Are you thinking of buying a house soon? Stellar! Last time, I started discussing the mortgage process and now, I’m finishing up.

Types of loans

Before you apply for a mortgage, think about what type of loan you want, fixed or adjustable, and the rate you want to apply for. Adjustable rate mortgages (ARMs) mean that the interest rate and your monthly payment will fluctuate as market interest rates change. So if one month the rate goes up then your mortgage payment will go up, but if the next month it goes down, then your payment will go down. Fixed rates are set at a rate (no matter what the market does) and monthly payments usually last for 15- to 40-year periods. This choice is popular because you don’t have to worry about your payment going up from month to month.

Pre-qualified vs. Pre-approved

There is a difference between getting pre-qualified and pre-approved. Pre-qualified means that someone (lender, real estate agent or even you) has taken a general look at your income and expenses and done a debt-to-income ratio (we’ll take a look at this a bit later). This gives you a general idea of the amount of house you can afford but it will not give you a lock in an interest rate and or take into consideration other factors that will affect your monthly payment.

Pre-approval means a lender has taken an in-depth look at your credit report and your income and determined you qualify for a loan. You’ll also be told the maximum amount of loan they will give you and what type of loan programs you qualify for and the interest rates they will offer. With a pre-approved loan you can go house hunting with confidence because you know exactly how much house you can afford.

I mentioned debt-to-income ratio but let me tell you what that exactly is. The 28/36 debt-to-income ratio (one of many ratios lending institutions use) is an easy way to find out if you can pay your mortgage once all your other payment obligations are met. Twenty-eight percent is the maximum percentage of your monthly gross income (before taxes) allowed for housing expenses (loan principal and interest, private mortgage insurance (PMI) hazard insurance property taxes, homeowners association dues). Thirty-six percent is the maximum percentage of your monthly gross income allowed for housing expenses and recurring debt bills (student loans, credit cards, etc.) that will not be paid off in 6-10 months.

You might be saying huh? Look at the example below.

Your yearly gross income (before taxes): $37,000

<$36,000 ÷12 (months in a year) = $3,000 (monthly take home before taxes)

$3,000 x 0.28 = $840 allowable for housing expenses

$3,000 x 0.36 = $1080 allowable for housing expenses and recurring debt

Of course the better your credit the easier the process will be but never fear my twentysometings with less than perfect credit. For those of you who are continuously paying your bills late and allow your bills to fall 30, 60 or 90 days late, you are in a special category, sub-prime.

People who have superb credit have rates that don’t differ much from lender to lender. But for those of you who are in the sub-prime category, you are so screwed. They have higher rates and the rates could be drastically different from lender to lender because they have different methods of determining your ability to pay back the loan. So it is truly important for you to shop around and compare the rates of different lenders before you pick one.

Happy House Hunting!