Home Mortgages Still Testing Financial Literacy

As we continue to recover economically, it is important to look at one of the major factors that contributed to the recession.   The dream of home ownership is still strong for many, but understanding how mortgages work can be a challenge. The days of home prices always going up are long gone, so buying a home should be recognized as a major transaction, with serious financial implications.  The process is a real test of any person’s financial literacy, so now is a good time to check your own understanding of all the elements.

In the long term, most experts agree that buying can be up to 45% cheaper than renting, primarily due to tax advantages, but the up-fronts cost, including the down payment, are much higher.

According to government statistics, about 65% of households in the U.S. last year were owned rather than rented, reflecting personal interests and cost advantages. But before you jump into this majority, here are seven key financial elements of this decision to contemplate:

1. Type of mortgage and payoff period.  The two basic types of mortgage loans are the fixed rate mortgage (FRM) and adjustable-rate mortgage (ARM).  Mortgages commonly have a term of 30 years with fixed monthly payments, except that adjustable-rate versions move the rate upward after an initial 3 to 5 years. Longer terms and lower rates mean lower monthly payments.
2. Payment amount qualifications.  The financial literacy “rule of thumb” is that you should never spend more than 30% of your annual income on the mortgage, and have savings available for 20% of the price as a down-payment. Most banks and lending institutions will review your specific financials, check your credit, and “pre-qualify” you for specific loan limits, before you start shopping.
3. Loan pre-approval estimate.  These qualified limits can then be formalized into a pre-approved loan amount, destined to be used to make an offer on the home of your choice, with a reasonable expectation of closing the deal before conditions change.  To prevent delays and disappointments, I recommend that you get a loan limit pre-approved before serious home shopping. And remember, you don’t have to spend the full amount you have been pre-approved for.
4. Loan commitment.  After a home purchase offer is made, you need to quickly get a formal loan commitment from the lender.  At this stage the lender will verify all of the financials you provided to get the pre-approval (i.e. income, employment, assets, etc.), and the property appraisal is ordered.. Once these activities are completed successfully, the lender can then issue a loan commitment and rate lock.
5. Loan rate lock. A mortgage rate lock is the lender’s promise to honor a specific interest rate and specific closing costs for a limited period of time. It’s meant to protect you from interest rate changes while your loan application and closing papers are prepared.  These activities can take several weeks, so don’t skip this step.  Most rate locks are good for a period of 30 or 60 days.  Banks may offer extensions on the lock, but for a fee, so it is important to be timely with anything the bank requests that you provide.
6. Purchase transaction settlement.  Often called closing, this is the final step to home ownership, where the property is formally transferred to the buyer. Key activities during closing include delivery of the payment from the buyer (or loan from the bank), the seller signs the deed and delivers the keys, the title company registers the new deed, and the seller receives the proceeds. You are now the proud owner of a home and a mortgage.
7. Mortgage payment process.  For many new homeowners, the reality sets in at this point.  You are now committed to making a fixed payment on a specific day each month, until you sell the home, or for the length of your loan, whichever comes first.  You can write a check each month, or have your bank account automatically debited, but the responsibility to have the money there is always yours.  Missed or late payments will reduce your credit rating, result in extra charges, and could lead to foreclosure.

The alternative to buying a home is renting, which has the distinct advantage of a predictable monthly expense, with much less volatility and long-term liability. Other advantages of renting include shorter term commitments, minimal maintenance activities or costs, potential access to perks like club houses and workout facilities, and no risk of loss on the next economic turndown.

Obviously, the positive side of home ownership is the potential for your home to appreciate (increase) in value over time, while giving you significant annual tax savings, and full control over your own layout and decorating interests.  You can settle into the community and get a feeling of permanence.

If all these points on home mortgages are clear, and no surprise to you, you should feel good to have a solid foundation of knowledge on the topic..  Now all you have to do is pass along your knowledge to your friends, family and children, as they get ready to strike out on your own.  If you aren’t sure how to get the conversation going, check out my Financial Mentorship site, where we talk about mortgages, credit and other topics that will help you improve your finances today. It is never too late to give the gift of financial literacy!

Warmly,

 

Sharon