Affordable Homes

Unlike most home buyers, you want to buy a house in a particular price range, not simply the house that you can afford under your current financial circumstances. You want the house of your dreams, and you want it now.

Most articles about mortgage affordability start with your income and your debts, and then proceed to tell you how much of a mortgage you can afford. In this article we’re going to start with the price range of the home you want, and then figure out how you can afford it.

The four major factors in determining the amount of credit a lender will extend to you are your income, your debts, your credit history and, in the case of mortgages, the amount of your down payment. If you currently don’t qualify for a mortgage for the house of your dreams, you’re going to have to change one or more of those factors.

Let’ s use $250,000 a hypothetical price of your dream house. Let’s also assume that you have $18,000 for a down payment, so you’re borrowing $232,000. If we use a monthly mortgage calculator, we find that the monthly payment on a $232,000 mortgage is $1390.95 at 6% on a 30 year fixed. This is assuming zero property taxes and zero insurance payments. If you know what the property taxes would be on your dream house, plug that number into the calculator, and do likewise for insurance.

If you don’t know the property tax and insurance costs, let’s just use $900 a year for insurance and $6000 a year for taxes. Using the mortgage calculator, we now find that the taxes and insurance have raised the monthly payment to $1965.95. (Makes a great argument for living in a low-tax state, doesn’t it?).

Can you afford to pay $1966 a month? Even if you think so, the underwriter who will be examining your mortgage application may not. The rule of thumb for underwriting is that a mortgage payment should not exceed 25% to 28% of an applicant’s monthly pre-tax income. So, to qualify for a $1966 a month payment, you (or you and your spouse) will need to have a monthly pre-tax income of $7021 ($84,252 per year) at 28% to $7864 ($94,368 per year) at 25%.

If your monthly household income is already at these levels, you can move on to your debts. If not, you’re going to have to do one of two things: make more money, or get a larger down payment.

Can you work a second job? Is overtime available to you where you work? Can you find a way to get promoted to a higher-paying position? These are the obvious questions. What’s not so obvious is that, even if you increase your income to the required level, you’re going to have to be at that increased income level for at least a year. Underwriters want to see at least one year’s tax return showing the increased income level. Ideally, you’ll want to show them three years.

What if there’s no chance of increasing your monthly household income to those levels? If that’s the case, you might want to ask yourself if you should really be buying that house. If it’s still your dream and you want it, then you’ll need to increase your down payment in order to reduce the amount you’re borrowing.

Do you have an extra car you can sell? What about a motorcycle, boat, hunting cabin, or any other luxury items you own?

What about your parents or other relatives? Would they be willing to give you money for the down payment? By law you cannot borrow money from them for a mortgage, but they can legally gift you money without you having to pay tax on it.

Reaching that 25% to 28% point doesn’t have to involve only increasing your income or increasing your down payment. If you can increase your income to some extent, and put the extra money away for your down payment, you just might be able to reach the underwriting goal. Let’s say that you increase your income and are able to save another $10,000 for a down payment. If you can do that, your monthly income requirement is reduced to $6807 ($81,686 annually) at 28% to $7624 ($91,488 annually) at 28%.

Keep plugging numbers into that calculator and, chances are, you’ll find a way to reach that 25% to 28% threshold. Maybe it’s a combination of increasing your income, selling off some things, and asking parents or relatives for money.

Let’s say that you’ve reach the threshold. What about your debts? Another component of underwriting is your debt to income ratio, which is the amount of long-term debt payments as a percentage of your monthly pre-tax income. Long-term debt is your mortgage payments, car payments, credit card payments or any other regularly scheduled financial obligations. A rule of thumb is that the debt to income ratio should be 33% or better. If you’ve managed to increase your income to the $7021 a month mentioned earlier, the total of your mortgage payment and other monthly debt payments should not be more than $2338 per month. If your mortgage payment is the $1966 per month figure mentioned earlier, you’re left with just $372 a month for car payments, credit card payments, or other debt payments.

Some lenders will set the debt to income ratio at even lower than 33%, while others will be more lenient and go as high as 38%. Be cautious about lenders who are too lenient, though. In the last couple of years we’ve seen what’s happened to millions of people who got mortgages under “relaxed” standards.

OK. You’re working 50 hours a week, or you sold your ’69 Camaro, or your parents gifted you $5000 as an advance on your inheritance, or maybe you did all three. You’re not out of the woods yet, though. You still have your credit history and credit score to deal with.

Your credit history and credit score will play a major role in determining the interest rate you get on your mortgage. If your credit score is below 620, you’re going to have a hard time getting a mortgage, especially these days. If it’s between 620 and 700, you’ll likely get the mortgage, but you won’t get the best rate (which is the one you always see advertised). If your score is over 700, you’re going to get a very good rate and, if your score is close to 800, you’ll get the best rate.

While you’re getting your other financials in order, get a copy of your credit report. Look for mistakes. Look for anything that reflects poorly on you and see if the problem can be fixed, and the issue removed from your report.

You may not have any problems on your credit report, but still have a major problem in that you don’t have any history of making debt payments. That’s right: not having borrowed money before can work against you. If you think about it, though, it makes sense. How is a lender supposed to know how you’ll handle your debts if you’ve never had debts before? If you’re in this spot, get a credit card, pay for some purchases with it, and pay the balance promptly.

With the right strategy and enough effort, you can get the home you really want. However, be sure to not neglect other aspects of your life, such as entertainment, hobbies, or vacations. There’s more to life than paying bills.

Richard A. Baker is the publisher of BuyYourHomeGuide.com More information on this topic can be found at “How To Afford The House You Want”, here

2007 BuyYourHomeGuide.com

Author: Richard A Baker
Article Source: EzineArticles.com
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This entry was posted on Monday, July 19th, 2010 at 9:18 pm and is filed under AFFORDABLE LIVING. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.