Tip #3a: Don't plan on borrowing the down payment. The down payment has to be YOUR money. Why? Because when the bank gives you the main loan on your house, they've calculated that you won't be able to pay back your loan if you take on additional debt, and borrowing the down payment is additional debt. Also, if you don't make your payments and they have to repossess the house and sell it, they'll often want to sell it for less than it's worth so they can sell quickly, and your down payment prevents them from having a loss if they do that.

But what if someone gives you the money for a down payment (your parents, maybe). That's okay as long as you get an FHA loan, but not if you get a conventional loan. (Realize though that many sellers won't agree to an FHA loan because it sometimes adds a little red tape and because the inspectors are more strict about the condition the house has to be in before it can be sold.)

Tip #3b: Pros of bigger down payments.

• The more you put down, the bigger loan you can get from a bank. For example, if you put only 5% down, a bank might want to lend you up to $65,000. But if you put 10% or 20% down, the bank might be willing to loan you up to $78,000 or $100,000, respectively.
• For a given house price, the more you put down, the easier it is to qualify for the loan.
• If you put 20% or more down, you won't have to buy Private Mortgage Insurance (PMI).

Tip #3c: Cons of bigger down payments.

• Every dollar you put into your down payment is a dollar that you can't save or invest in something else. Sure, your house is an investment, but you're often better off taking the difference between, say, a 5% and a 10% down payment, and putting it into a socially responsible mutual fund instead. The mutual fund will often give you a higher rate of return. It depends on the economy. During the boom years of the Clinton administration it would have been better to put your free cash in stocks. Today, it would be better to put your free cash into your house.
• Extra money you invest into your house via a bigger down payment is harder to get out of your house if you ever need the money for an emergency. (You'd have to get a home equity loan, whereas with a mutual fund you could simply sell your shares and convert them to cash.)

Tip #3d: Don't pay cash. Even if you can afford to pay cash for the house without getting a loan, don't.

Tip #3e: Decide whether to use your cash to pay down your debt or use it for the down payment. A common question among homebuyers is, "Should I use my extra cash to pay down my credit card debt, or should I save it all for the down payment?"

The loan you get from the bank is called a mortgage, also called a note. (We'll talk more about how to get a loan in a minute.)

The bank loaning the money is the lender. The amount you pay to the bank each month is your mortgage payment. The rate of interest on the loan is the mortgage rate (or the interest rate).

If you don't make your mortgage payments then the bank will repossess the house. Then they'll sell it to make sure that they can recoup the money they loaned to you, and that you didn't pay back.

The number of years it takes to pay back the loan is called the term, which is either 15 or 30 years. There are pros and cons of each:

15-year mortgage	.	.	30-year mortgage
• Saves a bundle on interest • Pay off the loan in half the time			• Easier to qualify for • Lower monthly payments • Allows you to buy a higher-priced home

The fact that you get lower payments with a 30-year loan is deceptive -- your payments are lower but you have to make those payments for twice as long, so you wind up paying a lot more than with a 15-year loan. The brief advice is:

Tip #3a:Get a 15-year loan if you can qualify for it, because you save a bundle on interest and pay the loan off in half the time. If the bank won't give you a 15-year loan, then get a 30-year loan and pay it off early (in 15 years) if you can.

Paying back a mortgage

You pay back your loan by making a payment every month. They don't send you a bill, so it's your responsibility to remember to make the payments every month. They do give you a cute little coupon book, with one slip for each month, so you can include the slip when sending in your check each month.

Part of your payment goes towards the principal (the amount the bank loaned you), and part of it is interest (the bank's profit from lending you money). So when the bank loans you $100,000 you pay them back that $100,000 and then some. If you only had to pay back the same $100,000 they gave you then what would be in it for them? That's why they charge interest.

Even though part of your monthly payment is for principal and part is for interest, you write only a single check to the bank each month, and that payment amount stays the same for the life of the loan. You don't have to know how much of your payment is for principal and how much is for interest, but it's usually printed on the coupon, as well as in an end-of-the-year statement the bank will send you for your taxes, since you'll get to deduct the interest you paid if you itemize.

Maybe you remember percentages from high school, so you figure that if you have a $100,000 loan at 9% you'll be paying the bank back $109,000? Nice try, but that's simple interest, and banks don't work that way. But all you really need to know for now is:

1. You'll be paying the bank a lot more than just simple interest.
2. Just a percentage point or two of interest rates means you'll be paying a lot of extra interest to the bank.

Here are some pretty pictures to tell that story. We'll assume a $125,000 loan for 30 years at various interest rates.

Total Interest Paid Over the Life of the Loan

So even at a very low interest rate of 6%, you're paying $145,000 in interest on a $125,000 loan. So you borrow $125,000 and pay back $270,000 -- more than double what you borrowed!

It's even worse if you have a higher interest rate. Note how going from a 6% to 10% interest rate means you pay an extra $125,000 over the life of the loan. So the total you'd pay on a $125,000 loan at 10% would be $125,000 principal + $269,907 interest = $394,907! Quite a lot to pay back for a $125,000 loan, huh?

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Average Yearly Interest ($125,000 loan, 30 years)

Here again, going from 6% to 10% interest means you pay an extra $5000 on average in interest each year!

How the interest rate affects the monthly payment

Owner Financing

You might be thinking, "Hey, could I just make payments directly to the seller instead of getting a mortgage? Then I wouldn't have to qualify for the mortgage." That indeed could be a good deal, except that owner-financed deals like this are rare, and are available only when the seller is unusually desperate, generous, or stupid.

Put yourself in the seller's shoes for a minute:

You own a $150,000 house, and you've got $110,000 left on the mortgage. If you sell it the regular way, you'll wind up with $40,000 in cash. (You'll get $150k from the buyer -- part down payment, part mortgage from the buyer's bank -- of which $110k will go towards paying off your existing mortgage before you even see the money.) You could do a lot with that $40k: make a down payment on an even bigger house, travel the world, add it to your nest egg to retire, go to Vegas, etc.

But let's say you owner-finance the sale instead, in which you get a down payment from the buyer, and let him/her make payments to you for 15-30 years. First off, you won't be getting as much money up front -- $15k on a 10% down, or $30k on a 20% down. Second, you'd have to pay off the existing mortgage before you could sell it! So you'd have to pay your bank $110k in cash, before you get the measly $30k down payment.

But what if you own your house free and clear? That is, what if you've already paid off your 15- or 30-year mortgage so you didn't have to worry about coughing up a lot of money to pay off the loan all at once? Then in that case, you don't get your $150k all at once -- you have to accept the small payments that trickle in month after month from the buyer.

Why on earth would you do this? Well, probably, you wouldn't, unless you're really desperate to sell for some reason, or you don't understand what a rotten deal it is for you, or you're unusually generous.

So you see, it's not in the seller's interest to finance the house for you, which is why you'll rarely find houses that are owner-financed.

But there are a couple of cases in which owner-financing might be a possibility for you:

You offer a higher interest rate. The reason that owners don't like to finance is that there's nothing in it for them. So you have to make sure there is something in it for them. One way to do this is to offer to pay a higher interest rate. Of course, you wouldn't make such an offer if you're able to qualify for a bank loan, but if you can't get a bank loan, then offering a higher rate directly to the seller might be what it takes to get you into the home you want. Also, once you've had the home for a year or two and your financial situation improves you might be able to move that loan to a bank.

Get the seller to finance part of the loan. Once I wanted to buy a home but I couldn't come up with the last $36,000. (I had no more cash left and couldn't get a bigger loan.) But I really wanted the house. So I asked the owner to owner-finance just that small part of the cost of the house, and I offered him twice the prevailing interest rate. He accepted.

Qualifying for a Mortgage Loan

Banks don't loan money to just anybody. They want to feel secure that you're able and responsible enough to pay them back. So you'll usually need these things in order for the bank to give you a loan:

Enough money for the Down Payment (3 to 20% of the purchase price) Two years of steady employment (same job or field) Good (not perfect) credit history Income that's 2 to 3 times higher than your expected mortgage payment

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If you don't have all these things right now don't fret. You still have some options.

Meet with a lender anyway. Don't just assume you can't get a mortgage. It can't hurt to go talk to a bank and see whether they're willing to give you a loan. Even if they won't give you a loan they can probably help you by letting you know where the deficiencies are, so you can work towards qualifying in the future.   Try for a Low-Doc or No-Doc Loan. In recent years banks have been offering loans to people who can't (or don't want to) provide details about their employment or their income. Naturally, you're expected to pay more if the bank is taking a bigger risk on you, so interest rates for Low-Doc and No-Doc loans are often 0.25 to 3.0 percentage points higher than traditional loans. Here's how the different loans stack up.   What you need for each kind of loan   Regular Loan Low-Doc ("No Ratio") No-Doc ("NINA") Down Payment Needed ♥ Smallest ♥♥ Bigger ♥♥♥ Biggest Credit Required ♥ Good ♥♥ Excellent ♥♥♥ Near-Perfect Employment History ♥     Proof of Income ♥     Proof of Assets   ♥ Possible Interest Rate ♥ Lowest ♥♥ Higher ♥♥♥ Highest

Get a co-signor. See if a family member or very close friend with a higher income and better credit than yours will cosign a loan for you. That means that the loan will be yours and you'll be responsible for paying it, but if you don't, the cosignor will have to pay it. Obviously the cosignor will have to have agreat deal of trust in you for this option to work.   Try to get a non-qualifying assumption. Being able to assume a loan is rare, but if you have no other options then it might be worth looking into.   Try to get the owner to finance all or part of the cost of the home. Getting an owner to finance a home is difficult, but if you have no other options then it's worth a try. You can increase your chances of success by offering a higher interest rate and/or asking the owner to finance only part of the cost of the home.   Use a Mortgage Broker. A mortgage broker represents lots of different lenders so they can shop around to try to find one who will make you a loan. They charge a fee for this service but if you can't get a mortgage otherwise then it could be worth it. You can find mortgage brokers in the homes section of the newspaper classifieds and in the yellow pages. A good online broker is E-Loan.   Plan for the future. Even if you can't buy a home right this very minute if you make home-owning a serious goal then within two years you can probably overcome most or all of any obstacles above.

In addition to the down payment, you'll also have to pay closing costs -- miscellaneous fees charged by those involved with the home sale (such as your lender for processing the loan, the title company for handling the paperwork, a surveyor, local government offices for recording the deed, etc.). The amount varies, but could be, say, $6000 on a $130,000 house. The range is all over the map -- from 1 to 8% of the price of the home, though more typically 2-3%. These costs are significant -- especially after you've already had to come up with a lot of cash for the down payment.

Your lender will give you a more accurate estimate of closing costs on the purchase of a particular house you've selected. (Don't ask me about this, ask your lender.) This is called a "Good Faith Estimate". If they don't give it to you, ask for it.

E-Loan has a good page which summarizes typical closing costs.

Tip: Make sure to get the Good Faith Estimate from your Lender. Review it, and direct any questions about it to your lender (not to me).

Tip: Roll in the closing costs into the mortgage. If you don't have enough cash to pay the closing costs, you can often get the closing costs added to the amount of the loan. For example, if the loan amount is for $150,000, and the closing costs are $4500, you'd add the closing costs to the loan amount so you'd actually be borrowing $154,500 total. This is handy if you're short on cash after making your down payment.

You need two things to be able to roll in your closing costs like this. First, you have to qualify for the bigger loan. If the bank will only loan you $150,000 from our earlier example and not a penny more, then you've already hit the maximum they're willing to loan. But don't get discouraged, because it's usually not a problem to get the bank to loan you a few thousand extra dollars extra.

The second thing is that the new loan amount can't exceed what's called the Loan-To-Value ratio (LTV), which is the amount of the loan compared to the to the value of the house, based on the appraisal. In simple terms, let's say the house is worth $100,000, and the bank will loan up to a 95% LTV, meaning they'll loan you up to $95,000. If your credit isn't so good then the bank might only loan up to an 80% LTV, meaning they'll loan you only $80,000.

Don't confuse the price of the house with the value of the house. The bank gets the value of the house -- what they think the house is worth -- from the appraisal, which is a report prepared by a professional which estimates the value of the house. The selling price could be higher or lower than the appraised value.

Okay, so the point of all this is, if you roll the closing costs into the mortgage, the new loan amount can't exceed your LTV. If the LTV amount was $120,000, and the $4000 closing costs would push the loan amount from $118,000 to $122,000, then the bank won't let you roll in the closing costs. You could get around this by making a larger down payment, so you don't have to borrow as much money from the bank, but if you have the extra money for the bigger down payment then you also have the extra money to just pay that money towards the closing costs instead of rolling them into the mortgage in the first place.

One way of rolling the closing costs into the mortgage is to have a seller concession. It's a little complicated so I recommend you just ask the lender if you can roll the closing costs into the mortgage the easy way. The lender might require that you use the seller concession method, though. If you have to go that route, the way it works is that you and the seller say that the sale price will be about 6% more than the price you agreed on, and then the seller "gives" you that extra 6% that you paid. For example, let's say the price was $100,000 and you're putting 10% down, or $10,000, so you're getting a loan for $90,000. You and the seller decide to go the seller concession route, so you agree that the price should be 6% more, or $106,000. That means you'll now put $10,600 down and get a loan for $95,400. See what happened? You got a loan for $5,400 more than the original loan. That's what you use to pay the closing costs. The seller doesn't keep the extra money because part of the deal is that (s)he gives that extra money back to you at closing.

Tip: Ask the seller to pay some of the closing costs. If you're short on cash for the closing costs and can't roll the closing costs into the mortgage, ask the seller if they're willing to pay part of the closing costs. It's not unusual for buyers to ask for this. Usually the worst that can happen is that they say no.

Tip: Get the lender to pay the closing costs. If you're short on cash for the closing costs and can't roll the closing costs into the mortgage, some lenders will pay part or all of the closing costs, but in exchange you'll have to pay a higher interest rate on the loan, perhaps 0.25% or 0.50% higher. Ask your lender if this is an option if you need it.

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