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Cover story: Planning takes fear out of mortgage
As waves of foreclosures have crashed into local housing markets, attention has been focused on how to help homeowners struggling to keep their homes.
While many of these homeowners are in trouble because of unforeseeable circumstances such as job loss, reduced income or an illness, some of the financial problems they face could have been prevented through better pre-homeownership education and financial counseling.
Some homebuyers may be delaying buying a home purchase out of fear of becoming a foreclosure victim, but with sensible planning and a budget, a purchase can be less frightening.
"The best advice I can give to a potential homebuyer is to take a home-buying class that will teach them everything about budgeting, mortgage loans and choosing the right property for their needs," says Gail Cunningham, vice president of public relations for the National Foundation for Credit Counseling (NFCC).
"Perhaps even more important is that consumers should never feel rushed or forced into buying a home," she says. "Home prices are more affordable right now, and interest rates are low, but consumers are much better off if they are fully prepared to buy a home than if they rush to take advantage of the market. Give yourself time to budget, plan and, most of all, save, before buying a home."
Budgeting for a home
Paul Defngin, a mortgage planner with the Parsons Mortgage Group at Apex Home Loans in Rockville, Md., says all potential homebuyers should sit down with a budget before considering whether they can buy a home.
"Everyone should know what money is coming in and what is going out," Mr. Defngin says. "People think they can afford to pay more for a mortgage than for rent, but if they are not disciplined enough, they may find themselves in trouble."
Mr. Defngin says that although lenders will look at the borrowers' debt-to-income ratio to qualify them for a maximum loan, consumers should determine for themselves a comfortable level for their housing payment and budget.
HomeFree-USA, a housing counseling agency approved by the Department of Housing and Urban Development, assists consumers before they buy a home and helps homeowners avoid foreclosure. HomeFree-USA provides the following list of questions for potential homebuyers:
- Do I have a good, steady source of income (usually a job)? Have I been employed regularly for the past two to three years? Is my current income reliable?
- Do I have a good record of paying my bills?
- Do I have few outstanding long-term debts, such as a car payment?
- Do I have money saved for a down payment?
- Do I have the ability to pay a mortgage every month, plus additional household costs?
While individual borrowers have different income levels and therefore different budgets for housing payments, most lenders follow the guidelines that monthly mortgage payments should be between 29 percent and 31 percent of monthly gross income. The total monthly debt-to-income ratio usually must be a maximum of 45 percent of monthly gross income, including housing expenses and non-housing expenses, such as a car payment, credit card payments, student loan payments or child support costs.
The debt-to-income ratio requirements vary by lender and individual circumstances. For instance, borrowers with a high credit score and significant savings may be able to qualify with a higher debt-to-income ratio than a borrower with a low credit score, a lack of job stability or few cash reserves.
Mrs. Cunningham and the NFCC recommend that consumers spend no more than 30 percent of their take-home pay on housing costs and no more than 20 percent of their take-home pay for other debt service such as car payments.
"Unlike lenders, we base our recommendations on consumer take-home pay rather than their gross pay, since, realistically, that's what they have to work with to pay their bills," Mrs. Cunningham says. "People will find themselves hamstrung if they are spending more than 50 percent of their paycheck on paying their debts, because they still haven't paid for their food, their utilities, child care and other bills that fluctuate."
An affordable housing payment can prevent families from slipping into financial problems or eventually even a foreclosure because the homeowners can continue to build a savings fund to help them withstand an emergency.
Saving money before and after becoming a homeowner can be the most valuable tool in preventing a foreclosure.
"No one ever says they saved too much money," Mrs. Cunningham says. "It used to be that financial experts recommended that everyone have three to six months of their income for an emergency savings fund, but now sometimes they say eight to 12 months. It is very hard to tell someone that they need that much money in the bank, because that can be daunting to try to save that much."
Mrs. Cunningham recommends that everyone put 10 percent of every paycheck into a "rainy-day fund" so that at the end of a year they will have money saved for emergencies such a home or car repair. The rainy-day fund should be in addition to other savings, she says.
"One-third of Americans put zero toward savings, so they are living on a slippery slope that could hurt them at any time," Mrs. Cunningham says. "We all work so hard for our money, and many of us spend it so casually."
Mrs. Cunningham recommends saving as much as possible for a down payment by budgeting, taking on a second job or perhaps moving in temporarily with parents to save on rent payments for a few months.
"People who live on an all-cash basis typically save about 20 percent of their income every month because their awareness of their spending is so much greater than people who use debit or credit cards," Mrs. Cunningham says. "The main thing is that if you take the time to save funds for a home purchase and reduce your spending, you will be improving your credit score and your ability to afford the maintenance and repairs that come along with homeownership."
While conventional lenders usually require a 10 percent or 20 percent down payment, consumers can make a down payment as low as 3.5 percent with an FHA loan. Those who qualify for a VA loan can obtain 100 percent financing. For a $300,000 home, a 20 percent down payment would require $60,000, while a 3.5 percent down payment would be $10,500.
"Conventional lenders want to see at least two months of the prospective mortgage payment, including principal, interest, taxes and insurance, that will be left as cash reserves after the borrower has paid the down payment and closing costs," Mr. Defngin says. "My preference is to see at least six to even 12 months in reserves. It is better to keep that money in the bank than to spend it on the down payment and closing costs, so if someone comes to me with $20,000 in cash, I suggest they do an FHA loan. That way, they can keep the money available for emergencies and repairs."
While home maintenance and repair costs vary according to the age and condition of the home, Mr. Defngin says consumers should budget 3 percent to 5 percent of their monthly mortgage annually for minor repairs and maintenance. A home inspection can help buyers evaluate the need for major repairs.
Understanding your loan
Most homebuyers opt for a fixed-rate mortgage loan of 30 or 15 years, so borrowers have an easier time understanding their loan payments than when adjustable-rate mortgages or interest-only loans were more popular.
"One thing people do need to understand is that even with a fixed-rate loan, their monthly payments will change because of changes in their property taxes and homeowners insurance," Mr. Defngin says.
While loan products have changed as a result of problems in the housing market, another difference Mr. Defngin sees is that the perspective of buyers has changed.
"Consumers are more educated and more serious about buying a home now," Mr. Defngin says. "They need to look at it as a long-term purchase and a place to live. If the value goes up before they sell it, that would be just icing on the cake."
Mr. Defngin says most people should stay in their home at least five to seven years to recoup the investment costs of buying.
"It may seem hard to plan that far ahead, but everyone should also think about their job security before they buy a house," Mr. Defngin says. "It might not be a good idea to buy a house if there is any level of uncertainty about your job or if there have been layoffs in your industry. You would be better off renting and waiting if you are not sure that you can stay in the area and have a stable job for the next five years."
Homeowners who find themselves struggling to make their monthly mortgage payments or know they are heading into problems because of a job loss or reduced income should contact their lender immediately.
"No one should be ashamed that they are having financial problems," Mr. Defngin says. "Lenders have a lot of programs now that they can use to help consumers. Never wait to contact your lender. The problems are harder to work out the longer you wait."
Mrs. Cunningham agrees homeowners in financial trouble should immediately contact their lender to see if they can make arrangements for a more affordable mortgage payment. In addition, she and the NFCC counselors recommend that consumers develop a strategy for paying their bills.
"If someone is having financial problems, they need to make sure that they pay their living expenses first and follow a very set order for paying everything else," Mrs. Cunningham says. "First, pay the mortgage or the rent because if you do not pay that bill, you could lose your home.
"Next you need to make sure you have money for food, utilities, child care, gas for the car and insurance payments so that you and your family have food and heat and everything necessary for living. The next payment that must be made is your other secured debt, usually a car payment. Most people need their car to get to work or to look for work, so you need to try to make sure it is not repossessed."
Mrs. Cunningham says many people choose to pay their creditors for non-secured debt, such as credit card debt, first.
"These creditors make the most noise, so they intimidate people, but everyone should focus first on keeping their home and their car and food on the table before they develop a plan to pay off their debt," she says.
A nonprofit credit counselor can help every consumer develop a budget and handle financial decisions, whether the consumer is on the path to homeownership or struggling with an unaffordable mortgage.
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