Mortgage Basics: Can You Afford a Home Today?

Whether you're currently a renter, a first-time home buyer or just seeing what home mortgage options are out there, here are some important points to consider when looking at whether you can afford a home today. 

PITI

All mortgages are based on the acronym PITI which stands for Principal, Interest, Taxes and Insurance. Oftentimes, buyers only consider the principal when purchasing a home but forget that lenders will require interest rate payments, property taxes and a certain amount of insurance to protect their security.

• Principal: This is the amount of money you owe a lender (minus the down payment) to purchase a home. For example, if you purchase a $750,000 home with a 20% down payment, your down payment will be $150,000 and the principal you subsequently owe the lender will be $600,000.

• Interest: The interest rate is a percentage of the principal that the lender charges you for allowing you to borrow money for a home. The higher risk you are (AKA if you have a lower credit score) the higher your interest rate will be. A good rule of thumb is this: "Higher Risk, Higher Rate; Lower Risk, Lower Rate." The better your credit is, the lower the amount of interest you're going to be required to pay.

• Taxes: Almost all real estate purchases require property taxes which may go to fund local schools, infrastructure, government jobs, etc. This tax is calculated by the assessed value of a property. Oftentimes, a lender may include these property tax payments into your overall mortgage payment.

• Insurance: Property insurance is a safety net to insure the property value is protected from a tree falling on the house, flooding, earthquake damages, etc. You generally have a monthly payment and get a deductible in the event there is a disaster covered by your insurance claim. If you put less than 20% down, lenders will usually require you to pay private mortgage insurance (PMI) which doesn't go toward your principal. This PMI provides greater security for the lender in the case that you default on the loan and are no longer able to pay your mortgage payments. Some lenders, however, don't require PMI even if you put less than 20% down. 

5 Types of Mortgages

Generally, there are 5 different types of mortgages buyers consider when looking for a home. Though there are  other creating financing options, these 5 types of mortgages are the most popular and widely used.

1) Fixed-Rate Mortgages - Fixed rate refers to the interest rate. These loans have a locked interest rate that never changes over the lifetime of the loan. Fixed rate mortgages can be 10, 15, 20, or 30-year loans. However, the 15 and 30-year loans are the most popular. 

2) ARM Mortgages - An Adjustable-Rate Mortgage (ARM) refers to a mortgage with an interest rate that is fixed for a certain time and then adjusts periodically based on the market rate. These kinds of mortgages usually benefit people who don't intend to have a mortgage for very long OR those who expect interest rates to go down in the future.

3) FHA Loan - An FHA loan is insured by the Federal Housing Administration. They give loans with down payments as low as 3.5% which is great for people with low credit scores and less than 20% down, but Private Mortgage Insurance (PMI) will be required. For those looking to buy a home for residence in California, CalHFA partners with the FHA to provide qualifying first-time homebuyers or those who haven't owned a home within the last 3 years extra FHA loan benefits such as downpayment assistance and homebuyer education and counseling.

4) VA Loan - A VA loan is insured by the Department of Veteran Affairs. Qualifying US veterans or those currently in the military can take advantage of this loan. It requires 0% down payment and no PMI. However, a VA funding fee would be required.

5) USDA Loan - A USDA loan is one backed by the Department of Agriculture. This kind of loan also requires 0% downpayment but it must be a home improvement loan or a personal residence home purchase for families within a certain income limit and geographical region (ie. usually limited to rural areas). There is also a cap to the value of the property that can be purchased. 

As a disclaimer, we are not licensed mortgage brokers and cannot provide detailed loan advising. However, if you are looking to buy soon, contact us and we will gladly walk you through the process of helping you find your next home or investment property!