Calculate How Much Home You Can Afford
A great place to start is understanding what you can afford. Keep in mind that there is often a difference between the loan amount you qualify for and how much debt you can comfortably take on. In other words, just because you can, doesn’t mean you should.
For qualification purposes, most lenders require that total housing costs not exceed 33% of gross monthly income, and total debt payments per month (including the mortgage) not surpass 36%. Some lenders may allow for a higher ratio but you want to be conservative when planning. Therefore, if you owe nothing and earn $40,000, according to a lender, $1,100 in monthly housing costs is within your range. If you make $80,000, you may be able to qualify for $2,200.
The down payment you make and type of financing you receive are key factors to consider when figuring out the price of home you can purchase. The calculator Mortgage Qualifier illustrates the difference these variables make in monthly housing costs.
Planning for Up-Front Costs
There are many costs associated with purchasing a home. Learn more about each of the costs.
Down Payment
While a 20% down payment was the norm in the past it is now possible to buy a home with much less of a down payment. Some ways to avoid putting 20% down are obtaining a second mortgage, taking advantage of a government program, or purchasing private mortgage insurance (PMI).
Keep in mind, however, that a substantial down payment works to your advantage—the more you have, the better the financing deal, the less you have to borrow, and the lower your monthly payments.
Earnest Money
Earnest money is a cash deposit of about 2% of the price of the home. It proves to the seller that you are serious about wanting to buy. When you submit your offer, the money is deposited into an escrow account.
If your offer is accepted, it will be applied toward the down payment. If it is rejected, the money will be returned to you, provided that is stipulated in the contract.
Home Inspection
Having a home inspection done by a qualified professional is your way of guarding against unseen and expensive problems popping up once you move into the home. Count on a comprehensive inspection costing several hundred dollars.
Closing Costs
Closing costs include all fees required to execute the sales transaction, such as attorney fees, title insurance, appraisals, points, and tax escrows. Typically paid up front, the average cost of these fees is 3-5% of the purchase price.
Post-Purchase Reserve Funds
You may need to prove to the lender that you have enough money to protect against potential cash flow problems. Most lenders like to see at least two months’ worth of housing payments in reserve, either in savings or assets.
The Extras
Extras are everything from moving costs to new furniture. If you plan to buy a fixer-upper or a home that doesn’t come with major appliances, add these to your budget.
When purchasing a new home, many home owners can run into what is called the "old sofa syndrome," where your old furniture no longer seems appropriate for your new home. Plan for this in advance and ask yourself if holding off one to two years on making major new purchases will put you in a better financial position as a new homeowner.
Begin Saving
As you can see, purchasing a home will require you to build up substantial savings, in many cases. Because most people do not have immediate access to the large sums of cash required to buy a home, a savings plan will be necessary. After you have calculated the amount of money you need, decide when you would like to buy. Then divide the desired sum by the number of months you have to save.
Example: If your objective is to save $15,000 and you want to purchase a home in three years, then you’ll need to set aside about $416 every month ($15,000/36). If the goal you have set for yourself is not feasible, consider expanding your time frame, saving for a less expensive home, or making changes to your income and expenses.
To make saving as easy as possible, have the determined sum automatically deducted from your paycheck or checking account and deposited into a separate savings account. Evaluate all of your assets, including IRAs, employer-sponsored retirement accounts, stocks/bonds, and valuables as potential resources to supplement your savings plan.
