Comprehensive post on what every Homer Buyer needs to know when buying a Home
Thank you Peter Mark for such a well thought out, informative post!
The question, how much house can i afford, is one where a lot of people have gone wrong in calculating their house affordability. Unfortunately if you get this wrong, it can end up ultimately ending in foreclosure. You need to fully understand how much a house will cost not only upfront but long term as well. To make sure that you can afford not only to get into your house but you can actually afford to live there. I have outlined some tips below. You will find a mortgage calculator and affordability calculator here as well.
More Savings and Less Debt Equals = More Home Buying Power
Before you begin the home buying process, it's important to determine exactly how much money you can afford to spend on your new home. Knowing this information upfront can save you a lot of time and effort and is one of the keys to long-term successful home ownership. Here's how. To determine how much you can realistically afford you'll want to determine how much you'll have for a down payment. In general, you will need to have at least 10% of the homes price for a down payment. If you want the best loan terms, you should plan to have at least 20% for a down payment. When making lending decisions banks also consider the cost of housing in comparison to your income. Your monthly housing expenses including your mortgage, taxes and insurance should be no more than 28% of your monthly income. Of course your other debts also play a factor. In general, lenders want your total debt to income ratio, which includes things like credit card debt, car loan and student loans to be no more than 36%.
Conventional lenders want you to spend no more than 28% of your gross monthly income on your mortgage, taxes and insurance and up to 36% in total debt. Total debt includes student loans, car loans, credit card debt, personal loans and any other debt you may carry. So if you don't have any more loans, then you can spend up to 36% of your gross monthly income on your mortgage, taxes and insurance.
Let's see how this plays out in real life. Assuming you earn $60,000 a year or $5,000 per month gross. You'll want 28 or 36% of that $5,000 or $1400 a month to be spent on your taxes, mortgage and insurance. If you have additional debts, that's all you're going to be able to spend. But if you don't have additional debts, you can spend up to 36% of your gross monthly income on these items for a total of $1800 a month.
So in addition to a good credit history, these are some of the things that lenders are looking for. It's very important to remember that qualifying for a loan and being able to afford that loan are two very different things. So before you make such a large commitment you'll want to consider a number of other factors too.
Determine How Much House You Can Afford by Understanding All The Variables
Different Types of Mortgages Have Different Costs Both Upfront and Long Term
From the time you start looking for your house through closing, the first thing you're going have to consider is your mortgage costs to close the loan. Your mortgage makes a big difference on how much you're going to end up paying when it comes to your closing.
There are really two types of main mortgages. There's a fixed-rate and an adjustable rate mortgage or an arm. Fixed rate as you know the rate is introduced at the time when the loan is enacted and then it just continues all the way through the loan term until either you sell the house, you refinance or you pay it off. The interest rate stays the same for the entire time in a 30year fixed or 15year fixed mortgage.
Adjustable rate mortgages are a little bit more complicated. There are three, five and seven year mortgagee loans and so you'll lock in an interest rate and then later on it could adjust down the road. Different reasons why people might want the adjustable rate over the fixed rate is if you already know you're going to sell anyway or if you want to build up equity faster. Honestly, adjustable rate mortgages are being chosen less and less right now because interest rates are already so low. So the adjustable rate mortgages don't actually offer that much lower of an interest rate than the fixed rates. If you can qualify for a fixed-rate, I would highly recommend just locking in a nice low interest rate and sticking with it.
Because Fixed Rate Mortgages are so low now, I highly doubt that they could go much lower and the direction that they could go is up. So locking in a good interest rate right now would be a better idea.
The other types of mortgages would be conventional or FHA, those are the two main types. There's the regular conventional, which start with about 5% down. The 5% connventional mortgage offer the least requirements out of all of the mortgages out there. Which is great. So again if you can qualify for a conventional mortgage, I'd highly recommend going for that.
The other type of conventional mortgage is what they call a jumbo loan. Jumbo loans you have to have a higher income to qualify for. You have to have a really high credit score and you have to have a large amount of money to put as a down payment. Also Jumbo loans have higher interest rates because you borrow so much in terms or price. A jumbo loan starts at a loan amount of $417,000. So with all of the money that you would have to put down on the house, these are for buyers that are looking who are looking for a home price of $500,000 and above.
Back when we had the housing crisis in 2007, the highest end houses were the ones that fell the most in value. Whereas the lower end houses really didn't have that far to fall, so they didn't really fall that far. But this was a really sad time because many states across the US were affected by foreclosures. You can lose a lot of equity really fast on a really expensive house as well as a lower priced home.
The other type of main mortgage would be the FHA. FHA loans are actually done through HUD. HUD stands for United States Department of Housing and Urban Development. These FHA loans are not just for first-time home buyers. There's a huge misconception that FHA loans are mainly for first-time home buyers. Although FHA loans have different kind of qualifications. So if you can get a conventional loan that's probably a better choice. The main reasons to get a conventional loan over an FHA loan is costs. With a FHA loan you a Mortgage Insurance Premium is required for the life of the loan if a you put down less than 10% as your down payment. Conventional loans have no upfront private mortgage insurance (PMI) and the PMI payments cancel when the Loan to Value (LTV) reaches 78%. Additional benefits of a conventional loan is the guidelines on the homes condition.
You have a better chance to get a fixer upper or a home with some repairs needed with a conventional.
FHA loans have some stringent guidelines on the home's condition before approving you for a FHA loan.
Either way I totally believe in homeownership, regardless of the loan you get. Compared to renting, you will be better off having your own place and owning it. If you really need help with mortgage loans, I have a great Mortgage guy I can recommend. So be sure to message me here.
FHA Loan Benefits
FHA loans can be a good choice for people because the down payment start as low as 3.5%. There are some issues with FHA loans however. They do require mortgage insurance for the entire life of the loan. Mortgage insurance ensures the people who loan you the money in case you default. Homeowner insurance protects you while PMI or Private Mortgage Insurance protects the lender. Many graduates I know, even Doctors with high student loans, started with FHA then switched to conventional. This is very common. Homeowner insurance and Mortgage insurance are two different things. Keep that in mind. Also there may be situation where a personal loan from a close relative may help you close the deal. Be aware there are strict guidelines to follow for this. So prep for this scenario as well.
With the Mortgage Insurance situation, you basically get nothing out of this and yet you're required to pay it. In a lot of cases it can be kind of pricey. So this adds to your payment instead of having say a $1,200 mortgage payment you may end up having a $1,300 mortgage payment. That's definitely something to consider if you are willing to have a little bit less to put down as a down payment.
I think the best case scenario which is really difficult for some people to do is actually to put 20% down so that you can eliminate that private mortgage insurance altogether and qualify for a conventional loan.
Owning a house with any mortgage is probably better than not home buying a house at all. In certain instances buying a house of course isn't right for everyone. If you want to buy a house and you have to choose a different type of mortgage in order to do so, by all means go for it.
VA and USDA Loans
A couple of other loans that FHA offers is a VA. VA loans are for veterans. The main benefit of VA loans is that they don't require any money down. You can buy a house with as little as $0. Just the closing cost and a few other things are required to close. Another type of FHA loan is a USDA loan. These are for rural people who have low or modest incomes. You have to make less than 115% of the median income in your area. So you have to make at least around what the median is or below. When home buying a property in a rural location in order to qualify for these loans, you will find different qualifications as well.
The Closing Costs - Upfront Costs of Buying a Home
This is one of the most underestimated things that are out there. People will say, okay well I want to put 20% down on my house. I want to spend about $250,000 on it and I have $50,000 saved. I can easily buy a house right? No! There are a whole lot of other costs to consider. When you actually go to the closing table on your house, that's when you pay your whole down payment, earnest money and associated closing costs. You have to pay closing costs depending on where you shop for your mortgage. If you want a good solid estimate of closing costs, be sure you contact a local Realtor or Mortgage professional. They are both valuable resources.
When it comes to closing costs, there are a lot of different closing costs. There are tons of different types of fees. Some people have administration fees, underwriting costs, origination fees, title fee and so on.
A lot of times you have to pay the prorated taxes. You have to pay the taxes on your house upfront for that year. You have to pay for an entire years worth of homeowners insurance at the time when you close as well. Determining real estate taxes is easy. Depending on where you live property taxes are generally 2-3% per year of the price of the property. This is just a guideline but if you have a property worth about a hundred thousand dollars, you can safely assume you'll have to pay $2,000-$3,000 a year in property taxes. Make sure to get a good estimate on the cost of your insurance premiums as well.
Oftentimes you have to pay for an appraisal to make sure the house is worth what you are buying it for. You have to pay for an inspection which I highly recommend that you don't skimp on because otherwise you can get yourself into a house that's a big problem. When we bought our home in Florida, we were so emotionally excited to get into it and just wanted to close and move in asap. We just had a friend inspect it. But after moving in we found so many problems we had. We spent over $7,000 on repairs. Installing new plumbing, electical and a water softener to name a few.If we only had a professional inspection done.
Interest Costs of the Mortgage Loan
Oftentimes you have to pay interest from the time that you buy the property until the first of the next month before the interest starts getting calculated toward your monthly payment.
So if you were to close on the house on the 15th, you have to pay the interest from the 15th through the 30th or 31st. Whatever you know for that month has how many days it has upfront at closing. Then the next interest is paid in arrears. So that when you pay your mortgage the next following month on the first you're paying all that interest in your first mortgage payment. Hopefully that didn't confuse you but yes there is some interest toward the loan that you're getting right now due at closing depending on what time of the month that you get it. It is lower at the end of the month when you close at that time. The interest is higher if you close on it at the beginning of the month because there are more days of interest you're actually paying off.
Oftentimes they'll charge you to get a credit score and so you'll have to pay for that. You'll have to pay for title insurance to check to see if your house is in a flood zone and the title is clear of any liens. Some places charge you fees if you have to start an escrow account.
Sometimes you have to get a survey. There could be even more fees on here that I don't even have listed.
Then again not every loan is going to require this. Maybe you buy a house that doesn't require an escrow account.
Not all these fees are going to be charged every time, but there are other fees that may be charged. So it's definitely important to ask and get the right Realtor to help you in the hombuying process. In some cases you can get the seller to pay some closing costs and or repairs.It really pays to have a Realtor on your side.
Costs of Homeownership After Closing
After you closed on your house and you're already in it, there's the continuing costs.
Those are really important to consider too because of course everybody wants to not only have their house but they want to be able to comfortably live in it too. So be sure you are in your low end price range just to be safe. Don't max out on your price buying power. Consider a homes price in relation to everything else. The house you can afford today may not be the house you can afford next year.
There's the mortgage. You obviously have to consider how much your mortgage payment is going to be. That can be a little overwhelming to try to figure out. Because if you go online and you look things up it's entirely different than if you go to a bank or try to figure it out on your own. A lot of people have gotten themselves into trouble.
For example, Investopedia says that you can borrow or should borrow somewhere around in the range of 2-2/12 times your annual gross income. Let's just say someone has that median income of about $70,000. So that means with that statement you should borrow around $140,000 - $175,000. Really not a whole lot. When we looked at the median house price it was substantially higher than that purchase price. So that seems a little bit on the low side. Some of these online pre-approval, get pre-approved now sites where you input your information and we'll tell you how much we can you loan to you. These you have to be careful with as well. They do give you a good picture but not the final consideration on how much house I can afford.
Input home affordability sites ask the different questions like, what is your credit score? What is you credit card limit? How much money you can put down. What other kinds of debts do you have?
Best-case scenario, high credit score, low credit card limits, 20% down and no debts. Some of these rather sketchy online pre-approval places, with my 70,000 income say I could borrow $442,000. So way more than that estimate from investopedia statement.
So what is the right amount of money to borrow considering your income?
How Much House Can I Afford Calculator
My personal choice is actually this calculator below. Otherwise I recommend you contact Larry LoVetere with Oak Leaf Community Mortgage. Probably the best Loan Officer in the United States! He has personally helped me and many of the Realtors I have worked with in the past. I believe he can loan in 45 states currently. Both FHA, Conventional and Jumbo Loans. So contact Larry now, you will be glad you did. Tell him Peter Mark sent you.
Simply fill out this little calculator sheet. Input all of your incomes. Lists some of your debts.
Input or find out the real estate taxes you would have to pay as well as insurances. etc
You just kind of fill that in and then it gives you an amount that you would probably be able to be pre-approved for through a reputable company. Either way you will need a pre-approval letter when submitting offers on a home. So be sure to get this done prior to any home search. Do not waste your time looking at homes you can't afford.
So when I put that same in with the same exact criteria I was using from the sketchy online sites, it says that with a 30 year mortgage, I could borrow $376,000. On a 15 year mortgage, I could borrow $366,000.
However, I have found that a lot of times when you get pre-qualified through anyone in person it is a whole different situation than what you get from online sites. Oftentimes they'll say, okay what is your gross income? You give them your gross income. What are your basic debts? Your social security information so that they can check your credit. Then they'll give you an amount that you can spend. Well, honestly it happens all the time. A monthly mortgage home loan is related to your household income when you want to determine how much house you can buy. Loan calculators are great, but you still need a holistic approach with all the variables. Even if you have bad credit, you can in some situations qualify to buy a home. Monthly spending, frontend ratio,backend ratio and the like are best handled with a mortgage professional.
Mortgage Pre-Qualification VS. Pre-Approval
In a initial Pre-Qualification lenders and banks will give you a number like $376,000. So you go and shop for a house and you put out you know a house under contract that's worth $375,000.
But then once you're under contract they start processing your application. Give us your last two years tax returns, pay stubs and the like. Then their answer is, oh well you know your overtime isn't consistent so we really can't count that overtime income. Your last year's tax return was good but the one year before that it was less. We have to take the average of those two.
Or we see that you're self-employed and you buy all these office supplies. So we're going to assume you have to buy every time. All of a sudden that pre-qualification number that a lender gave you and the actual pre-approval number for isn't what they can actually use when processing your loan. They can be two different numbers.
For example the lender will say, okay I'm sorry but that original pre-qualification of $375,00 that we originally quoted you for because of all the information that you've given us now, you can only be pre-approved for $350,000.
Well but you're already under contract for this house that's $375,000. So basically that contract falls apart due to the actual pre-approval. Now you have to go look for other houses and you probably paid some of those closing costs toward trying to buy that house. Maybe you've already got an appraisal. Maybe you've already got an inspection. So you've paid all this money to try to make the deal go through and then it falls apart.
That can actually cost a lot of money. That's why I highly recommend becoming pre-approved rather than pre-qualified. That means when you actually shop around for your mortgage you choose who you want to go through. You submit all of your information then. Whatever it is they require from you. You give them your tax returns and all the necessary paperwork. The lender or bank will look it over and will tell you exactly how much you could borrow.
That way you don't have these kind of instances come up later.
Consider your final Mortgage Payment plus Hidden Costs
Look at what the payment would actually look like. This is extremely important. Sometimes people will be like okay $350,000 sounds like a lot but they say that's what I can borrow so great.
Then they sit down at the closing table and it's like oh my gosh that's a $2,300 monthly payment. I can't afford that! My rent right now is $1500. That's quite a bit more than that. So when you get pre-approved or pre-qualified make sure you look at what they tell you that payment would look like and then consider that according to what you normally pay now.
Also look at some of the other costs that come up. There are of course other continuing costs when it comes to living in your house.
There's not only that mortgage payment but there's also going to be repairs. There may not be repairs now, but as you're living in that house there will be repairs later. The more services that you have, for instance a live-in engineer, a live-in doorman or 24-hour security, the higher the total costs will be and you'll have to account for that. When lenders look at this, they subtract those costs from the total amount you can spend on your mortgage, taxes and insurance.
If you own a single-family house you'll have expenses to maintain the yard, snow removal, tuckpointing, gutter cleaning and repair. You're going to want to get your systems flushed out as well. Depending on where you live you could easily spend $5,000-$8,000 a year maintaining your home and that doesn't include extras like replacing appliances when they fail every five to thirteen years. Think carefully. If all you can do is afford $2,000 a month and you're not going to earn any more than that ever, you will need to save 5-10% of that amount or a $100-$200 a month just for maintenance. With newer homes you'll probably pay less in the beginning. With older homes, you're likely to have to pay a lot more.
So it's important to budget for those types of costs and sometimes people buy fixer uppers that really do need repairs now. Sometimes there are outdated houses. So while the sink works fine that super bright pink countertop with that blue sink just doesn't work for you in your style so you want to upgrade it. So that's another cost.
Sometimes when you close on your house a utility company can charge you turn on fees or will try to get a deposit to get your utilities switched on. Of course there's always the monthly utilities. That's important to consider too because again if you're renting say a small apartment now and then you're buying a much larger house your utilities could easily double or even triple depending on what you have included in your rent and how much bigger the house is.
I know there are some districts around us where water is like double the price it is where I live now.
So monthly utilities is definitely something you want to consider and definitely don't skimp on asking about this.
I've been shopping for a house and I've been wondering about what the utilities are in the different houses we've been looking for. In many cases I had to ask the sellers agent hey what are the utilities for this house? What does an average monthly bill look like when you're heating it in the winter? I've never been told that the seller won't disclose this information. Every time I've asked it the seller agent has always been able to produce this information so that I can consider all my costs. I'm not going to end up buying a house that I can't afford.
There's the yearly taxes you're going have to pay on your house for the entire time you own it. It does not matter how long you own your home, you're still going to have to pay taxes. In some states, you can get into a foreclosure situation by not paying your real estate taxes. They can put a lien against your house and even if you own your house in full without a mortgage, they can foreclose on your house to take the taxes out of that sale price.
Not everywhere is this allowed of course so you know it can change according to where you live and what not. But yes taxes are definitely something you need to account for. Sometimes it's included in your mortgage, sometimes it's not. It depends on what kind of mortgage you have.
That's also important to find out because if you have that $1200 mortgage payment when you're used to $900 and in addition $1000 in taxes isn't even incorporated into that. You can see how people can get themselves in over their heads.
There are sometimes HOAs or Homeowner Associations where you have to pay additional monthly fees. Other dues including yearly insurances. Sometimes that's included in your mortgage, sometimes it's not. Again you want to find that out or yourself. Of course there's all this money or there are some things that you might need for landscaping. Especially if you're not used to having a home of your own or being a homeowner. You're going to want to consider the cost that it's going to take to either have somebody do the landscaping or do it yourself.
I would highly recommend looking at the whole list of costs, adding up all the stuff that pertain to you and balance it according to how much you're used to paying now. So that you can make sure that you're not going to get in over your head on the deal.
Final Note for home buyers and how much house can you afford.
House affordability is rather complicated but rewarding at the same time. You will feel better, have more pride knowing you own something. Best part is you can make it your own and benefit from it's appreciation or value increase over time. Who knows, it might pay off your student loans or debts at some point. The added benefits really outweigh all these monthly expenses with owning your home.
Hopefully I was able to break it down a little bit to where you can kind of better understand the costs involved. Be sure to comment below. Happy house hunting and here is a list of real estate agents I can recommend by their service area. Each Real Estate Broker/ Realtor/ Agent is clickable below with their contact profile. Whether you are buying or selling a home, check out these fantastic local Real Estate Professionals below.
San Jose, California area Broker I recommend Kathleen Daniels
Warner Robins, Georgia area Realtor I recommend Anita Clark
Barrington, Illinois area I recommend Broker Corinne Guest, Managing Broker
Tallahassee, Florida area Broker Fred Griffin
Beverly Hills, Encino California area Realtor Inna Ivchenko
Palm Harbor, Florida area Broker Annette Lawrence , Palm Harbor, FL 727-420-4041
Northern Maine area Broker Andrew Mooers | 207.532.6573
Franklin Massachussets area Broker Barbara Todaro