How to Budget for a Mortgage
So, the time has come. You are done with apartment living and ready to take a huge life step – buying a home! Before you do so, you should take several things into consideration.
- Your credit. Do you have a strong score?
- What can you afford? You’ll need to stay within your budget.
- Down payments and closing costs can get expensive. Have you been saving?
- Speaking of saving…do you have a healthy-looking savings account?
- Mortgages! Be prepared!
- The fun part – buy a house you really love. You’ll most likely be there awhile – buy something you WANT to come home to every day.
There are many measures that determine home affordability. You’ll want to do research on mortgage lenders and find one that you can trust! Remember to ask the right questions (think communication, fees, and requirements) and to always ALWAYS read the fine print. Traditionally, mortgage lenders typically expect home buyers (also called ‘the borrower’) to have a housing ratio of 28% or less. For example, if your salary is $4,000 per month, a lender would want to see the housing expenses (mortgage payment, insurance, property taxes, etc.) less than $1,120 per month. $1,120/$4,000 = 0.28. Get it?
You’ll also want to start thinking about what percentage of your monthly income you will be able to put towards a mortgage payment. Many people ask the question: Should I use gross monthly income or my take-home pay? And that’s a good question! Here’s a good rule of thumb: Consider your total housing payment, not just the mortgage. Many mortgage professionals agree that your housing budget should include not only your mortgage payment but also property taxes and other housing-related insurance. Don’t forget the homeowner’s insurance. The TRADITIONAL model is: no more than 28% of your gross income should go to monthly payments. Remember, you can reduce the amount of money that goes toward your mortgage every month by making a bigger initial down payment. Have you ever bought a car before? It’s the same concept. Depending on who you ask, many mortgage lenders suggest putting down 20% of the sale price of the home to get the best mortgage rates. So, if you are buying a $200,000 home, you’d want to put down at least $40,000. If you put down less, you may have to add the cost of private mortgage insurance to your monthly payments, among other costs.
Keep in mind that you will pay more for your house the first year you are in it because you’ll have closing costs that you won’t have to worry about in the following years – because they’ll already have been paid! If you plan on using the equity in your home, remember that most of your mortgage payments will go toward paying off interest at the beginning of your mortgage. This is where having a mortgage lender that you can trust comes in. You will want to work with him or her to determine when you will begin to have equity in your home. You’ll also need to consider (again, your lender can help you with this) your down payment and monthly payments. If your house goes down in value, it could affect your ability to take out a home equity loan. A lot of things can make your property value go down. Things like the economy, the environment, maintenance, foreclosures, amenities, and appearance can all play a factor.
So, the question is: HOW should I budget? Budgeting is easier said than done. It all depends on saving and how much you are able to save. It’s tough! This might mean one less meal out per week. No more monthly manicures. No more movie nights. And more!
As we mentioned above, first, you’ll have to build strong credit because a low score can prevent someone from buying a home or from qualifying for a good mortgage rate. You can request a free credit report from just about anywhere. Do check the report for accuracy and make sure to fix any mistakes.
Secondly, create a simple budget and set a goal for yourself for saving. Think about it like this. If you save $200/month, that’s $2,400 by the end of the year. The savings really add up! Mortgage lenders want to see proof of your responsible saving. Not to mention, you’ll need at least 3.5% of the total cost of the house for a down payment on an FHA (Federal Housing Administration) loan and at least 10% of the total cost for a conventional loan. Need some extra help to stay in line with your spending? Try out budget tools like Mint.com or Budgetpulse.
What goes hand in hand with saving? Reducing your debt. According to Tim Kirchner, former Vice President of MetLife Bank in Irving, Texas, “Paying off debt tops saving in terms of priorities because of the interest payments on the debt, which exceeds the amount of interest they can earn on their savings,” Kirchner says. “Lenders want to see that you are managing your debt and keeping your credit card balances low.” If you’re unsure which debts to pay off first, check out this debt payoff calculator.
Finally, educate yourself! The average consumer has no idea what $100,000, $200,000, etc., will buy when it comes to housing. So, take tours of homes and neighborhoods in your area of interest to understand home values better. And remember, we are here to help!