The largest purchase you will ever make in your lifetime is likely a home. You do not want to end up with a mortgage that you can’t comfortably pay, so it’s important that you have a realistic picture of what your budget will allow. There are many factors that should be considered when determining home affordability. Before you speak with a lender about the amount and type of loan or head out to house hunt, it’s a good idea to be informed and equipped with some helpful information.
To help understand your situation, it is important to gather all documents you’ll need for your pre-approval process. You’ll need several documents for pre-approval and to determine how much house you can afford. Gather all statements from bank and investment accounts, pay stubs and W2 forms, documents on assets including properties, statements on debts, including loans and credit cards, your credit score, and gift letters if you’re using a gift for the down payment.
How much home you can afford depends on your annual income, location, down payment, and your monthly debts and spending. Once you determine your monthly income from your statements and documents, the general rule is that you should not spend more than 28 percent of your monthly income on housing-related expenses and no more than 36 percent on debts and loans, such as a new mortgage.
This general rule was created to ensure that the remaining percentage left over will allow for food, gas, vacations, savings, and other needs. These percentages serve as general guidelines and could vary based on individual needs. You will need to also consider ongoing costs for the home, including repairs, property taxes, and utilities, as well as closing costs.
Your debt-to-income ratio and credit score are significant factors in determining your affordability. Your debt-to-income ratio compares your monthly income to your monthly debt. As for your credit score, the higher the score or range you fall within, the lower the interest rate you’ll likely be offered. Even a half a percent can make a large difference in what you’ll owe over time.
The standard down payment is 20 percent, although some mortgage loans are designed to allow for a down payment as small as 3.5 percent or even none at all, depending on the type. Although, the higher your down payment is, the lower your monthly mortgage payment will be, since your down payment reduces the total amount of your home loan. Your lender can review your options.
Your monthly payment is determined based on the duration of the loan and the interest rate. The longer the term, generally the lower the monthly payment, but you’ll pay more over the lifetime of the loan. The more you save for a down payment and the better your credit is, the more likely it is that you’ll qualify for a lower interest rate and have a lower overall payment. Even a slight difference in the interest rate will impact your total amount paid.
For example: a 4 percent APR on a 30-year loan could have a monthly mortgage payment of $1,432 with a total paid of $515,609 while the same loan duration at a 4.5 percent APR could result in a monthly mortgage payment of $1,520 with a total paid of $547,220. Just a half a percent can affect the overall loan by over $30 thousand.
Homeowners insurance is a combination of property insurance, which protects you from threats including weather and vandalism, and liability insurance, which protects you from lawsuits or third-party claims. This insurance expense varies based on the type of property and the amount of coverage. This insurance is included in your monthly mortgage payment. Additional insurance, called private mortgage insurance, is required for borrowers in cases where the down payment is less than 20 percent.
If you have questions about how a home purchase fits into your overall financial plan, it’s always a good idea to seek the guidance of a financial advisor or financial professional. Please schedule an appointment on Bayntree’s online calendar by selecting the date and time that is most convenient for you! You can also always reach us by emailing info@bayntree.com.
Bayntree Wealth Advisors provides comprehensive financial planning and wealth management. The Bayntree team specializes in all aspects of financial health, including retirement planning, risk management, investment advice, tax strategies, estate planning and insurance.
Bayntree does not provide specific legal or tax advice. Please consult with your tax advisor or legal professional for guidance with your individual situation
