Mortgages
What is a Mortgage?
A mortgage is an agreement between you and a lender (ex: bank, or any other financial institution) that allows you to borrow money from them to purchase a type of real estate (ex: home). If you don't repay the amount of money you borrowed after a specific amount of time (generally some years), then the lender has the right to take your property. Paying off a mortgage is an example of a need.
How to Qualify for a Mortgage?​
You need a stable, secure income, a solid credit score, documentation, and a facilitated debt-to-income-ratio.
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Income: Your income will typically determine how big your loan is. If you have a larger income, the bank will generally give you a bigger loan; whereas if you have a smaller income, you won't receive much. However, your other assets can make up for your low income, including other property, businesses, or anything you own, really. You can only sell tangible assets, meaning physical assets such as cars, furniture, etc, to make up for your low income. However, intangible assets cannot be sold, or even touched. This includes non-physical assets such as your licenses or copyrights.
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Credit Score: You need a credit score of around 620, although government-backed mortgages typically require a lower credit score.
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Documentation: You can apply for a mortgage whenever you want, and there is no age limit either, regardless of how old you are. The following documentation will be checked when you apply for a mortgage: Your name, your income, your social security number, The address of the home you are going to purchase/remortgage, an estimate of the property's value, and the amount you want to borrow.
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Debt-to-income ratio: Most people recommend a debt-to-income ratio of 43%. But what does this mean? This means that no more than 43% of your income should go to your debt repayments. Of this 43%, 28% should go to paying off your mortgage. You can calculate your debt to income ratio by using the following formula: (monthly debt payments/gross monthly income)
The bank will review your credit report, income statement, and other documentation to determine whether you are eligible for a mortgage or not ​
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Note: You need to be prepared to pay additional interest on top of your loan. This type of interest is called compound interest. Compound interest is calculated based on the initial amount of the loan that increases exponentially, rather than linearly like simple interest. Here is a simple calculator to calculate compound interest: https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
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What is the 28/36 Rule?
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We talked about budget rules in our last lesson, and this one can also be added to it. Compared to the other rules, this rule is a bit more complicated and prioritizes debt management. It states the following:
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A max of 28 % of ones take-home pay should be dedicated towards housing expenses.
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A max of 36 % of ones take-home pay should be dedicated towards paying off debt including mortgage, car loans, etc.
Keep in mind, the 28/36 rule mainly applies to conforming mortgages, rather than FHA, VA, or USDA mortgages that we will explore in future lessons.​
Example of using this budget rule:
Mia wants to pay for a house that costs 380,000 dollars. She realizes that she can only pay off 280,000 dollars, so decides to apply for a mortgage. Mia goes to her bank, who then reviews her credit report, income statement, and other forms of documentation, and decides that she is eligible for a mortgage. The bank gives her 20 years to pay off her mortgage loan of 100,000 dollars. She decides to use the 28/36 rule to see whether she can financially take on a mortgage or not. Her take-home pay per month is 3,000 dollars, which means that, according to the rule, she should pay 840 (28/100 * 3,000) dollars per month on housing expenses per month, and 1080 (36/100 * 3,000) dollars monthly for her debt (ex: mortgage). Primarily focusing on the amount of money meant to manage debt, she realizes that this mortgage is manageable. This is because Mia can pay 259,200 dollars (when paying 1080 dollars per month) after 20 years (1080 * 12 * 20). Because 259,000 dollars is much greater than 100,000 dollars, a 100,000 dollar mortgage is easily manageable for Mia.
Do you pay off your mortgage all at once?
Normally your mortgage needs to be paid within 15-30 years, so once again, its good to pay your mortgage off monthly. For example, you can pay off a sustainable 400 dollars per month for 20 years to pay off a mortgage of 96,000 dollars. Other methods include refinancing your loan, paying a dollar more than what you usually pay each month, rounding up what you usually pay each month to become your new payment (ex: round 776 dollars to 800 dollars), pay off an extra monthly mortgage by adding 1/12 extra each month, or use any unpredicted income that falls into your hand to pay off your mortgage.
Takeaways:
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You need to make sure you are eligible for a mortgage before you decided to apply for one
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You also should make sure that your conforming mortgage is manageable by using the 28/36 ratio.
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You need to make sure to pay off your loan debt monthly, little by little. Think about it like a long-term school project. You need to work on it little by little without cramming it all last minute!