Getting the Loan

Introduction
The first step in finding a home is figuring out how much you can afford to spend. This probably means you're going to need to borrow money, and that is what getting a mortgage is all about.

Taking out a mortgage is probably the biggest obstacle facing prospective homeowners. The financial institution may not want to lend you as much as you need. This is a big problem for you, but there's a reason for it. Put yourself in the financial institutions shoes: If you were going to lend people money, what would you want to know about them? Basically, you'd like to know 1) if they make enough money to pay you back, 2) if they've been trustworthy in the past, and 3) if they have something of value should they be unable to pay you back.

Congratulations: In financial parlance, you've just been introduced to the concepts of income, credit worthiness, and collateral. Let's look at each one.

Do You Make Enough to Pay the Lender Back?

Your lender will want to know not only how much money you have, but how much you will likely make over the next 30 years. Also, what are your other debts? Do you owe money for college or on credit cards? Do you have any other assets? Things like stocks and mutual funds or real property like a boat or a car are also considered in figuring out how much a financial institution will lend you.

In general, the lender will want you to come up with at least 20% of the value of your new home for a down payment before they will give you a mortgage. But, there are special financing arrangements for which you probably qualify that will get you into a new home for as little as 0% of the asking price.

The lender will also plug your income numbers into a couple of formulas: the front-end ratio (having to do with your mortgage payments) and the back-end ratio (having to do with your debt).

Let's say your gross income is $4,000 a month, and you have $1,000 a month in debt payments. The rule of thumb is that they'll allow you to pay 29% of your gross income toward your mortgage payment every month. This is known as the front-end ratio. In this example, 29% of $4,000 is just under $1,200 a month -- so, they'll reason, you can put $1,200 toward your mortgage payment.

Your debt ratio or back-end ratio, on the other hand, is 1,000/4,000, or 25%. That's not bad. They don't want more than 41% going to your other debt. (These ratios can vary somewhat; the ones given here are good examples).

Have You Been Trustworthy in the Past?

What is your credit rating? The three major credit reporting agencies are Experian (formerly TRW), Equifax, and Trans Union. For about $8 each (less in some states) you can order reports directly from their websites. These reports will indicate whether you have a couple years' history of paying your bills on time.

Your Comfort Zone

Before you borrow $90,000 or $200,000 or whatever the amount is, figure out whether you can really afford it. Just because the bank will loan it to you doesn't mean that you will live your life in such a way as to be able to pay it back. Are you planning on having a big family? Would you rather replace your Cavalier with a new Mercedes? Your house payment is just one piece of your financial puzzle. What might you need to give up to make that house a reality?