Understanding Home Loans ? Budgeting, Assets & Liabilities for Home Loans

Home loans are one of the longest-term loans that usually extend up to 30 years or more. Hence, it is necessary that you are acquainted with each aspect of the process before committing to the loan. Understanding the process also makes you more comfortable and confident in your negotiations.

The home buying basics:
The purchase price = Your down payment + the amount of your loan

A typical home buying process begins with the lender extending the buyer a loan for the price of the home. The loan amount is over and above the down payment made by the buyer. On receiving the loan, you have to sign a mortgage agreement which states that you agree to pay back the "principal" amount (the amount you are actually borrowing) with interest (the money charged by the lender for the loan). Interest Rates vary, depending on the type of loan and your ability to repay. On signing the mortgage agreement, you agree to make monthly payments to the lender to repay the money borrowed, with the interest additionally at the rate charged.

Budgeting
Homebuyers should understand that monthly mortgage payment is only a portion of the total costs involved in owning a home and taxes, insurance and other associated costs may add substantially to the total monthly housing costs.

Situations might also require you to make monthly payments into an impound account (i.e. a Tax and Insurance Reserve or escrow account) if the lender is paying property taxes, mortgage insurance and hazard insurance for you.

A purchase agreement might also necessitate an escrow, a process in which a third party holds all required money and documents until the buyer, the seller and the lender have fulfilled all of the conditions of the agreements.

A lender may also charge a loan origination fee or points at the beginning of the loan. Points are part of the cost of borrowing money with each point equaling 1% of the amount you have borrowed. You may opt to pay additional points in order to reduce the interest rate, margin or lifetime cap. However, you need to understand that payments made for additional points are usually considered as a buy down fee and may not be tax deductible.

Determine Your Assets
Determining your assets is of foremost importance when it comes to deciding how much you can spend on your new home. Determining your assets takes into account your income, savings, investments, and other holdings such as Individual Retirement Accounts (IRAs) or Keogh plans, the cash value of your life insurance, pensions or corporate savings plans, and equity in real estate. Lenders require this information before deciding if you are eligible for a home loan.

An important prerequisite is differentiating fixed asset from variable asset. Additional income earned through; bonuses, commissions and overtime pay, usually varies from year to year, and often lenders are reluctant to depend on them. Hence, average your income to get a realistic view of what your income level actually is.

Average income = total income (including bonuses, commissions and overtime) divided by the number of years for which income is considered

By liquidating your savings, investments, and other holdings into cash, you would become liable to be taxed on most of it. Gifts are often overlooked as a source of tax-free money. You and your spouse are entitled to take up to $40,000 gift from your parents, which will be counted as tax-free.

Liabilities
Your home loan is a long-term commitment. Understanding each aspect of the process can make you more comfortable and confident in your negotiations.

Here is a quick review of the basics regarding a purchase transaction:
The purchase price = Your down payment + the amount of your loan

The lender extends the buyer a loan for the price of the home over and above the down payment. When you sign a mortgage agreement, you are agreeing to pay back the "principal" amount (which is the amount you are actually borrowing) plus interest, which is what the lender charges for the money. Interest Rates will vary, depending on the type of loan and your ability to repay.

The buyer agrees to make monthly payments to the lender to repay the money borrowed, plus interest at the rate charged. When budgeting, remember your monthly mortgage payment is only a portion of the total costs involved in owning a home. Keep in mind that taxes, insurance and other costs incurred when owning a home may add substantially to your total monthly housing costs. Monthly payments into an impound account (also called a Tax and Insurance Reserve or escrow account) may be required if the lender is paying property taxes, mortgage insurance and hazard insurance for you.

Before closing, your purchase agreement may go through escrow, which is the process through which all required money and documents are delivered to a third party to hold until the buyer, the seller and the lender have fulfilled all of the conditions of the agreements.

A lender may charge a loan origination fee or points. Charged at the beginning of the loan, points are part of the cost of borrowing money. Each point is equal to 1% of the amount you borrow. You may decide to pay additional points in order to reduce the interest rate, margin or lifetime cap. If so, those extra points are considered a buy down fee and may not be tax deductible. Check with a tax adviser if you have questions.

What Are Your Assets?
The first thing you have to examine when deciding how much you can spend on your new home is how much you are worth, taking into account your income, savings, investments and other holdings such as Individual Retirement Accounts (IRAs) or Keogh plans, the cash value of your life insurance, pensions or corporate savings plans, and equity in real estate. Lenders will need this information before deciding to extend you the loan.

Often, the amount you earn may not be as important as how you earn it. Bonuses and commissions can vary greatly from year to year, and some lenders are reluctant to depend on them. Some lenders allow use of this income if you can show a two year running history. The same holds true if some of your salary is based on overtime pay. To get a realistic view of what your income level actually is, average your income (including bonuses, commissions and overtime) for the past two or three years.

While turning your savings, investments and other holdings into cash (making them "liquid"), remember that you will probably have to pay tax on most of it. One source of tax-free money often overlooked is a gift, or money given by a parent or other relative that need not be repaid. A person may give another person up to $10,000 per year without either person being taxed. Your parents, for example, could give you and your spouse up to $40,000 tax free.

Your Liabilities
Liabilities are those expenses for which you stand to be responsible each month. Usually, liabilities include outstanding loans (student, auto, personal, etc), credit card balances, etc. Calculate your liabilities before deciding about your payments.

Note: When calculating liabilities, add up the entire balance for your credit cards to check how much you are left with after paying them off entirely in one month. This will help you know your limits in case you run up an unusually high balance during your mortgage term.

Emergency Funds
Do keep some emergency funds when paying off a mortgage. Unexpected medical costs or substantial repairs may require you to pay those expenses. Financial experts suggest that you always have six months income on hand to tackle emergencies.

Annual Income
Sum up all your sources when calculating your annual income, for example, dividends from investments, alimony or child support payments, etc.

Annual Expenses
Remember that when you buy your house you will no longer have to pay rent, and your utilities costs will change. You can use this money for your mortgage payments or other operating costs associated with your new home.

Private Mortgage Insurance
Lenders often allow smaller down payment as low as 5% against a Private Mortgage Insurance. Private Mortgage Insurance requires an initial premium payment of 0.5 percent to 1.0 percent of your mortgage with a 10 percent down payment. This means a premium payment of $338 to $675 for the first year and an extra $15 to $20 a month in subsequent years.

The Costs of Homeownership
Homeowners’ insurance premiums usually run about $400 to $700 per year, while property taxes and maintenance costs vary depending on the size, age, and condition of your new house. Homebuyers are advised to take estimates for the costs of utilities, maintenance, and improvements from Realtors, local utility companies and others.

Some homebuyers also have to bear an additional cost of homeownership for buying into a condominium or co-op as they have to pay the condo or co-op fees that are additional amounts usually paid monthly on top of the mortgage payments. Some homeowners may also incur a homeowner’s association fee for their block or neighborhood.