Do The Math, The House You Can Afford May Not Be The One You Should Buy
Most of the home buyers head blindly towards the housing market with the hope that they will get the home of their dreams within a certain price range. While others may hit the jackpot, some will be forced to plan again for their finances to meet market home prices. There are lots of home affordability tools online which can help one calculate the type of house he/she can afford.
“Don’t follow the crowd, let the crowd follow you.” ~ Margaret Thatcher
These tools include various factors in their math and some of the factors are discussed below.
How Much Mortgage Can You Afford?
The kind of home you can afford is dictated by the amount of mortgage you can access. Depending on your debt-to-income ratio, your credit history etc. The monthly payment of mortgages should not be more than 25% of your income and the down payment should be ready when applying for a mortgage. The amount of mortgage one is eligible to depends mainly on the amount of income and monthly debt obligations. Savings is factored in when calculating the maximum amount of down payment one can raise. The type of mortgage also dictates the type of house you’re going to purchase if you have limited savings. While FHA loans may just require lower down payments as low as 3.5% of the home value, other loan types require up to 20 percent of the home value as down payment.
Debt Payments Vs Gross Income
Buying a new home should give you a peace of mind but if purchasing a house throws you into financial insecurity then buying a home may not be right for you. To know the type of house you can affords, ensure that the total debt payments should not exceed 36% of your pre-tax income (gross income). It’s hard for one to get a loan when the debt-to-income ratio is high meaning that most lenders are reluctant to offer loans to people who have a low margin of error. Lenders tend to charge higher interest rates on those people who break the 36% rule. So, if you go for a house that consumes about 45% of your income you may end up in a tough financial situation if you don’t cushion yourself.
The House You Can Afford and the One You Should Buy
The larger the down payment the better but lenders would always want borrowers to reserve some savings for other unforeseen financial obligations. Emptying your savings account isn’t recommended. What is important to know is that, after qualifying for a loan, you’ll live to make mortgage payments each month for about 10 years and live on the remainder of the income. Yes, you might afford a $1.5 million home because you have saved enough and your credit history is good but monthly mortgage payments may push you to a financial crisis.