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How
Much Can You Qualify For - A Self Test
INTRODUCTION
Imagine you
have just completed a search that included hundreds of hours of looking at
the exteriors and interiors of houses. You have sized up siding, reviewed
roofing and perused the petunias. And finally, you have found the house of
your dreams. Now imagine that this house of your dreams costs much more
than you can afford.
If you are
house hunting and have not done an important piece of homework, you could
be in for this kind of heartbreak. The first thing you need to know when
shopping for a home is how much you can spend.
A general rule
is that you can purchase a house valued at twice your annual income, but
this does not take into account your debts, a large down payment, or other
factors which can add to or detract from the amount you can afford.
The purpose of
this article is to help give you a more specific idea of what priced house
you can afford. It will address the value of your financial assets and
what you owe on a regular basis (your assets and liabilities) and what
costs you would most likely encounter once you bought your new house. In
general, you will be examining the same things a lender looks at when
deciding how large a mortgage you can afford
DOWN
PAYMENT
It is expected
that homebuyers have enough money available to make the down payment
(usually from 3 to 20 percent of the asking price for the house) and to
pay their share of the closing costs (3 percent to 6 percent of the loan
amount). You should figure this amount (which will depend on what you
decide you can afford) into your home buying budget. The down payment and
closing costs are usually made up of money drawn from your total assets.
However, recent mortgage trends have paved the way for alternative methods
of paying for the down payment and closing costs such as gifts from family
members, securitized loans, and Non Profit grants.
PRIVATE
MORTGAGE INSURANCE
In the event
that you do not have a 20 percent down payment, lenders will allow a
smaller down payment - as low as 3 percent in some cases. With the smaller
down payment loans, however, borrowers are required to carry Private
Mortgage Insurance. Private mortgage will require an initial premium
payment of 0.5 percent to 1.0 percent of your mortgage amount plus an
additional monthly fee depending on your loan's structure. On a $75,000
mortgage with a 10 percent down payment, this would mean a premium of $338
to $675 for the first year and an extra $15 to $20 a month in subsequent
years.
WHAT
ARE YOUR FINANCIAL ASSETS?
The first thing
you have to examine when deciding how much you can spend on your new home
is the value or total sum of your financial assets, taking into account
your income, savings, investments and other holdings such as Individual
Retirement Accounts (IRAs) or Keogh plans, the cash value of your life
insurance, pensions or corporate savings plans, and equity in real estate.
Lenders will need this information before deciding to extend you the loan.
Often, the
amount you earn may not be as important as how you earn it. Bonuses and
commissions can vary greatly from year to year, and lenders are reluctant
to depend on them if they make up a large part of your income. There are
similar problems when a large portion of your salary is based on overtime
pay, and you rely on it to qualify for the loan. To get a realistic view
of what your income level actually is, average your income (including
bonuses, commissions and overtime) for the past two or three years.
As a last
resort, pensions and corporate thrift plans can provide another source of
down payment money. Most plans or policies give you the option of either
withdrawing your money with no repayment or borrowing against the cash
value. Though it is not the best policy for most homebuyers to borrow from
these sources in addition to borrowing mortgage money, they can often get
rates substantially lower than those on many other kinds of loans.
Remember - if you borrow against the cash value of your life insurance or
employee thrift plan, you will be making principal and interest payments
for these separate from your mortgage.
While turning
your savings, investments and other holdings into cash (making them
"liquid"), remember that you will probably have to pay tax on
most of it. One source of tax-free money often overlooked is a gift, or
money given by a parent or other relative that need not be repaid. A
person may give another person up to $10,000 per year without either party
being taxed. Your parents, for example, could give you and your spouse up
to $40,000 tax free.
LIABILITIES
Your
liabilities are those expenses for which you are responsible each month.
These include outstanding loans, such as student, auto, personal and so
on, as well as credit card balances. When calculating your liabilities,
use the entire balance for your credit cards, as if you had to pay them
off entirely this month. That way, you give yourself some breathing room
should you run up an unusually high balance during your mortgage term.
ANNUAL
INCOME
When
calculating your annual income, remember to take into account all sources.
You may, for example, get dividends from investments, alimony or child
support payments. Calculate your annual income on the following page.
EMERGENCY
FUNDS
It is always
wise to put a little money away "for a rainy day" - especially
when you are paying off a mortgage. If something arises such as unexpected
medical costs or substantial auto repairs, you would want to be able to
pay those expenses without jeopardizing your ability to meet your mortgage
payments. Most financial experts suggest that you always have six months
income on hand in case of emergency.
THE
COST OF HOMEOWNERSHIP
Homeowners
insurance premiums usually run about $300 to $500 per year, and property
taxes and maintenance costs will vary, of course, depending on the size,
age and condition of your new house. Estimates for the costs of utilities,
maintenance and improvements can be obtained from Realtors, local utility
companies and others.
Some homebuyers
will also have an additional cost of homeownership if they are buying into
a condominium or a co-op. Condo and co-op fees are additional amount
usually paid monthly on top of the mortgage payments. Some homeowners will
also incur a home owners association fee for their neighborhood. These
fees vary greatly from location to location.
For additional
information and assistance with prequalfications, please visit the
following sections:
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