Budgeting Tips for the First-Time Homebuyer

Few things in life are more exciting, scarier, and confusing than buying one’s first home. From decades of front row experience as leading NJ Home Insurance specialists, we find most concerns for first-time buyers come from being unfamiliar with the ins and outs of financing a new home. With this Budgeting Tips for First-Time the Homebuyer guide, you’ll get up-to-date on how mortgages work, including what lenders expect from you before they approve your first home loan.

How Much New Home Can You Afford?

Before you begin buying your new home, you must determine the payment you can afford. First, you need to know this number precisely because the amount informs all your buying decisions. To determine what you can afford, lenders use a debt-to-income (DTI) ratio of 28%. Second, the ratio means your combined mortgage and monthly recurring debt should not exceed more than 28% of your monthly gross income and recurring debt. Third, Federal Housing Authority (FHA) loans are more lenient as they allow up to 31% on its debt-to-income ratio.

Mortgage lenders use these ratios as qualifying numbers for lending decisions. They pull all your financial records, prove the calculations themselves using your current debt obligations, including credit cards, student loans, and car loans, and verify your monthly and annual income. Buyers must know this baseline information and why it’s important to lenders.

How Much Money Do I Need to Buy a Home?

The available cash a buyer needs depends on a combination of the down payment, credit score, and long-term mortgage intention to secure a mortgage, i.e., how long the homeowner plans to stay. Before applying for a mortgage, check your credit report. Consumers are entitled to pull their credit history and FICO scores from all three major bureaus in one report annually at no cost. Check the Federal Trade Commission (FTC) website for details. 

Down Payment

Homebuyers must know how much money they need to put down on the house. Traditional home loans require a minimum down payment equal to 20% of the sales price. As home prices climb, saving that much money for a down payment becomes more challenging. To be flexible and more inclusive, lenders will work with a lower down payment but require Private Mortgage Insurance (PMI), which insures them from losing money if a buyer defaults on their loans.

Cash Reserves

Besides the minimum 20% down payment, lenders require borrowers to have cash reserves to cover three months’ worth of living expenses at closing time. Although it’s crunch time to save these amounts, having a little more to pay for unexpected costs in moving and settling in is ideal.

Types of Loans

Conventional lenders offering “conforming” loans are the most common mortgage type provided today. Government-backed loan lenders include VA loans, USDA loans, and FHA loans and while some vendors specialize in one or the other, most offer both options. 

• Conventional loans typically requiring 20% down are available from commercial banks, mortgage lenders, and credit unions.
• Veterans Administration (VA) loans are an exclusive benefit for active and inactive US Armed Forces members. A VA loan offers no down payment if the sales price exceeds the home’s appraised value. The terms and conditions include interest rates lower than traditional creditors and have no private mortgage insurance (PMI) or mortgage insurance premiums (MIP) requirements.
• FHA loans stimulate the housing market by providing lenders with more affordable financing options for their customers. They are an excellent vehicle for first-time homebuyers who lack large deposits and established high credit scores. Unlike most conventional loans that require a large down payment, with FHA loans, a buyer puts down up to 3.5 percent of the house’s purchase price. Buyers with bankruptcy or foreclosure history who can’t get a traditional mortgage may still qualify for a mortgage through the Fannie Mae (FHA). Higher interest rates are necessary to compensate for higher risk and small down payments. And although conventional loans let you cancel PMI once your equity has grown sufficiently, FHA loans require you to continue paying monthly mortgage insurance payments.
• The US Department of Agriculture supports USDA Loans. They are available to rural and suburban homebuyers who have difficulty obtaining traditional mortgages and offer options to secure low-interest mortgages, with no down payment in some cases.

Private Mortgage Insurance

Private Mortgage Insurance (PMI) is a safeguard for lenders that make home loans to buyers who can afford to make monthly payments on their new home but don’t have the 20% down payment. With PMI, they add the monthly cost of the insurance into your monthly mortgage. For non-FHA loans, when either your loan payments reduce your balance to below 20% of the purchase price or your home value increases to skew the percentage to your favor, you can request to have the PMI portion of your monthly payment removed.

Categories of Loans

Fixed-rate Mortgages

A fixed-rate home loan maintains the same interest rate throughout the life of the loan. The 30-year fixed-rate mortgage is the most common kind of home loan. The interest rate and the borrower’s monthly payments will stay the same each month during the lifetime of the mortgage. Most fixed-rate loans are set for 30-year and 15-year periods. The advantage of a 30-year loan is a lower payment but is more costly in interest paid. A 15-year loan has higher monthly payments but pays off in half the time of a 30-year loan with much less interest paid. For buyers who anticipate staying put for a long time and can handle a higher monthly payment, a 15-year fixed-rate mortgage is advantageous financially and highly recommended.

Adjustable-Rate Mortgages (ARM)

Adjustable-rate mortgages offer home loans with a low introductory rate, allowing borrowers to pay less money each month than a standard loan. However, the interest rate adjusts after a few years, causing potentially dramatic payment increases. An ARM is a risky loan because the payment will change at specified times.

A 5/1 ARM is the most typical example among many adjustable mortgages. As interest rates go higher, adjustable-rate lenders get creative, if not exotic, with options for home buyers. A 5/1 ARM is also known as a variable-rate mortgage. The details of a 5/1 ARM are it has a fixed interest rate during the first five years. In year six, the interest rate adjusts, usually every year. Various widely recognized published indexes are used to calculate adjustable mortgage rates, with descriptions are found below the margin. The median value of the T-Bill interest rate over the past 20 years is

The margin is the amount set in the loan as the kicker over the index. For example, a 2.5 percent margin on T-Bill produces borrower interest rates ranging from a historic low of .28 percent, making for a 2.52 percent rate up to a high of 8.74 percent, includin1.43 percent, which equates to a borrowing rate of 3.93 percent with a 2.5 margin. 

Standard ARM Margin Indexes Used by Lenders

• T–Bill is the price paid for 12-month Treasury bills at federal auctions.
• CMT is the one–year Constant Maturity Treasury and is figured from the auction prices for government-backed debt.
• COFI stands for the 11th District Cost Of Funds Index. It is a lagging index determined by costs for the previous month that uses the published rate savings institutions pay depositors.
• LIBOR gets its acronym from the six–month London Interbank Offered Rate. This widely used index is the six-month loan rate European banks charge each other.
• MTA gets its abbreviation from the Monthly Treasury Average, sometimes referred to as the 12 Month Moving Average Treasury (MAT) Index. It is calculated by taking the average or the previous 12 CMT monthly values.

The cap is the maximum amount of interest that the lender can charge no matter how high the index they use rises.

Additional Ongoing Costs of Homeownership

Beyond the expenses for your home loan, there are other ongoing costs to consider. To begin, it’s essential to budget for taxes, utilities, maintenance, and NJ Home Insurance. All are important, and none can be ignored. They are built-in costs every homeowner must handle. Conservatively, these extra costs can amount to 10 – 30 percent over your monthly mortgage payment.

Rainy Day Funds are highly suggested. You will need repairs, desire upgrades, and run into expensive, unexpected problems while owning your home. By putting away ten percent of your monthly payment into a Rainy-Day savings account, you will quickly build a reserve to help you pay those things you need or want without going into debt to finance them.

If you determine and live by the “Pay as you go” motto, you will suffer much less financial stress in your life, and you will retire with more money and peace of mind as well.

We love helping first-time homebuyers get the most from the thrill of becoming homeowners. As your local NJ Home Insurance specialists, we would love for you to tap our experience and assist you in making your first home buying experience the best experience possible. 

About Dickstein Associates Agency

Dickstein Associates Agency has distinguished itself as a leading provider of personal and business insurance in the tri-state area since 1965. We pride ourselves on being advocates for our clients and providing them with quality and affordable coverages. As Trusted Choice™ independent insurance agency, we partner with various national and regional carriers, allowing for flexible coverage for each client’s unique circumstances. For more information on how you can leverage all your insurance to work best for you, and how we can secure the best insurance in the marketplace suited to your specific needs and business objectives, contact us today at (800) 862-6662 or www.dicksteininsurance.com.