How Much House Can I Afford?
Estimating Home Buying Power
When you are first starting to think about buying a new home, one of the initial questions you will ask yourself is: “How much house can I afford?” To answer that question, it is essential for you to look at all of the pieces of the financial puzzle.
While it can sometimes be difficult to understand how your cost of living can impact the home you buy, it is essential to understand this concept and its implications. Taking these things into consideration now can help to make sure you get a house you love and one that won’t cause you stress later. And, if you need some help, here are some handy tips that will help you evaluate all the things you should- before picking your new home.
Consult Your Credit
Reviewing your credit report is the first place to start because your credit score determines loan approval, interest rates, and the loan amount- which will in turn give you a good idea of what your monthly payment might be. Most lenders use the Fair Issac Corporation (FICO) model in evaluations. That little score is one of the most significant deciding factors in getting your loan approved.
Remember, FICO credit scores range in the area of 300 to 850, with 750 being considered excellent. Higher scores offer the lowest risk to the lender, so banks reserve the best interest rates for those borrowers with the highest credit scores.
As you review your scores keep in mind that every home loan program has its own minimum credit score. For example:
Conventional and VA loans require a 620 score and down payment amounts vary from around 10% to 20% of the home’s purchase price.
FHA or a Federal Housing Administration loan requires a minimum score of 580 and ask for the lowest down payment of around 3.5%.
Since your comfortability in covering monthly costs is a big determining factor in how much home you can afford, and is impacted by the interest rates you have, understanding your score is vital to making a good home purchasing decision.
Factor in Your Lifestyle
Another critical thing to consider is the cost of your lifestyle. It is so easy to fall in love with a home because of the granite counters and high-ceilings and forget to factor in the extra hour commute you would have. Avoid future heartache by listing out everything that is most important to you and your family and then taking each item into account. Taking the time to do this ensures that once you have moved into your new home, your lifestyle is enhanced, not stifled, by something you forgot to consider.
Here are some top items you may want to include on your list:
Schools - If you have children, you might consider a neighborhood solely based on the school system. In that case, a smaller home may be a compromise you are entirely willing to make.
Commute - Drive time is a big deal for many people who do not want to spend their life on the freeway. Decide on exactly how much of a commute you are willing to make. Look for homes that would stay within that commuting radius.
Recreation - If you are an avid golfer, living in a community with an 18-hole golf course is probably on the top of your list. Or if you love the ocean, a home near the coast would be your number one choice.
Home Size - If your heart is set on a large home, but your budget is limited it might be smart to investigate your options. For example, maybe you work for a large company with several locations. Check out the possibility of keeping your current position, but transferring to a more affordable area.
Shopping – Make sure you also factor in how close shopping is when considering your cost of living calculations. For instance, you may want to map out local grocery stores, gas stations, hardware stores, and even restaurants to see how far they are. If you are used to being near everything in the city and then move to the country, you might be doing more driving than expected to get to these everyday conveniences and that could add up over time.
Once you have made your list and gone over everything, you may still need to make trade-offs, but that is why doing this exercise is essential.
Weigh Your Debt-to-Income Ratio Carefully
Besides credit score, your debt-to-income ratio (DTI) is the next thing to consider. Along with your credit score, it is one of the primary ways underwriters determine your home mortgage affordability. To figure your debt-to-income ratio just list out all your monthly housing and debt payment amounts. You do not need to list living expenses like utilities and food. Here is what you want to include:
Housing (if you are considering a mortgage payment of $1800 a month use that amount)
Any monthly alimony or child support you owe
Monthly loan payments including auto and student loans
The minimum payment on credit cards
And any other monthly obligations you have
Next, divide that monthly debt amount by your gross income (before taxes). That number is your debt-to-income ratio.
So, if your debts were $3,000 a month and your income was $8,000 a month your DTI would be 37.5%. A rule of thumb underwriters go by is they want to see the debt-to-income ratio below 43%.
It is a smart idea for you to look at this ratio and decide for yourself how much debt you are comfortable with. Although you may qualify for a bigger loan, you may opt for a more modest home with a smaller loan as there are huge advantages to having some wiggle room in your monthly budget. Remember, buying a home creates your lifestyle, and you want to make sure you are satisfied with your financial choices-not feeling cash-strapped.
We all know that there are a lot of things that you should consider when picking a home, from lifestyle to affordability. At Pulte Homes, we want to help you make the best choices regarding your next home purchase, and hope that understanding more about the cost of living will help you on your journey to homeownership.
Contributed to Your Home blog by Carol Youmans
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