Buying a Home
How Much Can You Afford?
Understanding how much you can afford is one of the
most important rules when home buying. Based on your
individual situation, your budget can affect everything
from the neighborhoods where you look for homes, to
the size of the house, and even what type of financing
you choose.
Bear in mind, however, that lenders will look at
more than just your income to determine the size of
the loan. Likewise, you may find that there are some
creative financing options that can help boost your
purchasing power.
Loan prequalification vs. preapproval:
One of the best ways to determine your budget is to
have your real estate agent or lender prequalify you
for a loan. Prequalification is different from preapproval,
because it is only an estimate of what you'll be able
to afford. On the other hand, preapproval is a more
formal process where a lender examines your finances
and agrees in advance to loan you money up to a specified
amount.
What factors are important to lenders?
Banks and lending institutions will use several criteria
to determine how much money they'll agree to lend.
These include:
- Your gross monthly income
- Your credit history
- The total amount of your outstanding debts
- Your savings (what you have available for a down
payment and closing costs)
- Your choice of mortgage (i.e. 30-year, FHA, etc.)
- Current interest rates
Two important ratios
Lenders also use your financial information to figure
out two very important ratios: the debt-to-income
ratio and the housing expense ratio.
Debt-to-income ratio:
Many lenders use a rule of thumb that the amount of
debt you are paying each month (car payment, student
loans, credit cards, etc,) should not exceed more
than 36% of your gross monthly income. FHA loans are
slightly more lenient.
Housing expense ratio:
It is generally difficult to obtain a loan if the
mortgage payment (principal and interest) will be
more than 28 to 33% of your gross monthly income.
Down payments make a difference:
If you can make a large down payment, lenders may
be more lenient with their qualifying ratios. For
example, a person with a 20% down payment may be qualified
with a 33% housing expense ratio, while someone with
a 5% down payment is held to the stricter 28% ratio.
Other ways to improve your purchasing power:
Gifts:
If you are having trouble saving money, many lenders
will allow you to use gift funds for the down payment
and closing costs. However, most lenders require a
"gift letter" stating the gift doesn't have
to be repaid. They will also require you to pay at
least a portion of the down payment with your own
funds.
Negotiating Closing Costs:
Through negotiation, some sellers may agree to pay
all or most of your closing costs (for example: if
you agree to meet their full asking price). If you
choose to try this, make sure to ask your real estate
agent for advice and check with your lender concerning
limits on closing cost contributions by the seller.
Loan Programs:
Many local governments have special loan programs
designed to help first-time homebuyers. Loans may
be available at reduced interest rates, or with little
or no down payment. Check with your local housing
authority for more information.
Loan Types:
Some homebuyers choose Adjustable Rate Mortgages (ARMs)
because of low initial interest rates. Others opt
for 30-year fixed-rate loans because they have lower
monthly payments than 15-year loans. There are significant
differences between different types of loans, so be
sure to discuss the pros and cons of different loans
with your agent or lender before making a decision. |
