Why would a mortgage rule come to your mind? For millions of people around the world, a mortgage is the biggest debt they’ll ever have to repay. Unfortunately, as anyone who’s ever gone through the process can attest, mortgages involve pages and pages of legal documentation that can be nearly impossible for most people to comprehend. To simplify mortgages, there are some basic guidelines that anyone can learn to make it easier on them. These guidelines can be known as mortgage rules. Below, we’ll go through three mortgage rules you should know.
Mortgage Rule 1: Keep Your Mortgage Payment To 25% Or Less Of Your Income.
Housing costs are typically the largest expense item in your household budget, but that doesn’t mean you can afford to break the bank. Lenders look closely at your income to determine how much you can truly afford to pay for a monthly mortgage payment, and one simple guideline they use is to take your available income and multiply it by 25%. If a mortgage would require larger payments than that, after taking into account the loan itself and associated payments like property taxes and insurance, then a lender will generally be less comfortable in giving you the loan.
Mortgage Rule 2: Avoid Private Mortgage Insurance By Making A 20% Down Payment.
Mortgage lenders typically require borrowers to obtain private mortgage insurance or PMI if they make a down payment that’s less than 20% of the value of the home. PMI protects lenders against the risk that the value of the home will fall below the outstanding principal balance on the mortgage, leaving the borrower “underwater” on the loan.
For borrowers, however, it’s an added expense that essentially provides no value to them. As difficult as it can be to save up a 20% down payment, the hundreds of dollars in PMI that it will save you could make the difference between being able to afford a slightly more expensive home and having to settle for less.
Mortgage Rule 3: Understand How Adjustable Rate Mortgages Work And What Risks Are Involved.
Fixed mortgages are easier to understand because the interest rate that they charge never changes, so you can count on monthly mortgage payments remaining constant throughout the lifetime of your loan. That’s not the case with adjustable rate mortgages or ARMs, which only remain fixed for a set period. Most lenders refer to ARMs with two numbers, such as 5/1.
The first number refers to how long the initial rate remains in place. The second number describes how often the rate adjusts after the initial rate ends. For a 5/1 ARM, the initial rate stays in place for five years and then changes every year after that. When rates change, they’ll also change your monthly payment, so make sure you understand the illustrations that your mortgage documents will provide so you don’t get a nasty surprise at the end of the initial term.
These mortgage rules would help you in your mortgage if you apply them wisely.