Mortgage Loan Dos and Don’ts
from daveramsey.com on 13 Jun 2013
You’ve got plenty of options when it comes to financing the purchase of your home. Dave doesn’t recommend most of them, but it’s a good idea to know what’s out there and why you need to avoid some of the more popular mortgage options.
Adjustable Rate Mortgages (ARMs)
ARMs hook homebuyers with a low initial rate, then, after a designated period, the rate fluctuates for the remainder of the life of the loan. This kind of loan actually transfers the risk of rising interest rates to you, the homeowner. Right now, interest rates are incredibly low, and they have been for some time. But once rates start to adjust, there’s only one direction they can go: up! This risk makes an ARM one of the worst mortgage options available. Do not finance your home with an ARM.
Federal Housing Administration Loan (FHA)
FHA mortgages are backed by the government, which means the government insures the bank so it won’t lose its money if you don’t make your payments. You can qualify for an FHA loan with a down payment as low as 3%. But new regulations require you to keep private mortgage insurance (PMI) for the life of the loan. PMI can cost around $100 a month per $100,000 borrowed.
Department of Veterans Affairs (VA)
Loans designed to make it easier for our country’s military veterans to purchase homes are a great idea in theory, but the program falls short in practice. VA loans are backed by the Department of Veterans Affairs and allow veterans to purchase a home with practically no down payment. VA loans also have lot of fees, and interest rates are usually higher than those for conventional loans.
Buying the Right Way
The best way to buy a home is to pay cash for it—the 100% down plan. It sounds unrealistic, but people do it every day. And not just those with super-deep pockets. Many save for years to achieve their goal.
If you’re going to buy a home with a mortgage, you need to be on Baby Step 3, debt-free with a three- to six-month emergency fund in place. In Baby Step 3b, save up your down payment—at least 10%, but 20% will allow you to avoid PMI payments.
Your home loan should be a conventional, fixed-rate mortgage with a 15-year (or less) term. Do not get a 30-year mortgage! A $175,000, 30-year mortgage with a 4% interest rate will cost you $68,000 more over the life of the loan than a 15-year mortgage will. That’s a lot of money you could use to build up your retirement fund or save for your kids’ college.
Your monthly payment should not exceed 25% of your take-home pay. Any more than that will tie up too much of your income and slow your progress through the remaining Baby Steps.
House Hunt With a Pro
Once you have your bases covered financially, it’s time to start house hunting. Talk with a professional agent about your financial goals so they can help you find a home that fits your budget.
Dave’s real estate Endorsed Local Providers (ELPs) understand how important it is to you to buy a home you can afford, so you can trust that your ELP won’t pressure you to consider homes that would bust your budget. Let us help you find your ELP today!