Understand yourself and your limits in the following areas:

1. Know your budget and how much you can afford.
2. Know your credit score.
3. Calculate your front and back-end bank ratios.
4. Calculate your bank ratios for LDS.
5. Choose your preferred loan type and term.
6. Know what you need for a down payment and upfront costs.
7. Have two years of copies of taxes.
8. Get pre-approved.

1. Know Your Budget. The first part of understanding your limits is to check whether or not you have developed and are living on a budget. In the April 1975 General Conference, President Spencer W. Kimball stated the following:

Every family should have a budget. Why, we would not think of going one day without a budget in this Church or our businesses. We have to know approximately what we may receive, and we certainly must know what we are going to spend. And one of the successes of the Church would have to be that the Brethren watch these things very carefully, and we do not spend that which we do not have. (as quoted by Marvin J. Ashton, One for the Money, pamphlet, Intellectual Reserve, 1992, inside cover)

Notice that no ifs, ands, or buts accompany this statement. Moreover, President Kimball says that one of the successes of the Church has been “that the Brethren watch these things [budgets] very carefully” (Marvin J. Ashton, “One for the Money” pamphlet, Intellectual Reserve, 1992, inside cover). If the Brethren watch their budgets carefully in the Church, shouldn’t we watch our budgets carefully in our families as well? We have already talked about many important topics related to budgeting in the section on Budgeting and Measuring Your Financial Health. If you have questions about budgeting, please review that section.

2. Know Your Credit History and Score. The second part of understanding your limits is becoming aware of your credit history and your credit score. If you don’t have good credit or a satisfactory credit score, you may find that no one is willing to lend you money.

Your credit history is a private record (to a great extent, although some records are now public) of all your loans, credit cards, and other borrowings; this record gives lenders a fairly good picture of how much debt you have and how good you have been at managing that debt. Every year you should review your credit history from all three reporting agencies. You can get a free copy from each of the major credit-reporting agencies each year from www.Annualcreditreport.com. You should also get a copy of your credit score every two years.

We have already talked about many important topics concerning credit in the section on Understanding Credit. If you have questions concerning credit, please review Section 6. As we have discussed previously, your credit history can play an important role in your opportunity to buy a home. When you request credit, financial institutions will pull your credit history to determine how likely it is that you will pay back the loan. If you have made timely payments in the past, creditors assume that it is likely that you will continue to make payments in the future. Because your credit history can have a big impact on how much you pay for your loans and whether or not you get a loan in the first place, you need to periodically examine your credit reports from all three major reporting agencies. Make sure the reports are correct.

3. Know Your Affordability Ratios. The third topic you should understand is mortgage lending. Know the rules of mortgage lending. We have already talked about the different types of mortgage loans in the section Consumer and Mortgage Loans. Review this section if you need to.

It is critical that you know your affordability ratios, or how much debt the bank thinks you can take on. There are two main ratios: the housing-expense ratio (or front-end ratio) and the debt-obligations ratio (or back-end ratio).

You should know how to calculate your housing-expense ratio. The housing-expense ratio, or front-end ratio, is your monthly payment of principal, interest, property taxes, and insurance (PITI) divided by your monthly gross income. Banks have determined that if this ratio is 28 percent or less, there is much greater chance that you will be able to pay back your loan.

The back-end ratio is your monthly payment of principal, interest, property taxes, and insurance (PITI) plus any other long-term debt (including any debt older than twelve months, i.e., car payments, student loans, alimony payments), divided by your monthly gross income. Banks have determined that if this ratio is 36 percent or less, it is an indicator that you have much more flexibility in your finances and are more likely to pay back your loan.

Know your affordability ratios before you get your loan. Don’t use all the money the bank will lend and don’t buy the most expensive house on the block. Do know how much you can afford.

4. Calculate Your Affordability Ratios for LDS.Before you calculate affordability, take into account the amount you should be saving. Look at your budget realistically. I recommend you set aside 10 percent for tithing, plus an additional amount for other offerings. Set aside 10 to 20 percent more for paying yourself, for money you are saving for retirement and other goals. Since you pay the Lord first with tithes (10 percent of your increase) and offerings and since you pay yourself each month as well you should really adjust these affordability ratios downward to take your donations and savings into account. I would not encourage you to borrow too much money for your home. To help you review your situation please see Learning Tool 11: Mortgage Payments for LDS, which is found in the learning tools section of this website. This spreadsheet takes ratios, as well as the fact that you pay tithing and savings, into consideration when it calculates the amount a bank will likely lend you.

5. Choose Your Preferred Loan Type and Term.Choose your preferred loan type. The best type of loan takes into account your goals, budget, income stream, down payment, and view on risk. There are a number of different types of mortgage loans available. These include:

• Fixed Rate (FRMs). This type is what I generally recommend. The lender takes the interest rate risk and you have constant payments throughout the life of the loan. This makes planning and budgeting easier.

• Variable or Adjustable Rate (ARMs). You take the interest rate risk, so the lender may accept a lower rate of interest. However, there is the risk that interest rates will rise in the future.

• Interest Only Options: Variable or Fixed Interest. This is an option on a fixed or ARM loan. However, once the interest only period is over, i.e., 3 to 10 years, the loan resets so the principle and interest is paid over the life of the loan, generally 30 years. There can be substantial payment shock when the loan resets. This is not like a minimum payment on a credit card.

There are also special loans, if you can qualify for them. The include Federal Housing Assistance loans for lower income borrowers, or Veterans Assistance loans which are guaranteed by the U.S. Department of Veterans Affairs for those in the military.

Choose your loan term. Generally, I recommend a 30 year fixed rate loan which may give you flexibility in case of financial concerns in the future. However, I recommend you make additional payments on principal to pay off the loan sooner if possible.

6. Determine Down Payment and Up-Front Costs: The next topic you should understand is your down payment and up-front costs. Before you buy, remember that the down payment on a loan may be from 3 to 20 percent the cost of the home, and the closing costs may be an additional 2 to 5 percent. Be aware that these costs are significant; given that these costs are paid up front, they must be planned for before you purchase the house.

Points are 1 percent of the loan value or one hundred basis points of the loan. Lenders charge points to recover costs associated with lending, to increase the effective interest rate they are receiving, to provide for negotiating flexibility in a market where interest rates fluctuate, and to adjust for differences in risk between loans. Points are deducted directly from the loan amount at closing. In other words, if you have a $200,000 loan with two points (2 * $2,000), you will only receive $196,000 at closing—the mortgage broker will keep $4,000. However, you will have to pay back the full $200,000.

Other up-front costs include title insurance, attorney’s fees, property survey fees, recording fees, lender’s origination fees, appraisals, credit reports, termite/mold inspections, escrow payments, and the home inspection report.

Your impound account (or escrow, or reserve account) is the portion of your monthly loan payments that is held by the lender or servicer to pay for specific costs. These costs include property taxes, hazard insurance, mortgage insurance, and other items as they become due. These payments are made in addition to your monthly mortgage payments of principal and interest. An impound account may or may not be required for a loan, depending on your lender.

7. Have Copies of Two Years of Tax Returns.Lenders want confirmation that you can pay back the loan. As such, they generally want to see two years of tax records for documentation. If you are a recent graduating student, you might share a confirmed job letter with salary.

8. Get Pre-Approved, NOT Pre-Qualified.Know that you should get pre-approved for a mortgage, not just pre-qualified. In addition, know your affordability ratios that the bank uses to determine credit worthiness. Pre-approved means the financial institution has done all the necessary analyses to qualify you for a loan, including checking your credit report and approving you for a specific amount. Pre-qualified, on the other hand, means that the financial institution has essentially said that you will roughly qualify for some undetermined amount on a mortgage loan. Many times people have thought that they were pre-approved for a loan when they were only pre-qualified. When it comes time for these people to close on a house, they may discover they can’t get all the money they need. Not only do they lose the house, but they may lose their earnest money as well. Earnest money is money given by a buyer to a seller to show their good faith. Should the deal fall through, the earnest money may be forfeited.