Can I Afford to Buy a Home?
Tired of throwing your money away on rent? Need to know how much you’ll need to buy a home in the Central Texas real estate market? Whether you’re looking at your first home or a retirement home, the basic question is; Can I afford to buy a home right now? The answer comes right down to your annual income, financial obligations (expenses & debt) and your financial strength. Your financial strength consists primarily of the amount of money you saved for a down payment and your credit rating.
The 28/36 Rule
Mortgage lenders use two ratios called debt-to-income ratios, as well as other requirements to help you qualify for a home loan. The two ratios are called the 28/36 Rule and it states that a borrower should spend a maximum of 28% of its gross monthly income on total housing costs (housing costs include mortgage payments, insurance and property taxes) and no more than 36% on total debt, including the mortgage loan and other debt such as credit cards and auto loans. This rule is used by mortgage lenders and other creditors to access the ability of a borrower to repay the loan, the point being that debt in excess of the 28/36 ratio could be difficult for a borrower to repay and could eventually lead to default.
A borrower with a monthly income of $6,000 and under the 28/36 Rule would be able to spend a maximum of $1,680 (or 28%) on monthly housing costs, this includes mortgage payments, insurance, property taxes and other housing expenses, such as HOA fees. In this scenario $2,160 (or 36%) would be allowed for the total household debt including the housing expense. So if the total housing cost is $1,680 (28%) per month and the maximum household debt allowed is $2,160 (36%) per month, that would allow $480 per month for other debt such as credit cards, auto loans and etc.
Down Payment, PMI & Closing Cost
It depends on your credit rating and financing, but you need to save enough money to put anywhere from 3.5% percent to 20% down. If you don’t have 20% to put down FHA requires a 3.5% minimum down payment, but don’t worry, your lender should be able to find alternatives that work for you if FHA isn’t an option.
Also note, by not making the 20% or more down payment means a mandatory additional expense called private mortgage insurance (PMI) would be required. PMI typically costs between 0.5% to 1% of the entire loan amount on an annual basis. For example, a $200,000 loan at a 1% PMI rate adds an extra $166.66 to your monthly house expense. PMI protects your lender against the possibility of you defaulting on the loan.
Remember, in addition to your down payment you will also have to pay closing cost. Closing cost can range between 2% to 5% of your sales price of your home. Before you even make an offer on a home your lender can provide you with an estimate of your loan costs with a Good Faith Estimate.
What to do before you buy
Whatever you can afford, you want to get the best interest rates and be in the best position when making an offer on your house. A great credit score will get you the best interest rates for your mortgage loan. Your credit score can have a direct affect on the interest rate you’ll pay. Check your score, and do what you can to improve it. To be in the best position when making an offer you should be pre-approved by your lender. Get pre-approved for a mortgage loan before you make an offer on a house. It will put you in a much stronger negotiating position.
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