Deciding to Buy a Home:
Finding the Right Home
How Much House You Can Afford
The foundation for buying a home is good money management skills. You need to review your financial readiness to buy a home and to find out how much you can afford to borrow while still meeting other household expenses.
Financial Readiness
If you have completed the Managing Money module of this program you probably have completed many of the work sheets necessary to determine if you are financially ready to be a homeowner. If you have not already done so, complete:
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These work sheets will help you answer the nine questions below about your readiness to buy a home.
- Do I have a steady source of income?
- Have I been employed on a regular basis for two to three years? If you own your own business, do you have your income tax records to confirm your income?
- Is my income reliable? If you receive child support, alimony, an annuity or other forms of income, do you have a 12-month history of receipt in order to document reliability?
- Do I have a credit history? This refers to whether you have ever borrowed money for any purpose. If you haven't checked your credit report(s) recently, now is a good time to do this.
- Do I have a good record of paying bills? Paying utility bills, rent and other bills on time establishes an alternative credit record if you haven't previously borrowed money.
- Am I able to pay my bills and other debts on time and have money left at the end of the month to save?
- Am I able to make the mortgage payment every month plus handle additional costs for taxes, insurance, maintenance and repairs?
- Do I have money saved for closing costs? The closing costs are the fees involved during the home-buying process. These may include but are not limited to appraisals, title work and inspection fees.
- Do I have money saved for a down payment? The down payment is the portion of a home's purchase price the buyer pays in cash. The more you have for a down payment, the less you will need to borrow.
Lenders prefer that you have 20 percent of the purchase price for a down payment. For example, 20 percent of a $50,000 mortgage is $10,000. However, there are many special loan programs that require a smaller or no down payment, including those for first-time homebuyers. Many people start the home-buying process with one of these programs or with one offered by local community organizations. Government loan programs are generally targeted to individuals and families with a modest income. Even if you qualify for a smaller or no down payment, you will need money saved for unexpected expenses.
If you make a down payment of less than 20 percent, you will generally have to purchase Private Mortgage Insurance (PMI) or participate in a government mortgage program. Mortgage insurance only protects the lender (not the buyer) if you default on the loan. It is an additional cost to the mortgage.
If you answered yes to the above questions, you may be ready to buy a home. If you answered no to any of the questions, concentrate on strengthening those Managing Money module or look for homebuyer education classes in your area. These classes are a good source of information and will help you prepare for homeownership.
How Much You Can Borrow: Do It Yourself
You can figure out for yourself about how much mortgage you can afford. This estimate will give you an approximate price range for a home.
Step 1: To get a general idea of the maximum monthly payment you can afford use this rule of thumb: your monthly mortgage payment (PITI - that is principal, interest, taxes and insurance) should total no more than about 28% of your monthly gross income. Remember, your monthly gross income is the income you receive before taxes and other paycheck deductions are made.
| Maximum Mortgage | ||||
| Gross Monthly Income: | $3,800.00 | |||
| X .28 | ||||
| Maximum Mortgage Amount | $1,064.00 | |||
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| mortgage affordability calculators |
If you are comfortable using a computer, you can find mortgage affordability calculators on the Internet such as the one at the Ginnie Mae website. (Ginnie Mae is the name used for Government National Mortgage Association.) The calculator allows you to enter your financial information and try various loan options such as interest rates. Mortgage interest rates affect how much you can afford. The lower the interest rate, the larger mortgage you can afford. These simple calculators allow you to see how current interest rates affect a mortgage payment.
Step 2: The amount of debt you have affects your ability to buy a home. Lenders do not want borrowers to have more than about 36% of their gross monthly income going to repay debt. This includes mortgage payments and all other debt payments such as credit cards and personal loans.
| Total Debt | ||||
| Gross Monthly Income: | $3,800.00 | |||
| X .36 | ||||
| Maximum Total Debt | $1,368.00 | |||
Step 3: If your monthly income is $3,800, you could afford $1,368.00 in total monthly debt including the $1,064.00 mortgage payment. This means all other debt payments, including credit card, auto and personal loan payments, can not be more than $304.00 per month.
| Maximum Debt (36%) | ||||
| Maximum Mortgage Amount | $1,064.00 | |||
| Minimum Credit Card Payment | 204.00 | |||
| Personal Loan Payment | 100.00 | |||
| Maximum Debt (36%) | $1,368.00 | |||
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| How Much Do You Owe |
If you are not sure about your other credit obligations, use the How Much Do You Owe Work Sheet to calculate monthly debt information.
How Much You Can Borrow: Pre-Qualification
When you are financially ready, you may want to get a more exact idea of how much you can borrow by consulting one or more mortgage lenders. One way to do this is to pre-qualify. It does not require a commitment on your part to borrow from the lender or for the lender to make the loan to you.
Pre-qualification is an informal way a financial institution can tell you the amount you can borrow to finance or refinance a house. It is important to know that the financial institution is making a tentative decision based on information that has not yet been verified. This is only an estimate and subject to change. You can pre-qualify by giving the lender some basic information over the phone or the Internet including:
- Employment
- Income
- Down payment information, and
- Outstanding debts
How Much You Can Borrow: Pre-Approval
The next step is pre-approval, which requires you to spend money for various applications and fees. Pre-approval is a commitment from a lender to lend you money and is used when you have not yet found the house you want to buy.
To obtain a pre-approval, you will need to assemble financial records and fill out an application. If you have completed the Managing Money module, you may have most of this information organized. It will be easy to pull it together and complete the loan application. The lender will tell you what to bring or send but you will usually need:
- Pay stubs for the last two-three months
- W-2 forms for the last two years
- Tax returns for the last two years
- Information about your assets and long-term debts
- Recent bank statements
- Proof of any additional income
The lender will not commit to a loan until the information you submit is verified and may require additional information or details. This same process is used if you have already found a house and want to apply for a mortgage. It is covered in detail in the Home-Buying Process module.
The pre-approval process tells you the maximum amount you can borrow and tells sellers you are approved to buy a house. Pre-approval is contingent on meeting the requirements of the title, appraisal and inspections determined by the lender at the time of pre-approval.
The amount you actually borrow will be repaid to the lender in a monthly mortgage payment. This is just one of the costs involved in homeownership.
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