Imagine you have just completed a search that included hundreds of hours of looking at the exteriors and interiors of houses. You have sized up siding, reviewed roofing and perused the petunias. And finally, you have found the house of your dreams. Now imagine that this house of your dreams costs much more than you can afford.
If you are house hunting and have not done an important piece of homework, you could be in for this kind of heartbreak. The first thing you need to know when shopping for a home is how much you can spend.
A general rule is that you can purchase a house valued at twice your annual income, but this does not take into account your debts, a large down payment, or other factors which can add to or detract from the amount you can afford.
The purpose of this page is to help give you a more specific idea of what priced house you can afford. It will address what you are worth and what you owe on a regular basis (your assets and liabilities) and what costs you would most likely encounter once you bought your new house. In general, you will be examining the same things a lender looks at when deciding how large a mortgage you can afford (we have a calculator for this!).
Completing the worksheet inside this brochure should save time while shopping for a home because it will narrow your choices based on costs. When you finally do talk with lenders, you will have some answers for many of their questions, speeding up your loan's processing.
It should be noted, however, that today many lenders will qualify you in advance for a mortgage, even before you begin to shop for a home. Many lenders advertise this service in the local newspaper, but contact any lender to see if this is possible.
In the event that you do not have a 20 percent down payment, lenders will allow a smaller down payment - as low as 5 percent in some cases. With the smaller down payment loans, however, borrowers are required to carry Private Mortgage Insurance. Private mortgage will require an initial premium payment of 0.5 percent to 1.0 percent of your mortgage amount plus an additional monthly fee depending on your loan's structure. On a $75,000 mortgage with a 10 percent down payment, this would mean a premium of $338 to $675 for the first year and an extra $15 to $20 a month in subsequent years.
The first thing you have to examine when deciding how much you can spend on your new home is how much you are worth, taking into account your income, savings, investments and other holdings such as Individual Retirement Accounts (IRAs) or Keogh plans, the cash value of your life insurance, pensions or corporate savings plans, and equity in real estate. Lenders will need this information before deciding to extend you the loan.
Often, the amount you earn may not be as important as how you earn it. Bonuses and commissions can vary greatly from year to year, and lenders are reluctant to depend on them if they make up a large part of your income. There are similar problems when a large portion of your salary is based on overtime pay, and you rely on it to qualify for the loan. To get a realistic view of what your income level actually is, average your income (including bonuses, commissions and overtime) for the past two or three years.
As a last resort, pensions and corporate thrift plans can provide another source of down payment money. Most plans or policies give you the option of either withdrawing your money with no repayment or borrowing against the cash value. Though it is not the best policy for most homebuyers to borrow from these sources in addition to borrowing mortgage money, they can often get rates substantially lower than those on many other kinds of loans. Remember - if you borrow against the cash value of your life insurance or employee thrift plan, you will be making principal and interest payments for these separate from your mortgage. You should estimate these payments under installment loans on the worksheet inside.
While turning your savings, investments and other holdings into cash (making them "liquid"), remember that you will probably have to pay tax on most of it. One source of tax-free money often overlooked is a gift, or money given by a parent or other relative that need not be repaid. A person may give another person up to $10,000 per year without either party being taxed. Your parents, for example, could give you and your spouse up to $40,000 tax free.
Your liabilities are those expenses for which you are responsible each month. These include outstanding loans, such as student, auto, personal and so on, as well as credit card balances. When calculating your liabilities, use the entire balance for your credit cards, as if you had to pay them off entirely this month. That way, you give yourself some breathing room should you run up an unusually high balance during your mortgage term.
You should estimate these payments under liabilities on the worksheet.
It is always wise to put a little money away "for a rainy day" - especially when you are paying off a mortgage. If something arises such as unexpected medical costs or substantial auto repairs, you would want to be able to pay those expenses without jeopardizing your ability to meet your mortgage payments. Most financial experts suggest that you always have six months income on hand in case of emergency.
When calculating your annual income, remember to take into account all sources. You may, for example, get dividends from investments, alimony or child support payments. Calculate your annual income on the following page.
This list should get you started, but you may have special expenses that are not listed here. Remember that when you buy your house you will no longer have to pay rent, and your utilities costs will change. You can use this money for your mortgage payments or other operating costs associated with your new home.
Of the costs of homeownership, the ones listed on the next page are the most important. Homeowners insurance premiums usually run about $300 to $500 per year, and property taxes and maintenance costs will vary, of course, depending on the size, age and condition of your new house. Estimates for the costs of utilities, maintenance and improvements can be obtained from Realtors, local utility companies and others.
Some homebuyers will also have an additional cost of homeownership if they are buying into a condominium or a co-op. Condo and co-op fees are additional amount usually paid monthly on top of the mortgage payments. Some homeowners will also incur a home owners association fee for their block or neighborhood. These fees vary greatly from location to location.