How Much Home Can You Afford?
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The first step in homeownership is to determine how much house you can afford
realistically. In fact, if you can’t afford your dream house, you may have to borrow
money from the bank, known as a mortgage. This step can either make or break your
homeownership prospects for three reasons:
- Your Ability to Pay the Mortgage: Your lender will want to know not only how much
money you have, but also how much you will earn in the next 30 years. In addition,
the lender has the right to snoop around in your debt history. For example, what’s
your credit card situation? Do you have any outstanding debts or loans you’re slow
to repay? Property such as a car or boat is also figured into how much the bank
will lend you.
Before the mortgage is issued, lenders generally want you to come up with 20 percent
of the home value to use as a down payment. Special financing arrangements that
may get you into a new home for as little as 3 percent of the asking price.
The lender will also plug your income numbers into a couple of formulas: the front-end
ratio (having to do with your mortgage payments) and the back-end ratio (having
to do with your debt).
Let's say your gross income is $4,000 a month, and you have $1,000 a month in debt
payments. The rule of thumb is that the lender will allow you to pay 29 percent
of your gross income toward your mortgage payment every month. This is known as
the front-end ratio. In this example, 29 percent of $4,000 is just under $1,200
a month so the lender will reason that you can put $1,200 toward your mortgage
payment. Your debt ratio, or back-end ratio, on the other hand, is $1,000/$4,000,
or 25 percent. That's not bad. The lender doesn't want more than 41 percent going
toward your other debt. (These ratios can vary somewhat; the ones given here are
- Your Past Financial History: Your credit rating is one of the most important factors
to qualify for a mortgage. The three major credit-reporting agencies are Experian,
Equifax and Trans Union. You can request your credit report individually from each
agency. Your credit report a nifty little compilation of your personal financial
history will reveal whether you have a track record of paying your bills on time.
If not, there are ways to clean up your credit that will make you more attractive
- Your Available Collateral: In case you can't repay the loan, the bank can do something
really nasty: foreclose on the mortgage and repossess the house. That means it owns
the house -- not you. You then find yourself out on the street with your dog and
your La-Z-Boy. Your house now belongs to the bank, and it is unlikely anyone will
ever loan you money again. Avoid this scenario at all costs.
In determining whether you should buy a new home, think about how long you're planning
to stay in it. It generally doesn't make economic sense to buy if you're planning
to stay there for less than four years. Why? Because you will pay fees to buy and
sell your house. It would have to appreciate in value very quickly between the buying
and selling to make it financially worthwhile. In other words, you'd have to get
Your Comfort Zone
Before you borrow $90,000 or $200,000, figure out whether you can really afford
it. Just because the bank will loan you the money doesn't mean that you will live
your life in such a way as to be able to pay it back. Are you planning on having
a big family? Would you rather replace your Chevy with a new Mercedes? Your house
payment is just one piece of your financial puzzle. What might you need to give
up to make that house a reality?
Shopping for a Loan
There are thousands of mortgage lenders across the country, and all have different
loan products. From lenders who only sell to the most creditworthy borrowers (at
the best rates) to those who will lend 50 percent of a property's value (at high
rates), there's a mortgage product for just about everyone.
One place to check is your local bank. This can result in a reasonably good deal
for the qualified customer. In many other cases, the bank will not have a program
that fits your needs, or you may fall outside the guidelines of its lending ability.
Once you have visited your bank, look in the real estate section of your local paper
for rates at other banks. It's a good idea to start the legwork on your own, before
bringing in a mortgage broker, so that you'll 1) avoid the hard sell from the get-go
and 2) have a better idea of what you could find on your own.
The Web lets you comparison-shop. Not only that, but you don't have to hunt down
a hundred different banks -- certain aggregator sites have done that for you. You
may well find the cheapest rates in town (or in the country) from the Internet.
If, however, you end up working with a real estate agent, you may feel more secure
with a lender that has a relationship with your agent. The idea is this: The agent
brings business to the lender, so the lender has some sense of responsibility toward
honoring commitments with that agent's clients. This is not the case for the internet.
You should be cautious of internet lending and scams.
When Should I Shop for a Mortgage?
Ideally, you should find a mortgage before you ever start looking for a house. Not
only will you feel more confident knowing that you'll have a certain amount of money,
but you'll be a more serious candidate to sellers.
What Information Should I Get from the Mortgage Company?
There are many questions to ask prospective lenders. You may find yourself feeling
a little nervous. After all, you may feel like they have you by the suspenders.
But don't think of it that way. You are going to pay them a lot of money for a very
long time. They serve you, not the other way around. Don't let them take advantage
of you or bully you into a deal that isn't to your advantage.