Mortgage 101
New game, new rules for buying a new home

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While the process of obtaining a mortgage has become arduous, the good news is it’s not impossible.

It’s the classic catch-22. Real estate prices are at historic lows, making it the perfect time to buy. But most people can’t buy without getting a mortgage, and today, that’s no easy feat.

The lending landscape has changed so profoundly that it seems like the only people qualified to get a loan these days are the ones who don’t need one.

While the process of obtaining a mortgage has become arduous, the good news is it’s not impossible. There are a number of strategies buyers can employ in order to obtain a low-interest loan.

Here are some of the things to consider:

Credit Score. There’s just no getting around it: your credit score will affect your interest rate. In fact, it will affect your ability to obtain a mortgage in the first place. According to Wisconsin Mortgage Corporation vice president John Inzeo, the absolute rock bottom score needed in order to qualify for a mortgage is 620.

“The minimum used to be 580, but now, even on an FHA loan, you’ll need to have a score that’s 620 or higher,” Inzeo says. “But even that doesn’t guarantee that your loan is going to be approved.”

In order to determine your credit score, pull copies from all three reporting agencies: Trans Union, Equifax and Experian. The middle score is the one that will be used to underwrite your loan.

If your score is below 620, there are a number of things you can do to bring it up. Start paying your bills on time and pay off credit card balances so that they’re under 40 percent of your limit, says Gary Novel, president of the kreditguru.com.

Check your credit report to make sure you don’t have any collection accounts — unpaid parking tickets, medical bills and utility bills tend to be the most common culprits — and don’t apply for any new credit, since that lowers your score.

And though it may be tempting, don’t close any credit cards when you pay them off.

“The more credit you have available to use and the less of it you actually use, the better it is for your credit score,” Novel says. “Just because you have credit, doesn’t mean you have to use it.”

Employment history. In the days of easy money, self-employed professionals could simply state — and in some cases, overstate — their income in order to obtain a mortgage. No longer. “The days of stated income loans are gone, and we’ve moved to a more of a 1980s lending style, for those of us who have been around that long,” Inzeo says. “You’ll need to show two years of stable employment and a strong two-year income history that’s verifiable.”

Overall debt. Just how much house can you afford to buy? The answer is not only determined by how much money you make — but also by how much you owe. “Your total housing expenses — the principal and interest of your loan payment plus the escrows required for your property taxes and homeowners insurance — really shouldn’t be more then 28 percent of your gross monthly income,” Inzeo says. “The second ratio is 36 percent of your gross monthly income for your housing expense plus any other debt.” If payments on all your loans will total more than 40 percent of your income, brace yourself for rejection. On the other hand, compensating factors might include such things as cash reserves or a strong credit history.

Down payment. No down payment loans? A thing of the past. Buyers should not only expect to fork over at least 20 percent for a down payment, they’ll need enough cash to cover closing costs as well.

“The two biggest obstacles for buyers today are down payment and closing costs,” Inzeo says. “The cash needed to purchase a home affects a buyer’s overall ability to qualify for home financing.”

Cash reserves. You need more than just a down payment to obtain a mortgage these days. You also need some cash in the bank. Buyers need to show they have cash reserves equal to at least two months of mortgage payments (including property taxes and insurance). Even if a buyer can afford to put down more than 20 percent, it’s often better to have a down payment that’s balanced by reserve funds, Inzeo says. “Especially for first time homebuyers, I would rather see them have six months of reserves set aside. You have to maintain a house, and that’s expensive.”

Loan amount. In general, the more money you’re trying to get, the tougher it is. “Jumbo loan financing is very limited today because of the concern for values,” Inzeo says. “Lenders are very skittish, because they don’t know if those higher-end homes will hold value.” While it’s not uncommon for lenders to seek two appraisals on a jumbo loan, the recent U.S. housing report may help lessen some of the concerns. “What we’re seeing is a better understanding, especially in the Midwest, of where the market’s strengths and weaknesses lie,” Inzeo says. “The Midwest will typically lead housing out of a cycle like this. We have more stability than many areas.”

First-time homebuyer loans. First-time homebuyers who are buying a home or condominium can obtain a loan backed by the Federal Housing Administration for up to $410,000. These loans offer several benefits: credit scores are not taken into consideration as much and the minimum down payment is just three and a half percent. While these loans do carry mortgage insurance, it’s at a reduced rate and interest rates are whatever the prevailing marketplace rate is, no matter what your credit score.

Borrowers should be aware that their closing costs will be higher with an FHA loan — 1.5 percent of the loan amount is paid at closing for mortgage insurance (about $6,000 on a $400,000 loan). But these fees can be financed into the loan or negotiated with the seller, who can legally pay between three and six percent towards closing costs.

It can’t last. Current interest rates are at 40-year lows, but most experts say it can’t last. “(These are) unprecedented times in terms of interest rates, but the Fed has signaled that by mid-2010, they will begin to back off the monetary policy,” Inzeo says. “By the end of 2010, early 2011, we’ll start to see rates increase to around six, six and a quarter range. The big question mark, he says, is whether we’ll begin to see inflation as a result of all the capital that’s been put into the market. If that happens, we could begin to see rates increase faster, in 2011 or 2012. Until then, the triple bonus of newly affordable real estate, low interest rates and a tax incentive make this an incredible time to invest in real estate.”

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