Budgeting For a Home
For most people, buying a house is not a spontaneous decision. It takes time to prepare your finances for a mortgage, to clean up your credit to get the best rates, and to save up for a down payment.
How Much House Can I Afford?
The most important factor when deciding to purchase a home is the monthly payment. Take a look at your finances and determine how much you can comfortably pay each month toward your mortgage.
The key word here is “comfortably”.
If purchasing a home will force you into a position where you’re struggling to pay your bills, you may need to think about a less expensive home or cutting back in other areas, like eating out or taking vacations, until you’re able to afford and save for what you want.
When calculating your monthly payment, don’t forget to include expenses like homeowners insurance, taxes, homeowners association fees, and private mortgage insurance (PMI) if applicable. In addition to a down payment (see below for more on this), you should also have the money for inspections, closing costs, and moving.
Once you have determined how much you can afford, talk to your lender. They should be able to tell you the price range of houses in your budget.
Typically, lenders would like to see that your mortgage payment (including principal, interest, taxes, and mortgage insurance) is less than 28% of your monthly gross income. This is known as your housing expense ratio.
Getting a Good Interest Rate on Your Mortgage
Now that you know how much you can afford to pay each month, you want to qualify for a low interest rate on your mortgage.
The biggest factor in determining your interest rate is your credit score.
A high credit score will help you get a lower interest rate, while a poor credit score will likely lead to higher interest rates or even disqualify you for a loan.
If you’re not sure what your credit looks like, request your free annual credit report. Make sure the report is accurate. If it isn’t, call the companies reporting the mistakes and ensure that they fix the errors. It is important to do this early on, as it can take months for changes to be reported and reflected in your credit report.
Of course, you will also want to make sure that you don’t miss payments or make late payments while you’re preparing to apply for a mortgage.
A large factor in your credit score is the amount of outstanding debt that you have verses the amount of credit you have available. Revolving credit lines that are close to the maximum amount of credit available will cause your credit score to drop.
To qualify for most mortgages, your total DTI should be less than 40% of your monthly gross income.
Start by paying down balances with the highest interest rates, and do this before you start saving for your down payment. The less debt you have when you apply for a mortgage, the better.
Saving For a Down Payment
Once you’ve paid down your debt and cleaned up your credit score, it’s time to start saving for your down payment. The more you put down on your home, the less you will have to borrow for your mortgage. Your monthly payment will be lower, and you will pay less interest over the life of the loan.
Conventional loans typically require a 5% down payment, while FHA loans require a down payment of 3.5%. If you’re looking to avoid paying private mortgage insurance (PMI), your down payment will need to be at least 20%.
While putting 20% down may seem like a lot, it may be worth it. If you’re required to pay private mortgage insurance, the fee will be added to your monthly mortgage payment.
Start saving for a down payment as soon as you can. One easy way that you can start saving is to set up an automatic bank draft from your employer:
- First, open a savings account for your down payment.
- Next, determine the difference between your current rent payment and your expected mortgage payment.
- Then, set up your bank draft so that this amount is automatically deposited into the savings account every month.
This will help you to both save and prepare you for your mortgage payment.
If you’d like to learn more about the home buying process, or if you have any questions, feel free to come in and talk to a mortgage specialist at a branch near you.