Desired Mortgage Amount: the total amount you will borrow. If you are folding closing costs into the mortgage, remember to include them in the figure you provide.
Monthly debt payments: amount you are paying each month on average for all your debts (other than the mortgage). Include car loans, student loans, credit card payments, and other debt. The calculator only allows you to enter a single amount, even though debt payments can change over time. The banks also tend to look at current debt rather than project your future indebtedness.
Monthly property taxes and insurance: the total amount you would have to pay in property taxes and insurance (homeowner's and any mortgage insurance) each month. Use the current property tax rate and assessed value. True, both the property tax rate and the assessed value will change over time. But the current values are what the banks use to determine mortgage eligibility.
Start Interest Rates At: the lowest interest rate you could realistically get. The available interest rates change every few months or so as the interest rate changes at the US government's Federal Reserve Bank, which controls the country's financial system. Your credit rating will play a big role in the rate for which you are eligible.
Loan Term: the maximum amount of time you have to pay off the loan. You select the term at the time you take out the mortgage; generally, the longer the term, the higher the interest rate, but the lower your monthly payment. The calculator lets you select from 1 to 30 years. (Thirty years has historically been the most common mortgage term).
A mortgage is a loan to buy a house. Just as a car loan uses the car itself as collateral for the loan, so does a mortgage use the house as collateral. If you don't make the mortgage payments regularly, the mortgage lender can seize your house and sell it in a process called foreclosure. Since mortgage lenders stand to lose a lot of money in the process of foreclosing on a house and having to sell it, they try hard to make sure that they don't give mortgages to anyone who won't be able to afford to make mortgage payments.
Types of Mortgages
The traditional mortgage is just a simple loan with a fixed rate of interest and a repayment schedule much like any other loan. The calculator assumes this is the kind of mortgage you are getting. But there are other more creative options for mortgages. Here are the big choices.
- A fixed rate mortgage is the most traditional mortgage, still the most common, and the one the calculator assumes you are getting. A fixed-rate mortgage has a single interest rate that never changes. Monthly payments usually stay the same, too.
- An adjustable rate mortgage will see its interest rate go up and down along with the interest rate set by the Federal Reserve, which leads the nation's financial system. Why would you agree to such an arrangement? Because the initial interest rate is usually lower than for a fixed-rate mortgage. Since interest rates are at historic lows, an adjustable rate mortgage may be a bad idea for anyone not planning on selling the property in five years or so.
- Interest-only mortgages only require you to make payments toward interest in the first few years, meaning you have much lower payments. An interest-only mortgage also means you are paying nothing toward principal, and so the whole arrangement is akin to an expensive form of renting. Eventually the interest-only mortgage ends and you either have to pay cash or take out another mortgage.
- There are also special mortgages to help you own your home. Some of them are through the Veterans Administration, Federal Housing Administration, or the Rural Housing Service. State and local governments back loans for first-time borrowers and some non-profit agencies offer down-payment assistance.
Qualifying for a Mortgage
There are firm guidelines for qualifying for a mortgage, which a large majority of lenders use. In essence the formula is simple: you look at all of the costs of the mortgage plus all of an applicant's major expenses, then look at the applicant's total income, and see if the costs and expenses won't overrun income. Will the applicant have enough money to make payments?
Costs of Homeownership
There are specific costs of homeownership that a mortgage lender will take into account when evaluating a mortgage application:
- mortgage amount borrowed (including closing costs if those have been folded into the mortgage)
- property taxes
- mortgage interest
- insurance, both homeowner's and any mortgage insurance
Of course, these aren't the only costs associated with homeownership. There are "soft" costs that drive up the total cost of homeownership significantly. Mortgage lenders don't specifically look at other costs of homeownership which may be harder to estimate upfront. Instead, the expectation that the borrower will have other drains on his or her finances is built into the formula, preventing a borrower from committing all his or her earnings to housing costs.
Still, you should consider what these costs will be in your own specific case, since they make owning a house far more expensive if they get out of control. These "soft" costs include one-time costs such as those of furnishing a new home and moving house. There are also costs you will have to pay for the life of the home, such as:
- air conditioning
- private security systems
Remember that the larger the home, the larger you should expect these "soft" costs to be. Conversely, a better built and maintained house will likely have lower costs. Often, newer houses cost more precisely because it is assumed that a new house will cost less to maintain, heat and/or air condition. Just remember to inspect any house well to make sure it won't pack expensive surprises.
Condominiums will often include some or most of these costs in a monthly fee, often called a "condominium fee," "homeowner's fee," or "common" fee. Just remember to check in advance what is covered and what isn't. Is maintenance within your unit, such as plumbing, covered? Is exterior maintenance such as repainting covered--or will that require a special extra fee?
Income and Qualifying for a Mortgage
Ultimately you need an income to pay a mortgage, or at least that's the way mortgage lenders think. That means that if you're retired or out of work for some reason, it may be much, much more difficult to get a mortgage. The self-employed may also face some hurdles: expect to be asked for two years or more years of tax returns and to have your income taken as an average of both years. In short, if you're contemplating leaving a traditional job for any reason, you may want to apply for a mortgage before you jump ship, not after. Of course, in any event, make sure you really will be able to make the mortgage payments safely. You should be at least as afraid of foreclosure as the lenders.
Credit and Qualifying for a Mortgage
One important issue in qualifying for a mortgage is credit. The better your credit, the lower your interest rate will be. Check your credit report well in advance of applying for a mortgage. Any nasty surprises could cost you thousands of dollars over the life of a mortgage. If you are applying for a mortgage jointly with someone else, you should check with the mortgage lender to see whose credit will be checked. Oftentimes, the lender will only check the credit of the higher-earning party to the mortgage.