As you start dreaming about buying a home, it’s important to think about how much house you can afford. It’s easy to start fantasizing about large, four-bedroom houses in the nicest part of town, but that may not always be realistic. Finding the sweet spot for your budget is essential for honing in on housing options that meet your needs and also fit with your financial goals.
To determine what type of home you can afford, it’s important to familiarize yourself with the market in your area, conduct a thorough review of your financial situation, and explore ongoing costs like property taxes and homeowners insurance. Once you have a handle on these factors, you’ll be able to quickly sort through your options and be well on your way to owning a new property.
Understanding the Basics of Home Affordability
Housing is one of the major living costs you need to factor into your budget, regardless of whether you rent or own your home. However, buying a house requires a bit more planning and budgeting than getting approved for a rental property. It involves saving up for your initial down payment and ensuring that your monthly payment will be affordable for years to come. As a result, you need to assess your current savings and your regular income to determine a reasonable price range for your house.
The Centrality of Income in Determining Your Price Range
Unless you have massive stores of cash to purchase a home outright, you’re probably going to need a mortgage to finance your house. Because a house is a huge investment, you’ll likely be paying off your mortgage for decades, and you need to make sure the monthly payment is something you can afford with your current income.
If you’ve ever rented an apartment in the past, you may have been required to prove that you make a certain amount, such as three times the rent, in order to qualify for your rental. Buying a home is similar, and you’ll need to be able to prove that you have a consistent income to help you pay for your housing costs. Mortgage lenders will look at your income to determine how much money they’re willing to loan you and help you figure out a payment plan that fits with your salary.
Key Factors Affecting Affordability
Your income isn’t the only factor that influences the type of home you can afford, however. You may be approved for different types of mortgages and loans depending on your overall financial health. Here are a few of the main details to consider as you start to look at properties.
Exploring Down Payment Implications
When you buy a house, you usually need to put some money down. Your down payment will be a percentage of the overall cost of the property. The more you put down, the less you’ll have to pay off over time. Lenders have different standards for down payments, but there are several affordable options that only require a small percentage upfront.
One of the most affordable options is Federal Housing Administration (FHA) loans, which require a minimum payment of 3.5% of the total purchase price. So, if you want to purchase a $300,000 home, you’ll need to spend a minimum of $10,500 on your down payment. If you have more saved up, you can put more down to potentially qualify for lower interest rates, get a shorter mortgage term, or secure a more affordable monthly payment.
Recognizing the Impact of Debts and Credit Score
Your overall credit history and debt-to-income ratio can also make an impact on the type of loan for which you’ll qualify. If you have a high credit score and a strong history of paying back your debts on time, a bank may be willing to lend you more money at a lower interest rate. Similarly, banks may view you as a high-risk applicant if you have a low credit score and lots of outstanding debts. To reduce their risk, they may only approve you for a smaller loan or charge you a higher interest rate to offset potential losses.
The Significance of Location and Market Trends
Housing costs can vary wildly from place to place. Certain locations have booming real estate markets, while other areas have much more affordable housing options. Even neighborhoods in the same city can have completely different average housing prices. Your bank will also consider your new neighborhood when determining your interest rate because of variations in market trends, repossession rates, appreciation rates, and other factors that can vary by location.
Along with your monthly housing costs and interest rate, your location can also impact other incidental payments like insurance and property tax rates. Make sure you understand how moving affects your auto and homeowners insurance rates by researching average premiums in the areas you’re considering.
Navigating Through the Mortgage Maze
A mortgage is often one of the first major loans people take out. The process of applying and getting approved can be complex, but having just a bit of basic knowledge can help you secure a loan that sets you up for financial success.
Choosing the Right Mortgage: Term and Type
Mortgages come in all shapes and sizes. There are a few common types of home loans, which have different structures and requirements.
- Conventional loans, which are insured by private lenders and are widely available from most major lenders.
- Government-backed loans, such as FHA loans, which are insured by the government and designed to help more borrowers qualify for mortgages.
- Jumbo loans, which are for high-value properties and often require high credit scores and down payments.
- Fixed-rate mortgages, which will have a locked-in interest rate for the entire duration of your loan.
- Adjustable-rate mortgages, which have interest rates that change over time and are often ideal for people who don’t plan to stay in their home long-term.
Mortgages also have different lengths, typically ranging from 10 to 30 years. The longer your loan term, the lower your monthly payment. However, you’ll probably pay less total interest if you choose a shorter term.
Interest Rates and Their Long-Term Effects on Affordability
A major part of your home loan is the interest rate. Your rate can vary based on the current annual rate set by the fed, your financial profile, credit, debts, down payment, and other factors. The lower your interest rate, the less you’ll pay over the life of your loan. It’s important to note that if you get a variable interest rate that changes with the market, you could end up paying more or less in interest each month, so you may have to budget for fluctuations.
Mastering the 28/36 Rule for Financial Health
The 28/36 rule is a well-known financial standard you can use to calculate mortgage affordability. According to the rule, your housing costs shouldn’t take up more than 28% of your gross income, and you shouldn’t spend more than 36% of your income on your total debts. Lenders will look at your potential housing costs and current debt payments, then use the 28/36 rule to determine what kind of mortgage payment is affordable.
Applying the 28% Front-End Ratio in Real-Life Scenarios
If you’re wondering how to calculate potential mortgage payments using the 28/36 rule, start by assessing your total gross income each month. For example, if you make $60,000 per year before taxes, you gross about $5,000 per month. That means your combined housing costs should be less than $1,400 per month, including your mortgage, insurance, and other fees.
Keeping Within the 36% Back-End Ratio for Financial Stability
Additionally, your total debt payments should add up to less than 36% of your gross income each month. In this scenario, you could spend up to $1,800 on both your mortgage and your debts. For example, if you had a $1,000 mortgage, you would have $800 to spend on car payments, student loans, credit cards, and other debt payments. This helps ensure you can keep up with your debts and avoid defaulting on any of your loans to pay for other living expenses.
Additional Costs to Consider in Your Budget
The sticker price of your home isn’t the only thing to consider when planning a budget. There are a few other factors to keep in mind.
Property Taxes, Insurance, and HOA Fees
As a homeowner, you’ll need to pay property taxes on your home each year. Rates can vary depending on where you live, with some areas charging less than 0.5% and others charging over 2%. Other costs include insurance to protect your investment and homeowners association fees if you live in an area with an HOA. Researching homeowners insurance for first-time homebuyers and exploring average taxes in your area can help you build these costs into your monthly budget before you buy.
Maintenance, Renovation, and Unexpected Costs
When you first start researching new homes, you’ll need to assess the current state of the house. Some properties are cheaper upfront but require significant repairs, maintenance, and renovations. Make a checklist of things to look out for in an open house, and carefully review the house inspection to make sure you have a good idea of any essential renovations and ongoing maintenance costs.
As a homeowner, you also want to plan for unexpected costs. If your HVAC system goes out or you need to repair your roof, you’ll need some wiggle room in your monthly budget to cover the expenses.
Ready to Buy Your New Home? Get a Quote on Homeowners Insurance
Carefully reviewing your finances before you start the house-hunting process is the best way to set yourself up for success. Review your savings, debts, credit history, and regular income to get an idea of what kind of loans you’ll be able to secure. When building your budget, it’s also critical to think about the kind of mortgage you want, and factor in incidental expenses like property taxes, interest rates, and HOA fees. Choosing a house within your means will ensure you can keep up with your expenses and protect your financial future.
Buying a new property is an exciting time, especially for first-time homebuyers. Once you find a house you love, you need to make sure it’s fully covered by getting the right homeowners insurance policy. Here at Freeway, we can help you find the protection you need at a price that works for you. Head down to a local Freeway Insurance office, get an online quote, or call 800-777-5620 to set up your homeowners policy today.
