What To Know About Buying A House – If you feel like you’re ready to buy a home, the first question you’ll probably ask yourself is, “How much can I afford?” And answering this question means analyzing several factors.
Before you buy that seemingly great home, learn how to analyze what “affordability” means. You’ll need to consider several factors, from your debt-to-income (DTI) ratio to mortgage rates.
What To Know About Buying A House
The first and most apparent decision point involves money. If you have enough means to buy a house with cash, you can certainly buy it now. Even if you don’t pay cash, most experts would agree that you can afford the purchase if you can qualify for a mortgage on a new home. But how much mortgage can you afford?
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The 43% debt-to-income (DTI) ratio standard is generally used by the Federal Housing Administration (FHA) as a guideline for approving mortgages. This ratio determines whether the borrower can make payments each month. Some lenders may be more lenient or strict depending on the real estate market and general economic conditions.
A DTI of 43% means that all of your regular debt payments plus your housing-related expenses – mortgage, mortgage insurance, homeowners association dues, property tax, homeowners insurance, etc. – must not exceed 43% of your gross monthly income.
For example, if your monthly gross income is $4,000, you multiply that number by 0.43 to get $1,720, which is the total you should spend on debt payments. Now, let’s say you already have these monthly obligations: minimum credit card payments of $120, car loan payment of $240, and student loan payments of $120 – a total of $480. This means that, theoretically, you can pay up to $1,240 per month in additional debt for a mortgage and still be within the maximum DTI. Of course, less debt is always better.
Discrimination in mortgage lending is illegal. If you believe you have been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One of these steps is to file a report with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
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You also need to consider your starting debt-to-income ratio, which calculates your income relative to the monthly debt you would incur just from housing expenses, such as mortgage payments and mortgage insurance.
Typically, lenders prefer this ratio to be no more than 28%. For example, if your income is $4,000 per month, you will have trouble getting approved for $1,720 in monthly housing expenses, even if you have no other obligations. For a starting DTI of 28%, your housing costs should be less than $1,120.
Why wouldn’t you be able to use your entire debt-to-income ratio if you had no other debts? Because lenders don’t like you living on the edge. Financial misfortunes happen – you lose your job, your car is totaled, a medical disability prevents you from working for a while. If your mortgage is 43% of your income, you won’t have any wiggle room when you want or have to incur additional expenses.
Most mortgages are long-term commitments. Remember, you will be able to make these payments every month for the next 30 years. Consequently, you must evaluate the reliability of your main source of income. You should also consider your prospects for the future and the likelihood that your expenses will increase over time.
Things You Need To Know When Buying A House
Being approved for a mortgage up to a certain amount doesn’t mean you can actually afford the payments, so be honest about the level of financial risk you’re comfortable living with.
It’s best to reduce 20% of your home’s price to avoid paying private mortgage insurance (PMI). Typically added to mortgage payments, PMI can add $30 to $70 to your monthly mortgage payment for every $100,000 borrowed.
There may be a few reasons why you might not want to put 20% down on your purchase. Maybe you’re not planning to live in the house for a long time, you have long-term plans to convert the house into an investment property, or you don’t want to risk investing that much money. If that’s the case, buying a home is still possible without a 20% down payment. You can buy a home with just 3.5% down with an FHA loan, for example, but there are bonuses in getting more. In addition to avoiding the aforementioned PMI, a larger down payment also means:
Being able to afford a new home today is not as important as your ability to afford it in the long term.
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While there are many benefits to a larger down payment, don’t completely sacrifice your emergency savings account to invest more in your home. You could end up in trouble when unexpected repairs or other needs arise.
Assuming you have your financial situation under control, your next consideration is the economics of the housing market – whether in your current location or the one you plan to move to. A house is an expensive investment. Having money to make the purchase is excellent, but it doesn’t answer whether the purchase makes sense or not from a financial point of view.
One way to do this is to answer the question: is it cheaper to rent than buy? If buying is cheaper than renting, that’s a strong argument in favor of buying.
Likewise, it’s worth thinking about the long-term implications of buying a home. For generations, buying a house was almost a guaranteed way to make money. Your grandparents could have bought a house 50 years ago for $20,000 and sold it for five or ten times that amount 30 years later. While real estate has traditionally been considered a safe long-term investment, recessions and other disasters can test that theory — and make potential homeowners think twice.
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During the Great Recession, many homeowners lost money when the housing market crashed in 2007 and ended up owning homes that were worth much less than the price they were purchased for many years later. If you are purchasing the property with the belief that its value will increase over time, be sure to factor into your calculations the cost of mortgage interest payments, property updates, and ongoing or routine maintenance.
In the same vein, there are years when property prices are depressed and years when they are abnormally high. If prices are so low that it’s obvious you’re getting a good deal, you can take that as a sign that it might be a good time to make your purchase. In a buyer’s market, depressed prices increase the chances that time will work in your favor and cause your home to appreciate in value in the future. For example, if history repeats itself, we could see a drop in home prices due to the COVID-19 pandemic and its dramatic impact on the economy.
Interest rates, which play a prominent role in determining the amount of a monthly mortgage payment, also have years when they are high and years when they are low, which is better. For example, a 30-year (360 months) mortgage on a $100,000 loan at 3% interest will cost $422 per month. At a 5% interest rate, it will cost you $537 per month. At 7%, it jumps to $665. So if interest rates are falling, you might want to wait before buying. If they are increasing, it makes sense to make your purchase sooner rather than later.
Seasons can also influence the decision-making process. Spring is probably the best time to shop if you want the widest possible variety of homes to choose from. Part of the reason has to do with the target audience for most homes: families who are waiting to move until their children finish the current school year but want to get settled in before the new year begins in the fall.
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If you want sellers who are seeing less traffic — which may make them more flexible on pricing — winter may be best for house hunting (especially in cold climates) or the height of summer for tropical states (the off-season for your area, in other words). Inventories are likely to be lower, so options may be limited, but sellers are also unlikely to see multiple offers during this time of year.
However, it’s worth noting that some savvy buyers also like to make offers around holidays, such as Christmas or Easter, in the hopes that the unusual timing, lack of competition, and general spirit of the season will get them a quick deal at a reasonable price. .
While money is an important consideration, many other factors can influence your time. Is your need for extra space imminent – a new baby on the way, an elderly relative who can’t live alone? Does the move involve your children changing schools? If you sell a home you’ve lived in for less than two years, would you incur capital gains tax—and if so, is it worth waiting to avoid the bite?
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