Buying a home is one of the biggest financial decisions you’ll ever make. So before you even start to look at homes, your top priority is to know how much home you can afford.
While there are all sorts of affordability calculators out there on the interwebz that can help you, these tools don’t analyze everything. Everyone has different circumstances that dictate how much they can really afford. Calculator or not, you need to look at all the factors that will affect affordability for your financial situation.
Factors that affect affordability
There are several things to consider when deciding if you are financially ready to buy a new home. I’ll cover a few of them here.
Everyone’s financial situation is different, but a general rule of thumb says you can probably get a mortgage loan for about 2 to 2.5x of your annual income. So if you make $60,000, you might be able to borrow $120,000-$150,000.
But, that’s just considering income. Other factors come into play here (read on)
Debt weighs as heavily as income when it comes to affording a home.
Mortgage lenders use debt-to-income ratios to determine loan eligibility. Each lender has different standards. They use their guidelines to see how your monthly housing expenses (principal, interest, taxes, and insurance) and all your other debt stack up against your monthly paycheck.
Your down payment is the amount of cash you have available to pay out of pocket for a home. It demonstrates your ability to save and shows good faith to repay the loan. Your down payment affects the amount you can finance as well. Also, the more money you can put down, the lower your payment will be.
You can get mortgages with a down payment of as little as 3%*, but more is always better. Many loan programs require you to pay additional Private Mortgage Insurance (PMI) if you don’t have a 20% down payment (this protects the lender if you can’t make your payment).
The costs of buying a home don’t stop at the down payment.
You will have to pay property taxes and homeowner’s insurance. Sometimes these are required to be pre-paid into your escrow account at the time of closing (depending on your lender and your loan program).
Also, you will have to pay any discount points (for a lower interest rate) plus other loan closing costs and fees paid to the lender, appraiser, lawyer and others involved in making it all happen.
Don’t forget to plan for moving expenses, along with the maintenance and utility costs of a new home. If you’re moving from a small home to a larger one, the expenses increase with more space. Even brand new homes have maintenance costs.
Your credit score is a 3-digit number that shows lenders how likely you are to repay your debt. Most lenders use a FICO score (300-850) to predict risk associated with lending you money.
When it comes to mortgages, your credit score is most likely to impact your interest rate. And your interest rate makes a huge difference in your monthly payment (and how much you spend over the life of the loan). Even a 1% difference in interest rates can impact your monthly payment by $100 or more (depending, of course, on how much you borrow).
Other things to consider
The bank doesn’t consider your expenses beyond your debt and mortgage payment. But you should. If you don’t already know all of your monthly expenses, make a list and add them up. How much do you typically spend on gas? Food? Insurance? All of these expenses impact the affordability of your monthly mortgage payment.
Rules of thumb
There is no shortage of advice out there on how much you should spend on a house.
Dave Ramsey takes a more conservative approach and recommends spending no more than 25% of your take-home pay.
The most well-known rule of thumb is the Rule of 28. This means your total monthly mortgage payment (principal, interest, taxes, and insurance) should not exceed 28% of your monthly gross income (this is not your take-home, but the amount of pay before taxes).
Affordability calculators are widely available – and they’re okay when you are just starting out. But they can be misleading because they don’t consider the whole (financial) picture.
For example – just for fun, I plugged my numbers into a popular affordability calculator. The calculator says I can afford a home over $100,000 more than mine cost. I feel like my house is affordable as it is – if I had the payment they say I could have, my monthly budget would be stretched to the max.
The most important thing is to know what your typical month looks like, financially speaking, and how a new mortgage payment fits into it.
Mortgage calculators are helpful. Rather than tell you how much you should (or could) spend, mortgage calculators allow you to run different scenarios. You can plug in any number and figure out what your payment would be.
A mortgage calculator allows you to more easily compare the new mortgage to what your current rent or mortgage (rather than encouraging you to “dream big” and strive for more house than you can actually afford).
Ask yourself how affordable your current housing is and go from there. Do the actual calculations – add up all of your monthly expenses and see if you have any room in the budget.
Des Moines area affordable housing programs
If you’re buying your home in Des Moines, Iowa, there are programs available that could provide additional financial incentives and assistance when buying your home.
- The Federal Home Loan Bank of Des Moines provides grant funding for area lenders to provide affordable housing in the community. Grants for loan programs and down payment assistance are available. Ask a local FHLB lender about these grants to see if you qualify.
- The Iowa Finance Authority provides affordable loan programs, down payment assistance and more.
- The Neighborhood Finance Corporation provides loan assistance for fixer-uppers in specific areas.
Are you ready to buy a home? Buying a home can, at times, feel intimidating and overwhelming. But it doesn’t have to be. At Coluzzi Real Estate, we answer all your questions and simplify the process every step of the way. Please don’t hesitate to contact us at any time!
*Certain loan programs require 0% down, but you must qualify (VA and USDA loans).
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