Figuring Out What You Can Afford

In addition to your monthly mortgage payments, there are many things to factor in when determining how much you can afford, or even if you can afford to buy a home at all. There is a down payment for the loan, closing costs, moving expenses, plus purchases and maintenance for the new home.  Generally, your annual gross income multiplied by 2.5 will give you an approximate amount for the price of home you can afford.  It could vary depending on how much you have as a down payment, your debts, financial situation, and credit history/rating.  Your debts, including alimony and child support, should not be more than 30 to 40% of your gross income.

Monthly Mortgage Payment

Lenders want to make sure you have the ability to pay your loan.  As a general rule of thumb, you can figure that your monthly mortgage payment should be equal to or less than 25% of your gross monthly income.  This also will vary depending on circumstances.

Amount of Money Needed

You will need money for a down payment and closing costs, plus any move related expenses and maintenance or repair costs for your home.

»  Down Payment – Your down payment is a percentage of the property value and is usually from 3 to 20%, or more if you want a lower loan amount.  This can vary by the type of mortgage you obtain.  Also, if your down payment is less than 20%, you may be required to pay mortgage insurance (PMI or MI).

»  Closing Costs – these are settlement costs involved in purchasing your home.  They range from 2 to 7% of the property value and include such things as points (a percentage paid for securing a particular interest rate), financing fees, taxes, title insurance, pre-paid and escrow items, and your down payment.  You will receive an estimate of these costs prior to closing.

»  Move In and Initial Expenses – these are costs associated with moving in such as movers, utilities, electric, cable, internet, new appliances needed, initial updates or repairs such as flooring, paint, electrical work, or any other initial expense that “pops up”.  Nearly every home comes with a few surprises.  You should have a savings set aside for these new home “adventures”.

What To Know About Credit

There is nothing more important than your credit when it comes to buying a home.  The first thing a lender will do is review your credit report.  This is a history of money you have borrowed in the past and how you have repaid those debts.  It contains a list of debts such as credit cards, car loans, and other loans.  It shows any bills that have been referred to a collection agency.  It lists other public record information such as liens or bankruptcies.  And, it documents inquiries about your creditworthiness and whether you were extended credit or not.  Your credit report is constantly updated and most information is deleted after 7 years (10 years for bankruptcies).  This credit information then helps generate a computer-derived number that indicates your risk as a payer of debts.  This is called your credit score.  Your credit history and/or your credit score is used to decide whether your loan is approved and it could be used to determine your interest rate.

If You Don’t Have Credit

If you haven’t established credit, start now.  Perhaps apply for a credit card or two, then use them carefully and pay them off each month.  Once you’ve done this, you’ve started your credit history.  Next, apply for credit on a store purchase such as an appliance, or a TV.  Do this even if you have the cash to pay for it.  When the first bill comes, use your cash to pay it off in total.  You see, buying on credit and paying it off helps your credit better than buying something for cash.

If You Have Bad Credit

It can take awhile to improve bad credit, but it can be done.  Since credit scores reflect much of your most recent activity, the first thing you should do is to start paying on time.  Pay all of your bills, even if it’s just the minimum.  Never pay less than what is due, and never pay late.  And, don’t max out your credit cards because it indicates poor money management.  One of the best things you can do is to make a budget to help with your monthly expenditures and then live by it.  Also, start a savings account and make it part of your budget.  You will need money for a down payment, or it will help if you lose your job or source of income.

Often What You Qualify For Is Different Than What You Can Afford

Depending on your credit, you may qualify for more or less than you can afford.

If your lender qualifies you for a loan that was larger than you expected… The qualification process took into account your income and credit history, but there are other factors to consider to decide what you could actually afford.  You may want to spend less on a house, so your mortgage payments would be smaller and you have more money left over each month for other things, like eating out and home decor.   Being pre-qualified for a home is a like having a credit card.  You get a limit on what you can spend, but it doesn’t mean you can afford to max it out.  It’s important to take a look at all your monthly expenses, both mandatory and discretionary, to determine how much you really want to spend on your mortgage each month without giving up the things that matter to you.

If your lender qualifies you for less than what you thought you could afford then you know you need to work on your credit, pay off some bills, and save up.  You have two options, downsize your list of wants in a home or delay purchase for several months while you work on your credit.

You Don’t Always Need A Large Down Payment

Coming up with a 20% down payment is one of the biggest hurdles for many.  There may be other options.  Different lenders offer different programs.  Some have programs with government assistance for the down payment and closing costs, some offer programs with as little as 3% down.  It’s good to talk to several lenders and do some research into which program and type of loan will be the best for you so you an be in a home and building equity sooner

Closing Costs  May Be More Than You Expected

Many people know they need a down payment, but don’t realize the money needed for closing costs on top of that.  Be sure when saving up you factor in closing costs.  This typically is 2% to 8% of the sale price of a home.  Your lender will provide you with a detailed estimate of these costs so you are prepared for the total amount required to close your purchase.  If you are planning to make a 20% down payment, that means you’d really need 22% – 28% of the home’s purchase price to cover all the costs, which can take a long time to save.  Luckily there are loan options available with as little as a 3% down payment, which means you’d only need 6% – 11% of the home’s purchase price to cover costs.

Save Some Money For Unexpected Expenses

“We were so excited to be in our new house, but when the dishwasher stopped working and the hot water heater ruptured within a few months of each other, we were worried about how we’d cover the expense.  We used all of our savings for the down payment and closing costs.  We should have kept something for emergencies.”
It’s no secret that there are many potentially expensive repairs that come with home ownership.  The seller is legally obligated to disclose any known problems with the home and the home inspection will give you a sense of what issues could arise, but there are always unexpected surprises.  Some not even related to the house – like losing your job, car problems, or getting ill.  That’s why even if you have enough money to make a sizeable down payment, it may be a good idea to put less money down if it means using all of your savings.  That way you have money available to handle the unexpected.