When you are starting the home buying process, the first question most people ask is: “How Much House Can I Afford?”
Many first time homebuyers are in the dark when it comes to what they can afford. They know they are ready to stop paying rent or move into something they can call their own, but unsure of how much they can actually commit themselves to for the long-term duration of a mortgage. Many buyers start their research online using affordability calculators, others rely on how much the bank is willing to lend. Be cautious, banks tend to be willing to lend more than what you can comfortably afford. Educating yourself first is the best tool.
How Much Can I Comfortably Dedicate To Pay Each Month?
Often, the best strategy for determining home much home you can afford is to work backwards by deciding how much you are willing to pay each month. Many mortgage lenders advise sticking to a payment that is between 25-30% of your gross income. However, sticking to no more than 28% is recommended.
What mortgage payment can I afford?
|Annual Gross Income||Maximum Payment with Escrow|
Use the table above to get a quick general idea of your maximum house payment based on your income. Don’t forget to factor HOA fees, PMI, and if you will be escrowing your homeowners insurance and property taxes into your payment.
Remember: Banks will also factor in monthly debts such as monthly credit card payments, monthly student loans, car payments, monthly child support, alimony, etc. Items such as utility payments are not factored in. These monthly debts will be included in that 25-30% of your gross income limit.
Let’s take a look at a quick example:
Monthly Budget ExampleGross Income of $70,000
Assuming 25% Taxation
Take Home Monthly Pay- $4,412
|Cell Phone Bill||$100|
|Left Over Income||$53|
The only reliable way to determine how much house you can afford is by adding all of your monthly bills and expenses. Don’t forget- homeownership can come with additional costs you may not have had before such as: lawn maintenance, pest control, pool maintenance and general home maintenance. A general estimate can be made, but for more specific amounts, contact your local service providers or real estate agent.
When adding up your monthly expenses, also include your cost of living – gas, groceries, entertainment, and savings contribution. Adhering to a budget and including a savings plan is especially important when owning a home, because you never know when an unexpected expense can arise. Don’t let that unexpected water heater dying leave you in a pinch!
How Much Should I Put Down As My Down Payment?
Once you have figured out how much you are comfortably willing to pay each month for your new home, you need to determine how much of a down payment you will need. A general rule of thumb with conventional loans is to put down 20% of the purchase price. Many lenders see buyers who have at least 20% down as more attractive and stable and will often give them better interest rates. When saving your money for the down payment, also remember to set some of that aside for costs associated with the purchase of the home such as inspections, appraisals, closing costs and moving expenses.
Some lenders are offering new products for conventional loans that only require 3-5% down. When choosing your lender, make sure to do a little research into what types of products they each offer. Depending on the lender, they can do some creative lending if your credit is less than perfect. Not sure what your credit score should be to purchase a home? Find out here!
I’ve Heard About PMI, But What Is It?
If you are not able to put down at least 20% of the purchase price of your new home, your lender will charge you PMI or private mortgage insurance. This is insurance for the lender in case the buyer is not able to make their monthly mortgage payments and default on the loan. Even if you cannot put down the full 20% of the purchase price, try and put down as much as you can. In most cases, the more you put down the lower your PMI will be. Speak to your lender for the most accurate rates for you.
Interest rates can have a big effect on your monthly mortgage payment. OR if you want to keep your payment at a certain amount, it can affect how much house you can afford. Not only will your monthly payment be higher, your loan costs will be greater over the life of a loan. Check out this example below!
|Interest Rate||Payment||Home Value|
How Do I Find The Best Interest Rate?
Of course having a 20% of more down payment and great credit will go a long way to getting a good interest rate, there are other things you can do to help lower the rate if that isn’t your situation.
Obtain your credit report and score - check your credit score before starting the loan application and try to fix any of the issues on it that you can.
Purchase mortgage discount points – discount points will cost 1% of the loan amount and will typically lower the interest rate by 0.125 for each point. This isn’t for every buyer; so make sure to consult your mortgage lender to see if it is an appropriate solution for you.
What is Escrow?
Earlier we discussed “escrowing your homeowners insurance and property taxes”. Now what does this actually mean?
An escrow account is a reserve fund held by the lender to make payments for your homeowners insurance and property taxes. Lenders will collect them monthly along with your loan payment and then pay the tax and insurance bills when they are due. That’s because your lender has a vested interest in making sure those payments are made. You may hear the term “prepaids” as well. That’s money collected in advance for those bills to ensure they’ve got enough on hand to pay them when they are due. This is great for you the buyer because it does a couple things. The bank takes care of paying the bill for you, so it’s one less thing you have to remember! Also, by paying small amounts into your escrow account each month, you won’t be left holding a big bill at the end or beginning of every year.
How Do I Know How Much My Property Taxes Will Be?
In Florida, property tax rates can be pretty easy to find by visiting your local tax collector’s office or website. Your real estate agent should also be able to tell you what the homeowner paid in taxes last year. **Remember** This amount could change depending on the purchase price of the home. So knowing the tax millage rate as well will give you the best estimate. You may also be able to apply for exemptions such as homestead, senior, widow and veteran.
Below is an example on how to estimate your property taxes, please note these millage rates are for example purposes only:
Millage Rate 16.0000
With No Exemptions - ($300,000 x 16.0000 millage)/1,000 = $4,800
With $50,000 Exemption - ($250,000 x 16.0000 millage)/1,000 = $4,000
Your home will be taxed based on the assessed value, which is not always the price you paid for the home. It is often times less than you paid. Someone from the tax collector’s office should come by your new home after purchase to reassess the value of the property. They should not need access into your home!
How Much Does Homeowners Insurance Cost?
Insurance agents should be able to give you an estimate quickly over the phone just by knowing a few basic facts about the home. They may even be able to offer you additional discounts if you have other policies with them such as car insurance, life insurance, etc. Your real estate agent should also be able to give you a general estimate to help you in determining your budget.
Putting The Pieces Together
Once you have looked at your income, budget, and estimated costs, you are in a great position to use a tool such as a mortgage calculator. A good mortgage calculator will give you the ability to plug in all the data you have collected such as purchase price, interest rate, loan term, PMI (if applicable), taxes and insurance. It should also be able to give you an amortization chart so you can see how much of your payment is going to interest vs. principal for the life of the loan. Play with the price of the home until you have found a monthly mortgage payment that fits into the budget you have laid out for yourself.
I Know How Much House I Can Afford, Now What?
Choose a mortgage lender and obtain either a pre-qualification or better yet, a pre-approval. With that in hand, when it comes time to put an offer in on the home of your dreams, the buyer will know you are qualified to purchase their home.
Find a licensed real estate agent. Often times, you may have friends, family or co-workers that can recommend someone they have previously worked with. Take a look at reviews of other buyers or sellers who have worked with that agent, see what they have to say. Once you have found 1 or 2 that you think may be a good option for you, give them a call. Ask questions. A good real estate agent will be happy to answer your questions and will appreciate that you are doing your homework. Once you’ve found someone you “click” with, talk with them regarding the expectations you have of each other so no one is disappointed or unhappy with the transaction.
I Know My Budget And Have A Pre-Approval, Now What?
Congratulations! Now comes the fun part - shopping for the home of your dreams. Your real estate agent should set you up with a search site and send you properties that meet the criteria you discussed. You can also use a home search site, such as this one to help locate your new home. Happy House Hunting!
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