If you feel like you’re ready to buy a house, the first question you’re likely to consider is “how much am i able to afford?” Answering that question means looking at several of factors.
Before you snap up that seemingly great buy over a home, learn how to analyze what “affordability” means. You’ll need to consider various factors which range from the debt-to-income (DTI) ratio to mortgage rates.
Determining your debt-to-income ratio (DTI)-more specifically, the front-end DTI-is an important factor in getting a mortgage.
Beyond the property’s price, a host of other financial and lifestyle considerations should figure into the calculations concerning whether you are able to buy a house.
You should also evaluate the local real estate market, the economic outlook, and the implications of how long you want to remain put.
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You’ll also need to consider your lifestyle needs, present, and future.
Understand Your Debt-to-Income Ratio First
The first and most clear decision point involves money. If you have sufficient means to acquire a property for cash, then you certainly can afford to buy one now. Even if you’t pay in 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?
The 43% debt-to-income (DTI) ratio standard is normally used by the Federal Housing Administration (FHA) as a guideline for approving mortgages.1 This ratio is used to determine if the borrower can make their payments every month. Some lenders may become more lenient or more rigid, with regards to the market and general economic conditions.
A 43% DTI means your regular debt payments, as well as your housing-related expenses-mortgage, mortgage insurance, homeowners association fees, property tax, homeowners insurance, etc.-shouldn’t equal more than 43% of your monthly revenues
What Mortgage Lenders Want
You also need to consider the front-end debt-to-income ratio, which calculates your earnings vis-à-vis the monthly debt you would incur from housing expenses alone, such as mortgage repayments and mortgage insurance.
Usually, lenders like that ratio to be no more than 28%. For example, if your income is $4,000 per month, you’ll have trouble getting approved for $1,720 in monthly housing expenses even if you have no other obligations. To get a front-end DTI of 28%, your housing costs should be under $1,120.
Why wouldn’t you be able to use your full debt-to-income ratio unless you have other debt? Basically, because lenders don’t like you living on the edge. Financial misfortunes happen-you lose your job, your car gets totaled, a medical disability prevents you from employed by a while. If your mortgage is 43% of your income, you’d don’t have any wiggle room for when you want to or have to incur additional expenses.
Most mortgages are long-term commitments. Keep in mind that you might be making those payments on a monthly basis for the next 30 years. Accordingly, you should evaluate the reliability of your primary income source. You should also consider your prospects for the future and the chance that your expenses will rise as time passes.
Can You Afford the Down Payment?
It’s best to put down 20% of your home price to avoid paying private mortgage insurance (PMI). Usually added into your mortgage payments, PMI can add $30 to $70 to your monthly home loan payment for each and every $100,000 borrowed.4
There may be some reasons that you may not need to put down 20% toward your purchase. Perchance you aren’t considering living in the house very long or have long-term plans to convert the home into an investment property. Similarly, you might not want to put that much cash down. If that’s the case, buying a home continues to be possible without 20% down.
You can buy a home with as little as 3.5% down with an FHA loan, for example, but there are bonuses to coming up with more.5 Beyond just the aforementioned avoidance of PMI, a more substantial down payment also means:
Smaller mortgage payments-for a $200,000 home loan with a 4% fixed interest for a 30-year term, you might pay $955. If your mortgage were $180,000 with a 4% interest for a 30-year term, you’d pay $859.
More choices among lenders-some lenders won’t give you a mortgage if you don’t put at least 5% to 10% down.
Being able to afford a fresh house today is not almost as important as your ability to afford it over the long haul. Needless to say, being capable to afford a house and having a down payment doesn’t answer the question of whether now is a great time that you can act on that option.
The Housing Market
Assuming you have your personal money situation under control, the next consideration is housing-market economics-either in your present locale or the one where you plan to move. A residence is an expensive investment. Having the money to make the purchase is great, but it doesn’t answer the question of whether or not the purchase makes sense from a financial perspective.
One way to do this is to answer the question-is it cheaper to rent than to buy? If buying computes to be more affordable than renting, that’s a strong argument and only purchasing.
Similarly, it’s worth thinking about the longer-term implications of your home purchase. For generations, buying a home was almost a guaranteed way to make money. Your grandparents could have obtained a home 50 years ago for $20,000 and sold it for five or 10 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 would-be homeowners think.
The Economic Outlook
Along those same lines, there are years when real estate prices are depressed and years when they are abnormally high. If prices are so low that it’s obvious you are receiving 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 boost the odds that time works in your favor and cause your house to understand within the future.
It’s too soon to tell exactly what will get lucky and home prices in 2021. But if history repeats itself, we can get a drop in home prices therefore of the COVID-19 pandemic as well as dramatic impact on the economy.
Interest rates, which play a huge role in identifying how big is a monthly mortgage payment, also have years when they are high and years when they are low. Obviously, lower is better. For instance, a 30-year mortgage (360 months) on a $100,000 loan at 3% interest will cost you $422 month to month. At a 5% interest rate, it will cost you $537 per month. At 7%, it jumps to $665. So if rates of interest are falling, it may be smart to wait before you get. If they are rising, it makes sense to make your purchase sooner rather than later.
Time of Year
The seasons of the year can also factor in to the decision-making process. If you need the widest possible variety of homes to choose from, spring is probably the best time to shop. “For Sale” signs tend to springtime up like flowers as the weather warms and lawns turn green. Area of the reason pertains to the target audience of most homes: families who are waiting to move until their kids finish the existing school year but like to get settled prior to the new year starts in the fall.
If you want sellers who may be seeing less traffic-which will make them more flexible on price-winter may be better for house hunting (especially in cold climates), or the height of summer for tropical states (the off-season for your neighborhood, to put it differently). Inventories are likely to be smaller, so choices may be limited, but it is also unlikely that sellers will be seeing multiple offers during this time of year.
Consider Your Lifestyle Needs
While money is obviously an important consideration, there are always a host of other factors that could play a role in your timing. Is your need for extra space imminent-a newborn on the way, an elderly relative who can’t live alone? Does the move involve your kids changing schools? If you might selling a house in which you’ve lived for less than two years, can you incur capital gains tax-and if so, is it worth waiting to stay away from the bite?6
You may want to cook with gourmet ingredients, take a weekend getaway monthly, patronize the performing arts, or workout with a personal trainer. None of these habits are budget killers, however you may need to do without them if you bought a home based on a 43% debt-to-income ratio alone.
Before you practice making mortgage payments, give yourself a little financial elbowroom by subtracting the price tag on your priciest hobby or activity from the payment you calculated. In the event the balance isn’t enough to get the home of your dreams, you may have to cut back on your fun and games-or start thinking of a more affordable house as your dream home.
Selling One Home, Buying Another
If you are selling a home and plan to buy another, save the proceeds from your current home in a checking account and determine whether or not-after factoring in other necessary expenses like car payments or health insurance-you will be competent to pay the mortgage. It is also important to remember that additional funds must be allocated for maintenance and utilities. These costs will undoubtedly be higher for larger homes.
When you calculate, use your current income, and do not assume you may making more money later on. Raises don’t always happen, and careers change. If you base the volume of home you buy on future income, you might as well set up a romantic dinner with your credit cards as you’ll conclude in a long-lasting relationship with them.
However, if you can handle these extra house costs without extra credit card debt, you are able to buy a home-as long as you have saved up enough money for your deposit.
Do You Plan to Stay Put?
Affordability should be the number one thing you look for in a home, but it is also best to know how long you are going to want to live there. If not, you could get stuck in a home you can’t afford in a city or town you’re prepared to leave.
Many financial experts suggest surviving in a home for five years before selling it as a guideline. Do not forget to take into account the costs involved with buying, selling, and moving. Also, consider the breakeven point for the mortgage fees from the home you can advertise. If you can’t decide what city or town you are going to stay in and what your five-year plan is, it may well not be the right time to buy a home.
If you want to buy a home without a five-year plan, purchase the one which is priced lower than the maximum you can afford. You’ll have to have the ability to afford to have a hit if you have to sell it quickly. Another exception: If you work for a company that buys the houses of relocated employees-one name because of this is a guaranteed buyout option.
The Bottom Line
Are you ready to buy a house? In short, yes-if you are able to do it. But “afford” isn’t as simple as what’s in your bank account right now. A host of other financial and lifestyle considerations should figure into the calculations.
When you factor in all these elements, “when you can afford to do it” starts looking more complicated than it first is apparently. But considering them now can prevent costly mistakes and financial problems later. Obviously, there is one best time to pounce: When you find the perfect house in the perfect place for sale-at a perfect price.