February 22nd, 2016 7:28 AM by Jackie A. Graves
are plenty of good reasons to buy a home in 2016. Mortgage rates are still
historically low, rent is increasing faster than home prices, and buying a home
can allow you to start building equity instead of just giving your hard-earned
money to a landlord. However, keep in mind that when you go shopping for a
home, the loan amount you can qualify for and the amount you can really afford
might be two different things.
is cheaper than renting — sort of
Many people (including myself) have written that owning a home can be cheaper
than renting in most U.S. housing markets. And, it's true. For example, in my
local market, an entry-level three-bedroom home in a good school district rents
for around $1,200. Meanwhile, the same home can be purchased for about
$125,000, which translates to a $477 monthly mortgage payment — assuming a 4%
interest rate and 20% down. Even including taxes and insurance, the payment is
likely to be no more than $700.
problem is that people tend to buy a larger and higher-end home than they would
be willing to rent. Renting is not cheaper than owning if you buy a home with
twice the square footage, a high-end kitchen and bathrooms, and a big yard.
much can you get approved for? You might be surprised.
Lenders traditionally use something called the 28/36 rule to determine how much
you can afford to spend each month on your mortgage, including principal,
interest, taxes, and insurance.
"28" is called the front-end ratio, and it says your mortgage payment
cannot be more than 28% of your pre-tax income. The "36" is the
back-end ratio, and says that your total monthly debt payments including your
mortgage cannot exceed 36% of your income. Your maximum mortgage is limited by
whichever ratio produces the lower payment amount.
numbers are by no means set in stone, and it's fairly easy to get approved for
a higher debt-to-income ratio. For example, it's possible, through many
lenders, to obtain a 45% debt-to-income mortgage if you have decent credit and
a few months' worth of mortgage payments in reserve. To illustrate this, if
your salary is $100,000 per year, and your other debt payments (car, credit
cards, student loans, etc.) are $800 per month, you could potentially buy a
$558,700 home at a 45% total debt-to-income ratio, assuming 20% down. If you
think this sounds like too much to spend on a house for someone who earns
$100,000 per year, you're right.
forget the hidden costs
Your mortgage payment is just one part of the true cost of homeownership.
When formulating your budget, keep the following expenses in mind:
Property taxes and homeowner's insurance — Yes, these are
generally taken into account when your lender determines how much you can
afford. However, keep in mind that these change every year, and usually not in
your favor. Even with a fixed-rate loan, your monthly payment is likely to
increase over time to keep up with these costs.
Maintenance -- You'll need to replace carpet when it wears out, put a
new roof on the house every 15-20 years, and perform smaller maintenance tasks
such as changing air filters regularly. When renting, your landlord generally
covers maintenance, so be sure to account for this.
Landscaping -- If you move from an apartment to a house, you'll have a
lawn to care for. Even if you don't do any elaborate landscaping, factor in the
costs of maintaining your lawn.
Repairs -- When you own a house, things break. Six months after I
bought my first house, the HVAC unit completely died, and replacing it was not
cheap. Even if you're buying a brand-new home, plan on at least a few
Utilities -- Don't forget the cost of heating or cooling your new
home. If it's significantly bigger than your previous home, this can make quite
a difference in your costs. Similarly, other utilities may be greater — as a
personal example, my current house is equipped with a sprinkler system for the
lawn, and I severely underestimated the cost of running it. As a renter, your
landlord may even cover certain utilities, such as sewer and trash.
HOA dues — These can vary drastically, or you might not have a
homeowners' association at all. Either way, be sure you know about them before you put your
Mortgage insurance — If you put less than 20% down when you buy your home,
you'll probably have mortgage insurance added to your monthly payments.
Furniture — Finally, don't forget that if you move into a bigger
home, you'll probably want to fill it up.
lose sight of long-term financial goals
I want to be completely clear — buying a home can be a smart financial
decision, but it isn't an investment.
Before you decide to sink half of your monthly income into your housing
expenses, be sure you have enough left over to save and invest for your future.
on who you ask, it's generally suggested that you save 10% to 15% of your
salary in a 401(k), IRA, or other retirement account. When you're figuring out
your home affordability, be sure to take this into account — it is
arguably the most
important expense you should plan for.
buy what you need
If you need to
fully extend your budget in order to meet your housing needs, that's one thing.
For example, if you live in a high-cost area like New York City, it's
completely understandable to spend a large portion of your income on housing.
just because you can buy a certain amount of house doesn't mean you should. If
you were approved for a credit card with a $30,000 limit, does this mean that
you should run out and spend $30,000 on things you don't really need? Of course
not. The same logic should apply to your home purchase.
By Matthew Frankel – To view
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