Deciding How Big of a Mortgage You Can Afford
Buying a home is probably one of the biggest financial investments you will ever make. But before you sign on the dotted line, there are some important things to consider. Instead of asking "How big a mortgage can I get?" ask yourself "How much house can I comfortably afford?". No one wants to be house-poor. If your mortgage payment leaves no room for anything else (emergencies, entertainment, etc.) the odds are great that you will soon find yourself in over your head.
What Lenders Look AtYour best opportunity for success when considering a home loan comes when you know what to anticipate from lenders. Here are three things lenders look at when reviewing a home loan application:
- Debt Ratio. When lenders refer to your debt-to-income ratio (DTI) they are basically talking about what you owe versus how much you make. You can easily calculate this by totaling all of your monthly debt payments (credit cards, loans, etc) and adding this amount to your projected monthly mortgage payment. The ratio usually required for a FHA loan is 31%. For a conventional loan, it is generally around 33%. Most lenders want to see a ratio of no more than 36% for consumers applying for a home loan.
- Down Payment. The days of "no down payment required" are pretty much a thing of the past. Depending on which type of loan you qualify for, required down payments can range from 3.5% to 20%. Generally speaking, the more money you can put towards a down payment, the better. Lenders tend to think of larger down payments as a sign that the prospective home buyer is serious about the financial commitment that comes with owning a home. If you do not have 20% of the purchase price to put down, you may be required to carry private mortgage insurance (PMI) which will increase your monthly payment.
- Credit Score. Your credit score gives lenders an overall picture of your financial health and also shows whether you make consistent, timely payments on all of your outstanding debt. This number usually ranges from 300 to 850 and is reported by the three main credit reporting bureaus: Equifax, Transunion, and Experian. A higher score indicates to the lender that you pay your bills on time, each and every month. Your credit score helps determine whether you will qualify for a loan and also influences the interest rate you will receive, if approved. You may request a free copy of your credit report from each of the reporting agencies once a year. Before you apply for a home loan, go over your personal credit reports and check them for accuracy. You always have the right to dispute false or inaccurate information.
A Comfortable Payment
Before you jump into home ownership, why not give it a trial run for a few months? If you're currently paying $900 in rent and your projected mortgage payment is $1300, set aside the extra $400 each month. Put it in a savings account and let it earn you some additional interest. Do this for four or five months and see how it affects your budget. If you don't really miss the $400 you will probably handle the $1300 mortgage payment just fine. However, if you are struggling to pay your other bills or seriously cutting back on activities which are important to you (dining out, traveling etc.) then you may want to consider waiting to buy a home.
Remember, too, that if you are pre-qualified for a mortgage, it doesn't mean that you have to borrow the full amount. Do what feels right to you. The last thing you want to do is over-stretch financially and then constantly struggle to make your mortgage payments.
Final ThoughtsIt's easy to get caught up in the excitement of purchasing a new home. Unfortunately, many prospective homeowners don't realize all the hidden costs that come with owning your own place. In addition to a sizeable down payment and the regular monthly mortgage payments, anyone considering applying for a home loan should seriously consider the following costs before making a final decision:
- Property taxes. These taxes vary depending on where you live. Your city, county, or both will tax your property based on its estimated value. These yearly taxes can cost you thousands of dollars so be prepared to pay them when due.
- Closing costs. The closing costs are due when you officially sign your mortgage papers and receive the keys to your new home. They generally include fees for home warranties, home inspections, and title service fees. Occasionally the seller will pay for a portion or all of the closing fees but you have to include it in your contract.
- Homeowner's insurance. Unless you pay for your home in cash, you are required to carry homeowner's insurance by your lender. Many times, the monthly amount is added to your mortgage payment.
Other costs to consider:
- Home maintenance/repairs.
- Lawn care.
- Pest control.
- Moving costs.
- Additional furniture and/or appliances.
- Security systems.