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How Much House Can You Afford?
After you've decided you want to buy a house,
figure out how much house you can afford. To do that, you must
understand how the purchase of a house is financed and how your
personal financial situation looks through the eyes of a lender.
What Size Down Payment? First, figure out
your net worth. This will help you determine how much cash you
have available for a down payment and how much you'll have left
over to meet expenses once you've moved.
Convert assets. There are two types of assets,
and you can use either as a source of cash to raise a down payment
Liquid assets are cash, money in checking and savings accounts,
and investments, such as stocks and bonds, that can easily be
converted into cash. Non liquid assets are items that typically
take weeks or even months to sell. These include cars, furniture,
collectibles, and any house or other real estate you already own.
Be realistic. Once you've evaluated your
net worth, subtract from the total any money you must set aside
to meet upcoming large bills such as college tuition, plus an
adequate reserve. Then subtract the cash you'll need to pay for
closing costs, moving expenses, home repairs, and any household
items you must buy as soon as you move. What you have left is
the amount available for your down payment. The bigger down payment
you make, the smaller loan you'll need and the less you'll have
to pay in monthly installments.
Keep payments comfortable. Exactly how much
you put down and how much you pay each month will, in large part,
be determined by the lender who finances your purchase. To determine
what's comfortable, calculate your monthly take-home pay, then
deduct all your current monthly housing expenses rent or mortgage
payments, utility charges, homeowner's or renter's insurance,
and so on. Next, deduct your other living expenses--food, clothing,
childcare fees, auto payments and insurance, health and life insurance,
minimum payments on credit cards, entertainment, and any other
regular bills, as well as any savings deposits you make. Add what's
left to your current monthly housing expenses and you have a pretty
good idea of how much you can afford to pay for housing expenses
without straining to get by.
If you can make a large enough down payment
to keep your monthly payments within 5 -10% of this financial
comfort zone, terrific. But if you're like most buyers, you'll
have to strike a few compromises. Why? Because lenders have to
be sure you don't take on more debt than you can handle. To do
that, they look at a variety of factors to determine the maximum
monthly payment you can afford.
Your Loan Alternatives. Most lenders that
make conventional loans (loans not insured or guaranteed by the
government) require borrowers to make a minimum down payment of
20 percent. But don't despair if you don't have that kind of cash.
There are a number of ways you can still purchase a house. Perhaps
the most popular source of help for first-time buyers is a gift
or loan from parents. Many others sell some of their assets or
borrow against them to raise money.
FHA and VA loans. Find out whether you're
eligible for a loan insured by the Federal Housing Administration
(FHA) or guaranteed by the Veterans Administration (VA). Your
Realtorref can tell you whether you qualify for either.
Privately insured loans. If you don't qualify
for either an FHA or a VA loan, you can probably line up financing
with only 5 or 10 percent down if you purchase private mortgage
insurance (PMI). This insurance works much like the FHA program,
but the insurance is purchased from a private company.
Estimating Closing Costs. Not all your upfront
money will be applied toward the down payment. More than likely,
thousands of dollars will be used to pay closing costs, a major
expense many first-time buyers overlook.
Points. The biggest single part of your
closing costs will likely be the discount points charged by the
lender. Points compensate the lender for a variety of costs. One
point equals I percent of the total loan amount. So, if you're
getting an $80,000 loan and the lender charges three points, you'll
have to pay an extra $2,400 (0.3 multiplied by 80,000) in points
at closing. One of the first things you should ask each lender
is, "How many points will I have to pay?" If you're
strapped for cash, you can probably find a loan that requires
no points. In return, however, you'll pay a slightly higher interest
rate over the life of the loan.
Other costs. The borrower almost always
pays his own points. Exactly who must pay the other closing costs--
the buyer or the seller--is largely determined by local custom.
You can try to get the seller to pay for items that buyers in
your area usually pay for, but make sure your offer to purchase
states clearly who will pay for what. If the proposed changes
aren't in writing, the seller can assume you'll follow local custom.
Qualifying for the Loan. The size of your
down payment plays an important role in determining how large
a loan you can get. The interest rate on the mortgage and your
income are two other important factors.
Interest rates. Interest rates determine
the size of your monthly payment. They're influenced by a variety
of factors including the size of your down payment and the length
of the loan term. If you make a 10 percent down payment, you can
expect to pay an interest rate 0.25 to 0.50 percent higher than
the rate you would pay if you put down 20 percent. And rates on
15-year loans are usually a bit lower than on the more popular
30-year terms because shorter terms put the lender at less risk.
Income-loan ratios. Your income will determine
the highest monthly payment you can handle and the biggest loan
you can get. Lenders use different ratios to determine how much
you can afford to pay each month. If you're making a 20 percent
down payment, most lenders figure you can devote up to 28 percent
of your gross, pretax monthly income to housing expenses. Your
housing expenses and all other installment debt obligations, however,
won't be allowed to exceed 36 percent of gross income. If you're
making a 10 percent down payment, most lenders won't allow you
to put more than 25 percent of your gross income toward housing
expenses. And your total monthly debt payments won't be allowed
to exceed 33 percent.
Your Housing Budget. Plan ahead for repairs.
Figure on spending an average of $50-$l00 a month on maintenance
or repairs. Start saving now and you'll be able to pay repair
bills later.
Cut everyday expenses. After you've settled
in, look for ways to save money around the house. You can save
more than $20 a month just by using common sense. Turn off the
light when you leave a room, sprinkle the lawn in cooler parts
of the day when water doesn't evaporate as fast, be frugal with
your heater or air conditioner, and make long-distance phone calls
in off-peak hours or on weekends. Reduce your heating or air-conditioning
bills by changing air filters every 3-6 months and by weather-stripping
your doors and windows, and put flow constrictors in your faucets
and shower heads. Consider more costly improvements, such as a
new water heater or better insulation, if you plan to stay in
the home for at least three or four years.
Save on insurance. Since all lenders require
insurance on homes they finance, many first-time buyers automatically
purchase a policy that reflects the price they actually paid for
their home. But many lenders require only structural insurance.
The land itself doesn't have to be insured because dirt is indestructible.
Depending on where you live, dropping the value of the land from
your homeowner's policy can save you more than $200 a year. Ask
your insurance agent about possible discounts. People who overhaul
an older home's electrical, heating, cooling, or plumbing system
are often eligible for premium reductions. Smoke alarms and dead
bolts can qualify you for discounts ranging from 2-5%. Burglar
alarms and fire sprinkler systems can cut your insurance bill
by more than 10 percent.
Remember other cost savers. To reduce your
property tax bill, ask your Realtor® or local tax assessor
whether your county or state allows you to take a homeowner's
exemption. Such an exemption has no effect on the value of your
house but excludes part of its value from annual taxation. And
if you purchased private mortgage insurance to obtain your home
loan, get a Realtor's® help in determining the value of your
house every year or two. When you've reached a 20 percent equity
share in your property, the lender should let you cancel your
PMI coverage.
A Good Time to Buy. On the basis of the
near-term outlook, the months ahead look like a good time to buy.
Once you have an idea of how much home you can afford, you'll
be able to narrow your search to homes that are both cozy to live
in and comfortable for your wallet.
Information from the National Association of Realtors
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