Homeownership can be a nerve-racking experience if you have never been through the process before. You tend to ask yourself, can I afford this? Is this the right house? What happens if something major breaks or collapses?
According to G.M. Filisko, former Editor of REALTOR® Magazine, “Homeownership should make you feel safe and secure, and that includes financially. Be sure you can afford your home by calculating how much of a mortgage you can safely fit into your budget. Instead of just taking out the biggest mortgage a lender qualifies you to borrow, consider how much you want to pay each month for housing based on your financial and personal goals.”
Filisko also mentions that major life changes such as returning to school, having a baby or even having a relative stay with you may/can affect your decision and budget.
Below are some tips you should consider before you take the next step into owning your own home.
The General Rule of Mortgage Affordability
Most lenders look at a person/family owning a home that is typically priced two to three times their gross income. For example if you earn $50,000.00/year, a rough calculation would say that you can afford a home that is priced between $100,000-150,000.
The only way for you to truly know if this works for your budget is to do the following:
1. Prepare a family budget and list all the costs of homeownership,
a. Include things like property taxes, insurance, maintenance, utilities, and home association fees (HOA), if applicable.
b. It is also vital to outline specific costs to your family, such as day care.
Factor in Your Down Payment
An important question you must know before you start shopping for a house is how much do I have for a down payment? Having more money to put down on a home can help you save money on your monthly payments. Today most lenders require that you put down at least 3.5% just to even go through with a purchase. For example, if you wanted a home that costs $150,000, you would need at least $5,250 or 3.5% to move forward. If you are able to put down 20% of the purchase price, then you will, in most cases, be able to avoid having private mortgage insurance which can add hundreds of dollars per month to your monthly payment.
Another set of expenditures you should consider include inspections, appraisals and title fees. Each home, area and lender will be different. Please make sure you keep in mind that these costs can add up in a hurry as you go through this process. If you are purchasing that $150,000 home mentioned above, you would need an extra $2,500 (on average) for closing costs and inspections. Of course, this is a rough estimate and you should speak to your lender and agent for accurate “final” costs.
Consider Your Overall Debt
Lenders such as United Consumers Credit Union tend to follow what is known as the 28/41 rule. Simply put, the sum of your monthly mortgage payments (home loan principal, interest, taxes, and insurance) shouldn’t exceed more than 28% of your gross annual income.
Your monthly payments for your mortgage plus all your other bills, like car loans, utilities, and credit cards, shouldn't exceed 41% of your gross monthly income.
As an example, if your gross annual income is $50,000, multiply it by 28% and divide by 12 months to arrive at a monthly mortgage payment of $1,166 or less. Next, check the total of all your monthly bills including your potential mortgage and make sure they don't top 41%, or $1,708.
By following this simple budgeting rule, you shouldn’t become too house heavy in regards to your yearly salary. This will leave you free to do other things such as: trips, update furniture, buy new clothes etc.
Use Your Rent as a Mortgage Guide
“The last and final budgeting tip is that tax benefits of homeownership generally allow you to afford a mortgage payment, including taxes and insurance, of about one-third more than your current rent payment without changing your lifestyle,” said Filisko. “So, you can multiply your current rent by 1.33 to arrive at a rough estimate of a mortgage payment,”
Here's an example. If you currently pay $1,500 per month in rent, you should be able to comfortably afford a $2,000 monthly mortgage payment after factoring in the tax benefits of homeownership.
Something to consider though is if you're struggling to keep up with your rent, consider what amount you would be comfortable with and use that for the calculation(s) instead.
Also, consider whether or not you'll itemize your deductions. If you take the standard deduction, you can't also deduct mortgage interest payments. Talking to a tax adviser, or using a tax software program to do a "what if" tax return, can help you see your tax situation more clearly.
Visit Houselogic.com for more information. Information courtesy of HouseLogic.com with permission of the National Association Of Realtors®.
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