mortgage – 30 year term at 3.75%: $740 monthly payment on the interest and principal for your loan; this payment remains the same for all 360 months of the loan’s term, regardless of market conditions. Total interest on the loan = $106,754
- ARM – 5/1 term, with 2.75% rate for the 5-year introductory period (total term = 30 years, or 360 months): $653 monthly payment on the interest and principal for your loan for the first 60 months; after that, rates could increase (there’s usually a cap on how much they can increase each year, i.e. 0.25%, with an overall interest rate cap, i.e. 8%); an increase to a 4.5% interest rate could bump your loan payments to $773 a month. Total interest on the loan = undetermined
- Interest-only loan, 5 years at interest-only 2.5% rate, then remaining 25 years at 4.75%, paying principal and interest: The initial payments for those first five years would be $333 – lower than with any of the other home loans we’ve examined; after that, though, your rate will increase as you start paying down the principal, too, increasing your monthly payments to $912. Total interest on the loan: $133,656
With both the fixed-rate and interest-only home loans, you’ll at least know your interest rates – and your monthly payments – throughout the life of the loan. With the ARM, it’s unpredictable; market conditions could remain steady, and you may benefit with a lower interest rate after the introductory period ends. Or, they could skyrocket, and you could pay two or three times more each month.
Making the Market Work for You
If you’re worried that money may be tight, there are plenty of adjustments you can make to your living arrangements to lessen the financial burden. For example:
- Reevaluate your target neighborhood. Changing your target zip code – even by just a few miles – can really impact market values, giving you more bang for your buck.
- Live with family members. Do you have aging parents? Grown children who need a place to live? A multi-generational home, with all adults helping to pay the home loan, is an option that’s becoming more popular.
- Take on a tenant. Depending on the home you buy, you may be able to rent out an extra bedroom or finished basement to a tenant. The rent they pay will defray your monthly payments; some lenders will take this into account when considering you for a home loan.
- Search for first home buyers’ grants. Local and state government often offer grants and other forms of financial assistance – such as down payment assistance or loans with little money down without the penalty of PMI – to first home buyers. Many FHA loans, a program sponsored by the U.S. government, offer this type of help. Ask your lender or mortgage broker for details.
A Dream Deferred
Even with low housing values and low interest rates, now may not be the best time for you. If you don’t have enough capital to finance a down payment, or if your credit score is unhealthily high, a lender may turn you down for a home loan.
If this happens to you, don’t panic. Instead, reevaluate your budget. Would you be happy with a smaller home in a less-desirable neighborhood? If the answer is no, then don’t stop pursuing your dreams; simply put the process on pause. Adjust your budget to maximize your savings, which will give you a bigger down payment later on. Work on improving your credit, either by paying down existing debts or improving your credit history by making on time payments or even learning to responsibly use a credit card.
Thanks to Betsy for this guest post. So, what do you think of her advice? Are there any points you would counter, agree with or have further questions / comments? We look forward to your comments.