Can you afford a new home?
The moment you decide that a new home is in your future, you need to understand clearly that sooner or later you and your assets will come under the microscope of your friendly lender. What steps can you take to be sure that you will be considered acceptable under the gaze of this powerful lens? The answer lies in knowing how to assess your purchasing power. Knowing how to do this will help you avoid surprises (and disappointments) during the loan application process. Most important of all, you will avoid wasting your time visiting homes that are out of your price range, or even worse, falling in love with a dream home that you cannot hope to buy.
The good news is that you do not have to play a guessing game as to what you can afford. As long as you are realistic and candid about your income and your debt, your real estate agent should be able to give you a very good idea.
Also, your real estate agent should be able to recommend a mortgage lender who can pre-qualify you. Since this is their main business, they will be able to tell you very accurately how much the lender will allow you to spend for housing.
In addition to helping you determine the price range of homes you should be considering, the lender can clarify for you the various types of loans that are available, and the advantages and drawbacks of each.
Many lenders will go beyond the pre-qualifying stage and actually pre-approve you for a mortgage of a given amount before you begin your house hunt. This gives you a strong advantage, especially in a competitive market. By having your financing secured in advance, you are telling the seller that you are a serious buyer, and give you a distinct advantage over someone who is still king for financing. Lenders use four main considerations in deciding whether or not to make a loan: Income, Credit, Equity and the Property itself. Each lender will have "rules of thumb" by which they make their decisions, but there are very few unbreakable laws. Generally the lender wants to make the loan, and they will look at a host of associated factors which will help them decide if you are a good risk and will pay back the loan as agreed, or if you don’t, whether the property has adequate value to recover their investment.
Lenders look not only at your income, but at your age, educational level, stability of your occupation and length of time you have remained at each job.
In considering your credit report, although they will call for explanations of even the most minute deviation, they will look for patterns of payment as called for by the contract rather than an isolated late payment.
A broad general guideline says you can afford to buy a home costing twice your annual gross income. Lenders, however are more precise, and generally look at two very important ratios. Number one is that your total monthly payment (principal, interest, taxes and insurance) should not exceed 28% of your gross monthly income. For example, if you earn $4,000 a month, the lender will allow you to spend $1,120 a month for a house. If you allow $350 per month for taxes and insurance, the balance of $770 will allow you to afford a mortgage of $104,900 if the interest rate is 8% on a 30 year loan. According to the second ratio, you should not spend over 36% of your gross income on housing PLUS all your other long term debt. This would include anything other than utilities that require payments longer than nine months.
So keep in mind that any auto loans or credit card debt or school loans which add up to more than $320 (8% of you monthly gross) will reduce what you can afford to pay for a house. Every dollar above the $320 you have in debt reduces by a dollar the house payment you can afford. If you owe $360 in monthly debt, you can handle payments of $730 (or a mortgage of $99,500).
A very important matter to the lenders is the amount of cash down payment you will have. Lenders love 20% or more down, and will reward you with lower rates and better terms if you can do this. However, lenders will accept as little as 5% down (and in some cases 3%), but they will charge a
higher interest rate, and require you to pay a mortgage insurance premium (P M I) which insures the lender against the higher risk of default on such loans.If you are short of cash for the down payment, lenders usually will allow a cash gift from a relative, as long as it does not have to be paid back. They will view with suspicion any recent large deposit to your account and ask you to explain it.
Recently, several lenders have offered zero down financing for buyers with good credit. Call us for information about these programs.
In addition to the down payment, the lenders will want a cash reserve in your account to cover closing costs and usually a 2 months reserve mortgage payment. You can plan on closing costs to be about 3% of the cost of the house. These costs include points (usually a fee paid to the lender to lower the interest rate), appraisal, survey, title search and insurance, homeowners insurance, property taxes, inspection reports and attorney’s fees.
HOW TO IMPROVE YOUR CHANCES
INCOME: either boost your income by part time work or trim your debt by refinancing or selling some of the liabilities and pay off debt. Usually six months of part-time employment is required to show stability. Typically two years of tax returns are required if you are in your own business.
DOWN PAYMENT: This is usually the chief obstacle for most first-time buyers. Areas to consider for this all-important resource are - gifts. A gift letter is required stating that no repayment is expected, and you must report the gift as income on your tax return. Your employer may have a 401k plan or a profit sharing plan, but there may be a penalty for early withdrawal, so be sure to check. Your life insurance policy may have cash value that you can either borrow against or cancel the policy and receive its value. See what you own that you can sell – maybe a sports vehicle or recreational vehicle or an expensive musical instrument. Maybe you can raise a lot of cash with a yard sale. See if you can arrange an advance on a bonus, or see if the lender will count a perk such as a company car as income. Maybe you can trade or barter your services to the lender, seller or the real estate agent as part of their compensation. Finally, negotiate. Ask for discounts from the lender, attorney, appraiser, surveyor or anyone else involved in the transaction. A discount is the same as cash. See if you can get a buy-down on your interest rate, or try an adjustable rate mortgage to lower your costs. Check with your mortgage banker to see if there are any other alternatives to help you lower your costs.
It is easy to see that your dollar does not buy as much as it did 5 or 10 years ago. This does not mean that purchasing your own home is out of reach. Take time to look at all your options. Analyze all your resources. Check every available loan option. You may be surprised to discover that you can afford more than you think.
Allan Hofland is a Realtor ® in Wheaton, Illinois. He and his wife Joyce opened their own independent office in Wheaton in 1979. They deal primarily in assisting buyers and sellers of residential real estate, as well as the management of rental homes in the central DuPage area. In addition they have restored many older classic homes in the Wheaton area.