Financing a Real Estate Purchase 101
Welcome to my new series, “Understanding Financing.” This is the first blog in this series and I am going to be covering the basics of financing a real estate purchase. As the series continues, I will cover a variety of topics related to securing financing for your real estate purchases, including info on how your credit, income, and assets affect your ability to secure financing, a summary of the loan process and how you can get ready for it, understanding the role of the appraisal, and a summary of loan programs currently available for down payment assistance.
When you want a loan to finance the purchase of a house, you are applying for a mortgage. Your mortgage payments will include your principal payment, interest payments, taxes, and insurance. The principal is the amount you borrowed. The interest is what the lender charges you to borrow the money. In addition, you will also make payments toward your property taxes and home insurance. If your home is in a federally designated flood zone, you will also need to purchase flood insurance. Initially your monthly payments will largely go toward paying interest and gradually will pay larger amounts toward the principal owed.
When you apply for a mortgage, what is a lender looking for and how are they evaluating you? We call them the 3 C’s – Credit, Collateral, and Capacity.
Credit is your credit score and previous credit-related reputation. Do you have any liens against you? Have you had a foreclosure or bankruptcy? What credit accounts do you have, how long have you had them, and what is their current status? Have you requested new credit recently?
Capacity begins by looking at your debt-to-income ratio. This is your monthly expenses to monthly income ratio. Typically, lenders will want to see that your expenses are not more than 40-45% of your monthly income. Do you have cash reserves?
Collateral takes into account how the property will be used and the down payment provided toward the property. How much equity will be in the house/how large is the down payment? Will the house be a primary residence or an investment property?
It is important to keep in mind that, when you get a mortgage, you are agreeing to pay your lender the cost of the loan itself with interest. Your house is the collateral on that loan. If you do not make those payments, the lender has the right to take the house and sell it (foreclosure).
In my next blog, I will discuss credit, income, and assets and how this affects your mortgage application.