Q. I am a 24 year-old woman, looking to purchase her first home within the next six months based only on my income and credit. My credit score is 690 and my annual income is $30,000. My monthly debt payments are $80. I wanted to know would a 7/1 ARM be better for me than a 30-year fixed-rate loan. I feel that I am buying a starter home and would not be in the home more than seven years. I believe that a 7/1 would have a better rate therefore allowing me more house for my money. Am I thinking correctly or not? Please help....
A. You are definitely on the right track as far as getting a 7/1 ARM if you are only planning on staying in the house that period of time. A quick check showed that you could save up to half a percentage point if you get a 7/1 ARM instead of a 30-year fixed. The only item to beware of is that some ARMs contain a prepayment penalty, but that probably wouldn’t affect you. Since you are not planning on keeping this mortgage for more than the introductory period, you really don’t have to worry about margins and rate caps.
You say that you are looking to buy within six months. I would like to suggest that during that time you work on improving your credit score. If you could push it into the low 700s, you might get a better rate.
The first thing to do is order your free credit reports from: www.annualcreditreport.com or call: 1-877-322-8228. Check for errors and make corrections where possible, and be sure to pay every bill on time. This is the most important thing you can do to improve your score. You should check your credit reports prior to applying for a mortgage anyway, so starting now should give you ample time to fix any mistakes you see. Each report will outline the steps to take if errors are present — and they often are.
On the Interest.com mortgage page there’s an article on improving your credit score called “5 steps to get the best possible rate” that you might want to read.
Q. I'm a first time home-buyer who has been approved for a stated income home loan of $200,000. My loan, however, comes with an 8 % interest rate. The actual home I buy will probably cost around $160,000. I need to buy this home on my own because my partner has horrible credit that would actually raise the interest rate more. And if I waited for an income based loan, it would be for a lot less money (but likely a better interest rate).
Here is my question: Is it worth getting a loan now at 8 % if that is the best I can do?
A. Your 8% loan is a little more than a percentage point higher than the current average rate for a 30-year fixed-rate loan. So that's not a big penalty. If you had said 12% or 13% waiting would make a lot of sense.
Now you need to figure out how much you can afford to spend on a house with your 8% loan.
Since you are a first time home-buyer, you don't have equity from a previous house to help with the down payment.
So let's assume you buy a $160,000 house, putting $5,000 down and borrowing the remaining $155,000 with a fixed-rate, 30-year loan. At 8%, you'd have to pay $1,137 a month for interest and principal. Taxes and insurance -- including mortgage insurance, since you are putting less than 20% down -- will add at least $200 a month to that, and probably more like $300 to $400 a month.
Conservatively, your total monthly payments would be $1,337. But you shouldn't be surprised if it was more like $1,500 a month.
The general rules lenders use to determine if you can afford a house are:
- Housing costs -- including principal, interest, taxes, assessments or any other fees -- shouldn't exceed 28% of your gross, or pre-tax, income.
- Monthly debt payments – including your mortgage, auto loans, utility and credit card bills – shouldn’t exceed 36% of your pre-tax income.
That means you'd need an annual income of $57,300 to $64,285 to keep those payments within 28% of your pre-tax income.
If you added just $500 a month for car payments, credit card, gas, electric and other recurring bills, that goes up to $61,233 to $66,666 a month to meet the total debt rule.
If you waited until you could qualify for a 30-year loan at the average interest rate of 6.9%, your payments would be about $117 a month less.
Now your annual income could be as low as $52,285 a year to stay within the housing cost rule, and $56,666 to stay within the total debt rule.
You didn't say how much you expect to be earning, but the biggest mistake first-time buyers make is spending more than they can afford. So work backwards from how much you expect to make to figure out the price range you should be looking at.
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