How To Get A Home Loan
With all the factors that go into deciding your loan terms, keep in mind that some of these are determined by you; others are and always will be beyond your control. An investor’s ability to judge whether you are a good candidate for a loan, and if so, how large that loan should be, comes from two factors: your financial status, and the current economic environment.
Financial Status
When you talk to a loan officer and express interest in procuring a mortgage loan, they’re going to ask you a few questions about your personal finance. Be ready to provide honest and accurate answers to these questions; anything else will only make things hard on you in the long run and may get you into trouble.
The loan officer will ask about your job; who you work for and where you work, how much money you make, and how long you’ve been employed there, along with other sources of income you may have from renters, a side job, or freelance work. They’ll want to know about any assets you have besides your monthly income such as savings or investment accounts, cars, and a rough estimate of the total value of the other merchandise and personal property you own. Your place and length of residence will also be in question; if you currently own any other houses, and if you have ever filed for bankruptcy.
The officer will probably inquire as to any debt you have incurred - credit card balances, back taxes, liens or other loans. They may ask if you know what your credit score is, but whether you do or not, they’ll check it for you. All of this information will be used to figure out what your debt-to-income ratio is and therefore how much you can borrow. The debt-to-income ratio is a measure of how much a mortgage of a given amount would cost you each month versus how much you make in an average month. Target DTI ranges vary depending on the type of loan you end up with, but they typically hover somewhere around 30% of your gross income.
The Fed Funds Rate
Just wanted to insert a quick note on the fed funds rate and a crash course in economics, for any who may not have the background of how this works. The Federal Open Market Committe (FOMC) is in charge of setting interest rates based on the economic climate in the United States. Banks are always lending money to and borrowing it from one another. The fed funds rate is the interest rate that banks use to lend money to each other overnight. This is one way the FOMC (hopefully) keeps events like the Great Depression from happening in the future; it’s a way of manipulating our supply of money (incidentally, called the money supply) so that people aren’t spending and saving too much or too little.
When interest rates go down, it’s usually to stimulate a slow economy. Lower interest rates promote borrowing, because money becomes cheaper to get and easier to spend. A rate hike should happen when money is being spent too freely and prices are going up at a more rapid pace than is sustainable. The goal of our economy is to promote a strong and steady growth rate; we want to grow, but not too fast. So changing interest rates like this maintains a certain degree of control over our system and balances the economic scales for the most part. Now back to how this affects your home loan.
Economic Environment
When you apply for a home loan, the lender wants to give you money. You’ve got to have it to make it, of course, and the way lenders make it is by setting the interest rate at which they lend money a few percentage points higher than it costs them to get that money in the first place. So a high fed funds rate means a bank has to pay more to get money. In turn, they have to charge you more to borrow it from them so they can still turn a profit. The average interest rate set by banks is called the prime rate, and in the United States it is generally about 3 percent above the fed funds rate. Banks use the prime rate to set their own rates for loans as they see fit.
What happened in the subprime mortgage meltdown was that lenders were offering loans at values less than or very close to the prime rate. These were called “teaser rates” because the terms of the loans they were attached to specified that they were only to last for a short period of time when compared to the overall length of the loan. When the introductory periods began to expire and many found themselves unable to make payments, a rash of foreclosures took place and banks were swamped with huge inventories of vacant properties.
Real estate values plummeted, and banks could no longer sell these homes anywhere near the amount they had lent the original borrowers. Then, due to increased supply and lacking demand, some of the leftover homeowners who had purchased at high prices bought second homes and voluntarily let their first, overpriced ones go into foreclosure. Some didn’t mind the extreme negative effect this had on their credit scores - after all, credit scores can be fixed over time, and in the end they were left with much more affordable housing.
Your Rate
Your rate will be determined mostly by your credit score; if you have a solid credit history and little debt you can count on your rate being fairly close to the average. If you’ve had some trouble paying things off on time in your recent past, though, you may be stuck with a higher rate. Refinancing is one way you can remedy this in the future, but you’ll want to wait and make sure a refinance is worth your while.