This is the latest installment in our Rookie Buyer series, which follows one couple's quest to purchase the perfect New York City apartment, and chronicles the mistakes they made in hopes that other first-time buyers won't have to.
After a couple of tense weeks of waiting to, we finally received word that a seller had accepted our offer on a two-bedroom, two-bath condo in Bed-Stuy. We had won the New York City housing game!
…or so we thought.
We hired lawyers—as is required in New York—and thought all we had to do was sit back and relax.
The first step any homebuyer will face in New York is having the lawyers negotiate a contract. We had asked for a standard mortgage contingency, which gave us 30 days from signing the contract to acquire a conditional approval for a mortgage. If we couldn’t get approved despite making a good faith effort, we would be able to back out of the deal and take back a 10 percent deposit we were required to put down when signing the contract. Despite being pre-approved from several lenders, it turned out to be much more complicated.
Here’s what we learned, and what you should know about mortgages to make things go much more smoothly than they did for us.
Mortgages allow you to pay off your house over a certain time period, with the most popular options being 15 or 30 years. The shorter the time period, the lower your interest rate will be. However, a shorter mortgage also means bigger monthly payments, so make sure you run all the calculations.
After deciding on the length of the mortgage, you’ll have to pick between a fixed- or adjustable-rate mortgage, or ARM. Fixed-rate mortgages mean you’ll have the same interest rate throughout the life of the loan. You’ll pay the same amount every month, but usually have the option to pay extra to the “principal,” or main amount of the loan. You’ll pay off your loan quicker, but you’ll pay the same amount every month until your last payment.
Adjustable means the rate will move over time. Adjustable rates start out lower than fixed rates, but more than likely will end up higher in the long run. Conventional wisdom says to pick the fixed rate, especially since mortgage rates are so low right now. If you’re planning on moving in a few years, a 5-1 ARM rate or a 7-1 ARM could be a better bet. Those rates stay fixed for 5 or 7 years respectively, and then adjust on an annual basis after that.
The next choice is between a conventional versus a government-insured loan. A conventional loan is a standard loan that is backed by the bank. Government-insured loans are backed by the federal government, which will provide payment if the borrower defaults. Government loans are good news for first-time buyers because they usually require lower down payments, but note: you won't be able to borrow more than the conforming loan limit of $636,150. More on loans higher than that amount, known as jumbo loans, below.
One of the most popular government options, backed by the Federal Housing Administration, may require as little as 3.5 percent down. Military service members can qualify for a U.S. Department of Veterans Affairs loan, which may not require a down payment at all. However you will have to pay an additional monthly fee called mortgage insurance to get these loans.
Mind those extra fees
Banks usually put some some of your fees in escrow. Typically real estate taxes or homeowners insurance costs end up there. You’ll have to pay a little bit every month, but the bank will take care of paying the right authorities.
There are also the monthly co-op or condo fees you’ll be responsible for (maintenance and common charges, respectively), so don’t forget to calculate those into your monthly budget.
Know your limits
Banks usually employ the 28/36 percent rule when approving people for mortgages. What that means is that no more than 28 percent of your gross monthly income can be spent on total housing expenses, and no more than 36 percent of your income can go toward your total debts including your home mortgage, credit cards and other loans. Note: Paying off student loans and credit cards can be a way to line up a higher loan amount.
In addition, New York apartments are expensive, so you may find yourself in need of what is called a jumbo loan if you have to borrow more than $636,150. These loans have stricter terms, but because banks are pickier with jumbo loan clients, jumbo mortgage rates tend to be lower than the standard mortgage rate. (The rates change often, but we saw jumbo rates at 3.65-3.75 percent APR, while conforming loan limit rates around that time were starting at 4 percent APR and up.)
Jumbo mortgages can sound too good to be true, and they almost are. To get these low rates you’ll need stellar credit—we're talking over 720. There are other requirements you’ll have to meet, including showing a certain percentage of the money used for the down payment came from your own funds and wasn't a gift from someone else. (We found banks asking for between 5 to 10 percent.) If you do need to get extra money from a family member, you’ll need documentation that it is a gift that will not be repaid and not a loan.
To save yourself a headache, aim to borrow less than the jumbo threshold. Sure you’ll get a slightly higher rate, but you’ll have less debt, plus it’s much easier for first-time buyers to qualify when they're borrowing less.
You can also lower your mortgage rate by buying discount points. Each point lowers your mortgage rate by 0.1 percent, but will cost you 1 percent of your total borrowed amount. It lowers your rate, but you'll have to pay your fees up front. If you're thinking of selling in a few years, what you pay may not be worth the lower interest rate.
Next up in Rookie Buyer: More on the mortgage pitfalls we personally encountered.
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