The first step toward buying a house
is to do what we call "pre-qualifying”. This is simply determining
how much house you can afford to buy. Knowing your affordable price range will
bring your house hunting into focus. Many lenders will send out all required verification
and pre-approve you for a mortgage, allowing you the opportunity to negotiate
as a cash buyer.
How much house you can afford to
buy depends on two things: how much you can afford for the monthly housing payment,
and how much you can invest in the down payment. Monthly payments include the
principal and interest on the mortgage loan, and property taxes and insurance
against fire and other hazards. These four costs are often abbreviated "P.I.T.I”.
(For some buyers and lenders, monthly housing costs may also include homeowner
association dues, condominium fees and mortgage insurance).
In today's market, an "affordable"
home is not so much determined by the sales price as it is by the financing which
translates that price into a monthly payment. A home buyer's first step is to
set a housing budget, then go shopping for the house (price) and payments (P.I.T.I.)
that fit that budget.
Even though there are many ways to
qualify to buy a home, make sure the monthly payment makes sense for you. A current
rule of thumb is that the monthly payment should not be more than 25-33% of gross
The key items to housing affordability
are the size of the down payment, interest rate, APR and the amount of the mortgage.
The down payment might be zero in the case of VA-backed mortgages. Or a buyer
may invest 20 to 25 percent of the purchase with a conventional loan and not be
required to buy mortgage insurance.
source of money for your down payment is either your savings or the proceeds from
the sale of a home you already own. But there are some other not-so-obvious sources.
In recent years, for example, "parent power" has taken some new twists
for first-time buyers.
Home Equity Loan
Parents often have considerable equity built up in their own homes - and many
are tapping that asset through home equity loans to make a gift to the youngsters.
Ask your tax advisor for current information. Often lenders will require a "gift
letter" to verify that parents don't expect repayment.
In return for providing a part of the down payment, the parents (or another investor)
share in the "profit" or net equity of the house when the homeowners
eventually sell it.
If you have built up a cash value on your life insurance policy over the years,
you may be able to borrow from your insurance company up to the amount of this
accumulated cash value. Often they will even ask a more favorable interest rate
than would be asked for other types of loans.
Stocks and Bonds
If you feel the market doesn't favor selling your stocks or bonds now, you may
be able to secure a bank loan using your portfolio as security.
Company Profit Sharing or
Look into the possibility of withdrawing what you have in your profit sharing
or savings plan account or borrowing against it, if your company has these programs.
Mortgage Insurance Can Reduce Down
If you need a conventional loan, there is a way to put down only 5 or 10 percent.
Through the lender, you will be required to buy private mortgage insurance (PMI).
This insurance provides protection for the lender in case of default, and allows
the lender to approve a larger mortgage amount.
In a common approach, you'd pay an
initial amount at closing (often one percent of the mortgage if your down payment
is 5 percent, 1/2 of 1 percent if you put down 10 percent). Then, included in
your monthly payments for your mortgage, you would pay an additional one-twelfth
of 1/4 percent of the mortgage balance. This payment will usually continue until
dropped at the discretion of the lender, unless a stop point is specifically written
into the deed of trust, such as accumulating 20% equity. Ask your lender for specific
figures for any loan program you are considering, as the amount of mortgage insurance
varies by the type of loan.
The larger the down payment, the
less money you need to borrow, which means a lower monthly payment. However, remember
that in addition to your down payment and monthly payments, you will need money
to pay for closing costs, moving, appliances, household setup, a reserve for family
emergencies and other miscellaneous items. So don't plan to put your last cent
down on the closing table.
figure that the homebuyer shouldn't pay more than 28-38 percent of gross income
for P.I.T.I. payments, or 36-38 percent for both P.I.T.I. and monthly debts combined.
This might be a little more or a little less depending on other outstanding long
term debts (more than 10 months), alimony/child support payments, number of children
and their ages, and other household budget items.
The easiest way to make a quick estimate
of the mortgage amount you may qualify for requires applying the two basic formulas
for loan application that lenders use. Keep in mind the loan balance will vary
over the term of the loan, although the monthly payment remains the same.
Two Lender Formulas
Most lenders will require that loan applicants meet both guidelines before approving
a mortgage loan. The first formula, compares income to housing costs without including
long-term debts, the second includes all debts.
Total Monthly Housing Costs
__________________ = 28% (or less)
Gross Monthly Income
P.I.T.l. + All Monthly Debts
__________________ = 36% (or less)
Gross Monthly Income
A variety of other formulas exist.
VA and some lenders use a single ratio based on mortgage payment and all debts,
which allows easier qualifying for a more expensive home for a borrower with little
To figure your housing budget, simply
multiply your gross monthly income (before taxes) by 28% and 36%. For example,
a family with a monthly income of $3,500 might qualify for a mortgage with payments
up to $980.
More Mortgage Help
New types of mortgages, such as graduated payment mortgages, flexible payment
mortgages and deferred interest loans, feature monthly payments that start lower
than usual in the early years--and thus help home buyers "afford" more
house and buy sooner by qualifying on a lower mortgage payment.
At Home Selling Assistance By The
Bay, we will assist you through exploring your home financing options and be there
every step of the way, from pre-approval all the way to the settlement table.