Buying a home is one of the most significant purchases you will make in your life. It not only provides a secure roof over you and your family’s head, but if done right, it can be an excellent investment.
Before you leap homeownership, you will need to know how much house you can afford. There are several variables to the costs of purchasing a home. It is essential to educate yourself on mortgages, down payments, and other expenses before you begin the process.
To start, it’s helpful to evaluate your finances, and we’ll talk about that now. Then we’ll cover the down payment, shopping for a great interest rate, and the extra costs that come with a home purchase and loan.
Track Your Monthly Income and Expenses
Either use a budgeting app or create a spreadsheet tracking how much you (and your co-buyer, if applicable) earn every month. Be sure to include all means of supplemental income, including earnings from investments, inheritance, rentals, retirement, social security, and funds generated from court settlements, such as alimony and child support.
Then you should document monthly expenses like car and credit card payments, tuition/student loans, transportation costs, estimated grocery bills, medical fees, and any other expenses incurred in an average month.
When you sit down to track your expenses, it helps to review bank statements from the past six to 12 months. Then you can average those expenses.
Determine How Big of a Payment You Can Afford
It is important to look at the larger picture. Where do you plan on being in the next 30 years? Do you plan to get a new job, start a new business, start a family, or retire early? How long do you plan to live in the home? Are you prepared for a long-term investment? Keep your expectations realistic. You want to make sure you’re not biting off more than you can chew. Be sure you’re able to put some funds aside for a rainy day.
Try to Follow the 28/36% Rule
Most financial planners advise potential home buyers not to spend more than 28 percent of their monthly income on housing expenses, or at the most, 36 percent of total debts. This debt to income ratio rule helps safely determine how much debt you can afford to pay each month.
Start Shopping for a Mortgage
Once you know how much you can spend each month, it’s time to start looking for a mortgage lender. Here are some essential things to think about before you get started.
Check Your Credit
Your credit score will determine a lot. Before applying for a loan, check with one of the three major credit agencies (Experian, Equifax, and TransUnion). If your score is low, or there are any blemishes, create a plan to raise your score or dispute any erroneous recordings.
Shop Around for Good Rates
Research mortgage interest rates with several lenders. Get a snapshot of average rates and loan terms so you know where you can get the best mortgage loan.
Understand Your Debt to Income Ratio (DTI)
Lenders pay close attention to how well you manage your money. They examine your monthly income compared to your monthly debt to determine if you are a risk.
The higher your DTI, the more challenging it will be to get a mortgage, especially at a decent interest rate. Lenders tend to be turned off by a DTI ratio higher than 43%.
Note: Only debt (money owed) is considered part of your DTI. Monthly expenses, such as food expenses, utilities, and transportation costs, are exempt.
Think About Your Down Payment
The larger your down payment, the smaller the mortgage loan. The smaller the loan, the lower your monthly payment. The larger your down payment, the more secure your lender will feel loaning you the money. But as a general rule, lenders ideally prefer 20% down for mortgages.
For some home buyers, 20% is an intimidating amount. The good news is, it’s not necessarily a deal-breaker. Many lenders are willing to work with you to make your dream a reality. Credit Unions are always a great place to start looking, primarily since they aren’t focused on making a profit.
As an example of a 20% down payment, let’s look at a home priced at $300,000. Twenty-percent of $300,000 is $60,000. It could take several years of tight budgeting for a lot of people to save up for that. So you need to be prepared.
There are some programs, which require as little as 3.5 % down. It is even possible to pay private mortgage insurance (PMI) if you cannot put 20% down. In many cases, as you build up enough equity, the extra charge can be dropped by lenders.
There are also several first-time homebuyer loans and government-subsidized loans, which offer little to no down payments. Loan officers can be a great help in researching the best option for home buyers.
Consider the Additional Expenses
Before you agree to buy a home, you need to know about the other costs that come along with a home loan and purchase.
Inspections
Lenders require home buyers have the house inspected before taking the risk. The excellent news is inspections aren’t costly. It is crucial to hire a licensed and certified inspector who is very thorough. If you’re working with a real estate agent, they can recommend a professional for you.
Inspections typically cost anywhere from $200-600. Homebuyers are expected to pay this upfront.
Appraisal Fee
Your lender will hire an independent agent to assess the value of the property. Lenders want to be assured the property isn’t valued at less than the loan amount. Some lenders incorporate the cost of appraisal into their fees, and some require the home buyer to pay it upfront.
Appraisals typically cost between $250-600.
Escrow
You will be required to make an initial deposit into your escrow account. Homeowners pay a little each month to pay taxes and insurance. The amount can vary based on where you live.
Closing Costs
Closing costs are one of the biggest surprises for new home buyers. Closing costs are typically 2-5% of the home purchase price.
Closing costs include several fees related to the home’s final sale, such as loan origination fees, attorney fees, and title search. Many lenders require closing costs paid upfront at the time of closing, but some allow borrowers to include the amount in the loan.
Calculate Your Mortgage Amount
We know we’ve given you a lot to think about. Now we want to provide you with something else. We have a helpful Mortgage Calculator that lets you calculate different loan amounts, interest rates, and loan terms to help you find the perfect loan to meet your needs.
Check out our Mortgage Calculator and let us know if you have any questions. We’re always here to help.
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