Understanding how
much you can afford is one of the most important rules of home buying.
Depending on your individual situation, your budget can affect everything
from the neighborhoods where you look, to the size of the house, and even
what type of financing you choose. Bear
in mind, however, that lenders will look at more than just your income
to determine the size of the loan. Likewise, you may find that there are
some creative financing options that can help boost your purchasing power.
Loan
Prequalification vs. Preapproval
One of the best ways
to determine your budget is to have your real estate agent or lender prequalify
you for a loan. Prequalification is different from preapproval, because
it is only an estimate of what you'll be able to afford. On the other
hand, preapproval is a more formal process where a lender examines your
finances and agrees in advance to loan you money up to a specified amount.
What
factors are important to lenders?
Banks and lending
institutions will use several criteria to determine how much money they'll
agree to lend. These include:
Your gross monthly
income
Your credit history
The amount of your
outstanding debts
Your savings--or
the amount of money you have available for a down payment and closing
costs
Your choice of
mortgage (i.e. 30-year, FHA, etc.)
Current interest
rates
Two
important ratios
Lenders use your financial
information to figure out two very important ratios, the debt-to-income
ratio and the housing expense ratio.
Housing Expense
Ratio
It is generally difficult to obtain a loan if the mortgage payment will
be more than 28 to 33 percent of your gross monthly income.
Debt-To-Income
Ratio
Many lenders use a rule of thumb that the amount of debt you are paying
on each month (car payment, student loan, credit card, etc,) shouldn't
exceed more than 36 percent of your gross monthly income. FHA loans are
slightly more lenient.
Downpayments
Do Make a Difference
If you can make a
large down payment, lenders may be more lenient with qualifying ratios.
For example, a person with a 20 percent down payment may be qualified
with the 33 percent housing expense ratio, while someone with a 5 percent
down payment is held to the stricter 28 percent ratio. But there are other
ways to improve
your purchasing power:
Gifts
If you're having trouble saving money, many lenders will allow you to
use gift funds for the down payment and closing costs. Most lenders require
a "gift letter" stating the gift doesn't have to be repaid,
and will also require you to pay at least a portion of the down payment
with your own cash.
Negotiating Closing
Costs
Through negotiation, some sellers may agree to pay all or most of your
closing costs (for example, if you agree to meet their full asking price).
If you choose to try this, make sure to ask your real estate agent for
advice.
Loan Programs
The federal and local governments have special loan programs designed
to help first-time homebuyers. Loans may be available at reduced interest
rates, or with little or no down payments. We will help you determine
if you are quailified for one of these programs.
Loan Types
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low
initial interest rates. Others opt for 30-year loans because they have
lower monthly payments than 15-year loans. There are significant differences
between different loans, so we will discuss the pros and cons of each
type of loan with you before you make a decision.
