style="font-size:15px;"> ❯❯ Implement a first-time home-buyer IRA withdrawal. If you have an Individual Retirement Account (either a standard IRA or a newer Roth IRA), you’re allowed to withdraw up to $10,000 (lifetime maximum) per individual IRA account (so a married couple can access $20,000) toward a home purchase as long as you haven’t owned a home for the past two years. Tapping into a Roth IRA is a better deal because the withdrawal is free from income tax as long as the Roth account is at least five years old. Although a standard IRA has no such time restriction, withdrawals are taxed as income, so you’ll net only the after-tax amount of the withdrawal toward your down payment.
Because most people have limited discretionary dollars, you must decide what your priorities are. Saving for retirement and reducing your taxes are important goals; but when you’re trying to save to purchase a home, some or most of your savings needs to be outside a tax-sheltered retirement account. Putting your retirement savings on the back burner for a short time to build up your down-payment cushion is fine. However, be sure to purchase a home that offers enough slack in your budget to fund your retirement accounts after the purchase.
Most people borrow money for a simple reason: They want to buy something they can’t afford to pay for in a lump sum. How many 18-year-olds and their parents have the extra cash to pay for the full cost of a college education? Or prospective homebuyers to pay for the full purchase price of a home? So people borrow.
When used properly, debt can help you accomplish your financial goals and make you more money in the long run. But if your financial situation allows you to make a larger than necessary down payment, consider how much debt you need or want. With most lenders, as we discuss in Chapter 5, you’ll get access to the best rates on mortgage loans by making a down payment of at least 20 percent. Whether or not making a larger down payment makes sense for you depends on a number of factors, such as your other options and goals.
The potential rate of return that you expect or hope to earn on investments is a critical factor when you decide whether to make a larger down payment or make other investments. Psychologically, however, some people feel uncomfortable making a larger down payment because it diminishes their savings and investments.
You probably don’t want to make a larger down payment if it depletes your emergency financial cushion. But don’t be tripped up by the misconception that somehow you’ll be harmed more by a real estate market crash if you pay down your mortgage. Your home is worth what it’s worth – its value has nothing to do with the size of your mortgage.
Financially, what matters in deciding to make a larger down payment is the rate of interest you’re paying on your mortgage versus the rate of return your investments are generating. Suppose that you get a fixed-rate mortgage at 6 percent. To come out financially ahead making investments instead of making a larger down payment, your investments need to produce an average annual rate of return, before taxes, of about 6 percent.
Although it’s true that mortgage interest is usually tax deductible, don’t forget that you must also pay taxes on investments held outside of retirement accounts. You could purchase tax-free investments, such as municipal bonds, but over the long haul, you probably won’t be able to earn a high enough rate of return on such bonds versus the cost of the mortgage. Other types of fixed-income investments, such as bank savings accounts, CDs, and other bonds, are also highly unlikely to pay a high enough return.
To have a reasonable chance of earning more on your investments than it’s costing you to borrow on a mortgage, you must be willing to invest in more growth-oriented, volatile investments such as stocks and rental/investment real estate. Over the past two centuries, stocks and real estate have produced annual average rates of return of about 9 percent. On the other hand, there are no guarantees that you’ll earn these returns in the future. Growth-type investments can easily drop 20 percent or more in value over short time periods (such as one to three years).
Chapter 2
Qualifying for a Mortgage
IN THIS CHAPTER
❯❯ Starting off right with preapprovals
❯❯ Understanding how lenders size up borrowers
❯❯ Solving typical mortgage problems
We love a good thriller. If you’re looking for a spine-tingling mystery, however, Mortgage Management For Dummies isn’t it.
Qualifying for a mortgage shouldn’t be the least bit mystifying. And after you understand how lenders play the game, it won’t be. This chapter removes nearly every bit of puzzlement from the process. We show you exactly how to get started, tell you what lenders look for when evaluating your creditworthiness, and help you solve your mortgage problems – whether you’re looking for a loan as a first-time homebuyer or trying to refinance or pay off your mortgage faster.
Getting Preapproved for a Loan
Everyone knows that time is money, so we decided to begin this section with a timesaving tip. If you’re a homeowner who wants to refinance an existing mortgage, you have our permission to proceed directly to the next section, which discloses how lenders evaluate your credit. This segment applies only to folks who haven’t bought a house yet. (Don’t feel slighted. We devote Chapter 11 entirely to the fine art of refinancing.)
Now, for all you wannabe homeowners, be advised that there’s a right way and a wrong way to start the home-buying process. The wrong way, astonishingly, is rushing out helter-skelter to gawk at houses you think you may want to buy.
Don’t get us wrong; knowing what’s on the market is important. It’s even more crucial to educate yourself so you can distinguish between houses that are priced to sell and ridiculously overpriced turkeys. If you don’t know the difference between price and value, you could end up paying waaaaaaaaaay too much for the home you ultimately purchase. (To find out everything you need to know about buying a home, check out Home Buying For Dummies, by Ray Brown and Eric Tyson [Wiley].)
But … first things first: If you can’t pay, you shouldn’t play.
Suppose you’ve been looking at open houses from dawn to dusk every Saturday and Sunday for the past seven weeks. Just when you begin to think you’ll never find your dream home, it miraculously appears on the market.
You immediately make an offer to buy casa magnífico, conditioned upon your approval of the property inspections and obtaining satisfactory financing. When the sellers accept your generous offer, the bluebird of happiness sings joyously.
Three weeks later, the bird croaks. The loan officer calls to regretfully advise you that the bank has rejected your loan application. The reason isn’t because you offered too much for the house. On the contrary, the appraisal confirmed that the property is worth every penny you’re willing to pay.
The problem, dear reader, could be you. Unfortunately, your present income and projected expenses may be out of whack. You may not earn enough money to make the monthly mortgage payments plus pay the property taxes and homeowners insurance without pauperizing yourself. Adding insult to injury, this depressing discovery is delivered to you after you’ve blown hundreds of dollars on property inspections and loan fees and put yourself through an emotional wringer for three weeks.
Now the good news: It doesn’t have to be this way. After you establish how much you can prudently spend for your dream home, which we cover in Chapter 1, the next
