Everyone dreams of buying their own home, for some this dream becomes a reality sooner whereas for others it becomes a reality later in life. Whatever the case may be, buying a house is actually a task that requires meticulous planning and execution of those plans.
In 2019 over 5 million people purchased their own homes through house mortgage. 2020 has not been a very good year in terms of business and the same is true for the real estate sector. In 2019 the real estate sector was on the path of stable growth. The Covid19 pandemic however has dented this growth and cut down the growth of the real estate sector.
While all may not seem good, there is a silver lining in this for potential homeowners. The housing market is down and this means that this is the right time to purchase your dream home.
If this is your first time buying a house, then there are a number of factors that you will need to be aware of. Buying a house is not like buying any other asset or commodity. Since almost no one buys houses on cash, there is almost always a mortgage option involved and this makes matters slightly complicated. This is why it is better to do your homework and know what buying a house requires before you actually get into the process of buying your dream house.
As mentioned above, almost no one buys a house on cash, except the ultra-rich perhaps. The working class has to use mortgages in order to borrow money from banks to buy their dream home. So what is a mortgage? A mortgage is simply a loan where the bank assesses your target property, values it, and then funds about 80% to 90% of the property value.
The borrower can purchase the property with this value and pay back the loan repayments in installments consisting of principal and interest over the term of the mortgage that can be anywhere between 5 years to 30 years. It is common for mortgage terms to be between 20 and 30 years.
Mortgage lenders require the borrowers to pay a portion of the home value upfront. For instance, if the value of the property is $100,000, then the lender may require the borrower to pay up to $10000 in down payment upfront. The lender will therefore fund at maximum up to 90% to 95% of the home value.
Now this percentage of the down payment may vary with lenders and it will also depend on the creditworthiness of the borrower. The more creditworthy a borrower is, the more the bank will be willing to provide funds, and therefore the lower the down payment will be.
Borrowers with high credit scores may be able to secure funding as much as 95% of their property value whereas borrowers with a good or satisfactory credit score may be able to secure up to 75% to 80% of their property value in funds.
In simple words the down payment that you may be required to pay for your home may be anywhere between 5% to 25% of your property value, depending on your creditworthiness.
Creditworthiness however is not the only determining factor. The lender also makes a lot of difference in the amount of down payment that you will be required to pay. Let us now look at different lenders and how much you may be expected to pay for them.
The United States Department of Agriculture (USDA) provides mortgages to borrowers living in rural agricultural areas. USDA mortgages do not carry any down payment, which means that USDA mortgages are fully funded mortgages. The eligibility requirements for USDA mortgages are as follows
- The property in question must meet eligibility requirements based on location
- Borrowers must have the income within the prescribed income brackets of their state to be eligible.
- The borrower must meet other requirements as specified under USDA terms and conditions.
Federal Housing Authority (FHA) mortgages are partially backed by government guarantees. The down payment on FHA backed mortgages can be as low as 3.5% of the property value.
Eligibility requirements for an FHA mortgage are
- The mortgage must be for a primary residence
- The property must meet the cost requirements set out by FHA
- The debt to income ratio of the borrower must be between 43% and 56.9%
- Borrowers must meet other credit requirements, as specified.
Conventional bank mortgages
Conventional bank mortgages are the mortgages funded by conventional banks. The down payment on these mortgages can be between 10% to 25%, depending upon creditworthiness of the borrower. The eligibility requirements depend upon the policy set by each lender. The most important factor, therefore, is to have a good credit score and a good report.
General eligibility requirements for conventional bank mortgages include
- Credit score around 600 marks, possibly above it.
- Borrowers must be employed.
- No bankruptcy, delinquency, or court orders in at least the last two years.
Other costs associated with Mortgage
The down payment is not the only cost linked with the mortgage. Closing or settlement costs are also a significant part of the mortgage. Closing costs include costs for documentation, legal fees, origination costs, and other related fees charged by the lender to sign the mortgage.
Typically the closing costs are between 3% to 5% of the mortgage value. Therefore if the mortgage value is $100,000 then the closing costs at maximum can be $5000. Similarly, if the mortgage value is $200,000 then the closing cost would be around $10,000.
In addition to the down payment and settlement costs, there can be other additional costs such as prepayment penalty and discount costs.
- A prepayment penalty is not a cost per se, it is a penalty for the early payment of the mortgage.
- The discount cost is a feature in mortgages that allows the borrowers to pay extra to reduce the interest rate by 100 basis points or so. This is basically a way to buy a lower rate of interest on the mortgage.
In total, borrowers should have enough cash to pay for the down payment and the closing costs at the time of origination of the mortgage. For a $100000 value mortgage, this sum may come around to $15000. For a $200000 value mortgage, this may be around $20,000. The borrowers must therefore roughly have roughly this amount of cash in hand, to pay for their mortgage upfront.