Home affordability means more than just whether you can make the monthly mortgage payments. There are many factors that you need to think about, and some of those things can change in time. Part of it is strategy, and part of it is simply making the best plans with the information you've got.
If you spend a little time organizing your financial picture before you look at properties, you'll have a lot more ammunition to strike the best deal possible. It also helps if you go into the process a bit more grounded. It's easy to start dreaming about the perfect home. Knowing what you can afford lets you get realistic about the right home.
Here are a few things you need to know budget for a new home you can afford without feeling a pinch.
Your Debt-to-Income Ratio Helps Determine Financing Options
Even though you believe you can afford a certain mortgage payment, lenders have their own way of determining home affordability on your part and risk on theirs. CNN Money explains that most lenders consider a 36 percent debt-to-income ratio the high end. Yours should fall under that mark.
Your debt-to-income ratio is a straightforward look at how much debt you have, and what your fixed monthly expenses are for this debt versus how much money you earn. The less debt you have, the more home you can afford and the safer risk you are to lenders.
There's more to determining affordability from the standpoint of the lender. Once the debt / income ratio is assessed, they'll also consider your housing debt to income. That should be no more than 28 percent. A mortgage payment that's higher than 28 percent of your income can be considered an unnecessary burden.
Different Mortgage Terms Can Help Make a Home More Affordable
Many home mortgages are set for 30 years at a fixed interest rate. But that's not the only game in town. Creative financing can help you buy a home that you couldn't afford with a 30-year, fixed rate loan. Also, shorter terms can help you buy a home and pay off the debt faster. But that might mean buying a home that's less expensive than one you've got your eye on. (Read: First Time Home Buyer Tips)
There are numerous ways to arrange mortgage terms. Some buyers prefer the security of a fixed rate. Others like the idea of a variable rate where there's a chance to pay lower interest when the prime lending rate drops. If you're considering an adjustable rate mortgage (ARM), make sure you understand how quickly your mortgage payments can rise.
The risks and rewards of any mortgage loan should be part of your overall plan to buy a house. Even a fixed rate has its risks. Home affordability changes as interest rates rise and fall. If you buy now and secure a loan at 5 percent interest, the rates could drop much lower in the years to come (see how mortgage rates have varied since 1971). But then again, you might have the option of refinancing if that happens.
Pre-Determine How Much Home You Can Afford
Before you set out in your search for the perfect home, you can take steps to get a better idea of what you can afford. By understanding home affordability, you can save yourself a lot of grief and a lot of time. (Read: Home Mortgage Savings Tips)
It all begins as if you're designing a new budget. Tally up your debts and income first, to know what you're starting with. You'll want a copy of your credit report, too. That will give you an idea about whether you can expect a good interest rate, or if you'll need to settle for one that's not ideal.
Remember that your current housing costs will be replaced by those from a mortgage loan. And don't forget to account for other expenses, such as homeowner association fees, taxes and insurance, which increase the cost of home ownership.
Saving a Down Payment Boosts Home Affordability on Pricier Properties
Your down payment reduces the total amount you'll finance. The more you put down, the lower your monthly payments will be. A good rule of thumb is to make a down payment of at least 20 percent. That's a lot of money, but it saves you money in the short and long term.
In the short term, you won't need to pay for private mortgage insurance (PMI). This is insurance that protects the lender against default on your part. Bank of America says most buyers who pay less than 20 percent down will also pay PMI insurance until the balance of the loan has been paid down to approximately 78 percent of the home's total value.
When it's time to think about buying a home, remember that what you can afford isn't necessarily what you ought to buy. Many home owners use outdated advice that says you should buy poor. This means spending the maximum the bank will lend, in the belief that everything will work out ok in time.
If the housing market has taught us anything since the mid-2000s, it's that nothing is a guarantee. The house you can afford is one that doesn't cause undue financial strain. Life is more than the building you live in. Choosing one that's more affordable gives you a better chance of security in the long run.
Are you thinking about buying a house, or have you recently bought one? Which factors were most important for you with regard to home affordability?