Who doesn’t dream of having their own home? Buying a home is an exciting and wonderful experience, and it’s one of the most important transactions that any person can enter into. A home purchase is a decision that requires thorough planning and serious consideration. You have to be able to determine how much you can afford and stick to it.
If you found a home that you’re interested to buy, here is a guide to help you evaluate your purchasing capacity and options.
How much should you prepare to purchase a home?
First things first, you need to set your budget to resolve how much you can afford for your home. This thinking process includes determining the cost of your desired home, and the loan amount that you can afford. If you intend to purchase through a home loan, you will still need to secure money for a down payment. Lenders will require this amount as part of the computation for the loan amount that they will grant you. Approval of your home loan will rely on your credit rating, cash on hand, and debt-to-income ratio.
Once you’ve been approved for a loan, you can write an offer for the home purchase, which the seller should accept. After this, you will need to make a deposit called earnest money as part of the offer. Take note that this is different from the down payment required by the lender. The amount needed as earnest money will be about 1-2% of the total asking price.
Sellers seldom accept the intent to purchase without the earnest money, but it is important that you issue the check to the Title Company and not to the seller. Otherwise, if things go haywire, it would be difficult for you to get your money back. Always pay to the Title Company, which will put your money in an escrow account until the final stages of a home sale. This deposit will then be converted as down payment and closing costs.
In addition, those who qualify as first-time home buyers are able to get down payment support from the government depending on their home county. You might also want to check if you qualify for below market fixed interest rate loans.
On top of all these, the purchase will incur closing costs that are not inclusive of the financed amount and can sum up to 3-5 percent on top of the selling price. These include the attorney fees, title service costs, recording cost, documents, transaction stamps, taxes, survey fee, brokerage commission, mortgage application fees, pre-paid interest in the form of points, appraisal fees, inspection fees, pre-paid property, insurance, pro-rata property taxes, pro-rata homeowner association dues and pro-rata interests. In some cases, closing costs are made part of a home purchase agreement wherein the seller shoulders these costs from their proceeds. As the buyer, you can take this up with your real estate agent.
Why you shouldn’t buy a home?
Not everybody is advised to purchase a home for the following reasons:
- You don’t have the capacity to afford it.
- Renting a home makes better sense.
- The only option you have is to buy a home through a risky type of loan like adjustable-rate mortgage (ARM) or negative amortization loan.
- You are always mobile and can’t stay in one place for more than five years.
- The real estate market is and will always be a cyclical industry that is often affected by changes in the economy. Buying a home during a time of decline is not advisable.
- You have difficulty balancing your finances because of multiple debts.
How do I get started?
Begin by a self-assessment of your financial status. Can your income pay for the monthly amortization of the loan? While you are excited with the notion of owning a home, never let your emotions run amok! Be aware of your budget before exploring your options. Take a rain check when you think you don’t have the capacity to afford home ownership at this time. On the other hand, if you have some leeway in your purchasing capacity, then by all means, consider buying a home!
What is debt-to-income ratio?
Lenders use this figure to establish what kind of mortgage payment best applies to the buyer. As a buyer, you may qualify for a certain payment category but you should be careful not to be tied up in a scheme that puts you too close to your bottom line.
The debt-to-income ratio helps lending institutions assess the loan amount that you can afford to pay for. For instance, if you are currently staying a home that requires a monthly rent of $1,700, you will likely afford to pay a mortgage of the same amount.
A lender may follow a different standard for debt-to-income ratio from another, but if your credit history is good, you can get lower interest rates because lenders give emphasis on your credibility as a buyer. Below is an example of a typical debt-to-income ratio for a person who is buying a home for the first time:
Monthly gross household income: $6,000
Monthly debt ratio (28 percent) $1,680
Expenses and overall debt (36 percent) $2,160
Based on the illustration above, if you are paying $1,700 for monthly rent, you can very well afford the mortgage debt in the table. Therefore, it is safe to assume that you are qualified and can afford to pay your monthly dues, as long as your expenses and overall debt do not exceed $2,000 to $2,300.
It is always wise to be in good credit standing for you to enjoy as much as 38/45 ratio. A good credit report will also allow you to easily get approval on federally-issued loans. Even if you are a first time buyer applying for a VA or FHA loan, a laudable credit will qualify you for a higher overall debt ratio up to 41 percent of your monthly earnings.
What is a front-end ratio?
This is also called the “housing ratio”. As a general rule, a buyer’s monthly housing payment – inclusive of the principal, interest, insurance and taxes – must not exceed 30 percent of his income prior to taxes.
What is a back-end ratio?
Lenders call this the “overall debt ratio”, and prefer this to be less than 36 percent of all monthly financial commitments such as minimum credit card payments, student loans, or car loans.
How do I compute the costs?
When asking yourself how much you can afford, you need to consider a lot of factors: indices, variables and available lending programs. Being realistic can always get you the best deals. Don’t be complacent, though; go out of your comfort zone and explore other home financing details online such as mortgage interest rates and property tax rates.
To give you a clear picture, here is a sample breakdown for a mid-range home against a lower price-range home purchased with the same loan terms and the same interest rates:
Monthly gross household income (pre-tax) $7,000
Mortgage debt ratio: 28 percent $1,960
Home price $350,000
20 percent down payment $70,000
Interest rate on 30-year mortgage 3.25%
Mortgage payment (principal and interest) $1,219
Monthly gross household income (pre-tax) $3,600
Mortgage debt ratio: 28 percent $1,008
Home price $150,000
10 percent down payment $15,000
Interest rate on 30-year mortgage 3.25%
Mortgage payment (principal and interest) $588
Will there be other costs?
After the home purchase, you need to calendar payment schedules for insurance fees, homeowners’ taxes, and neighborhood association fees if applicable.
You should allocate funds for other costs not covered in the contract. It is natural that you feel like splurging on your new home but having free cash on standby can come in handy under the least expected circumstances.
Are you ready to buy? Do you have more questions?
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