Rodney Campbell, BrokerLicense # 613021 Stewart and Campbell Real estate, LLC., Keep Austin Weird Homes LLC.,(512)740-6486 AustinTexasAgent@gmail.com
Finding Your Home Price Range
Most of us know how much money we can spend this month on groceries or whether we could afford to move into a bigger apartment next year. We may not know exactly how much house we can afford.
Real estate prices vary throughout the country. If you’re buying in Manhattan or San Francisco, the $188,000 median home price may buy you a storage closet. (Shop around enough and you may find one with the light bulb included!) In other markets, $188,000 may get you 2,500 square feet of house on a couple acres.
What matters, though, is this:
Could you afford a $188,000 mortgage?
If not, what is your price range?
How to Find Out How Much House You Can Afford
Everybody faces different financial challenges and has different demands on their monthly budgets. Only you can know for sure about your situation.
However, many financial advisors recommend spending no more than 25 to 28 percent of your annual income on housing.
Let’s take this idea for a spin: We’ll say you earn $96,000 a year.
25 percent of $96,000 = $24,000 a year for housing
$24,000 a year divided by 12 months = $2,000 a month for housing.
Most people like to include homeowners insurance premiums and local property taxes into their housing budget. Let’s go with $200 a month for insurance and $200 a month for property taxes for a total of $400 a month.
$2,000 a month housing budget – $400 for insurance and taxes = $1,600 a month for a mortgage.
You can buy a lot of house in many markets for $1,600 a month.
Remember, though: This 25 percent rule may not work for you if you have significant demands on your monthly budget.
If you borrowed $100,000 to get an advanced degree from an elite university, or if you already have heavy debt from other property purchases, adjust your estimates accordingly.
Your ultimate goal will be to find out how much house payment you can afford, reliably, every month for up to 30 years. Your number may be only 15 percent of your income; it may be 35 percent.
I say “up to” 30 years because you can get mortgages with a variety of terms, and these terms have tremendous influence over how far your house money will go.
We’ll go into these details next.
Knowing the Right Kind of Mortgage
Mortgages vary widely. This can be good or bad for you, the consumer.
It’s good when you have learned about the market and you find a product to fit your exact needs. It’s not so good, though, if you wind up with a mortgage that doesn’t match your needs.
In fact, getting the wrong mortgage can be devastating to your personal finances.
If, for example, your interest rate increases after the first couple years because you got a variable rate, your house payment could suddenly become unaffordable.
Interest rates aren’t the only variables you should know about:
You may hear the word “term” when you’re investing, getting a mortgage, or even getting a new life insurance policy. It usually refers to a specific amount of time. In the case of your mortgage, your term is the length of time during which you’ll owe money on your house, assuming you pay it off on schedule. A 10-year mortgage spreads your debt across 10 years. If you take the same debt and spread it across 30 years, you’ll have a lower monthly payment.
But by hanging onto the debt longer, you’ll pay more in interest.
How much more?
Let use $175,000.00 mortgage as an example:
30-year fixed term: At 4 percent interest, you’d pay $835 a month but also pay $125,000 in interest charges over the life of the loan. Your $175,000 house would cost you about $300,000.
20-year fixed term: At 4 percent interest, you’d pay $1,060 a month and pay $79,500 in interest charges over the life of the loan. Your $175,000 house would cost you about $254,500.
10-year fixed term: At 4 percent interest, you’d pay $1,772 a month but pay only $37,615 in interest over the life of the loan. Your $175,000 house would cost you about $212,600.
As you can see, a shorter term costs more in the short run but saves tremendously over time. The difference between a 10-year and a 30-year mortgage in our example above is about $87,400.
Which is why finding the right term matters so much. If you can afford the payments on a 10-year loan, by all means, take advantage of those long-term savings.
If you can afford only a 30-year loan, that’s OK too.
Yes, you’re paying more, but at least you’re getting a foot in the door of a more stable financial future without blowing up your monthly spending plan. Later on, you could refinance with more favorable terms.
Fixed vs. Adjustable Interest Rate
So far we’ve discussed only loans with fixed interest rates. With a fixed rate loan, your interest rate — and, as a result, your monthly payment — remains the same throughout the life of the loan, even if it’s 30 years or longer.
Not all mortgages have fixed rates, though. You can also get a loan with an adjustable interest rate. As your interest rate changes, usually in, response to a specific rate index, your payment will rise or fall accordingly.
This sounds scary, and it can be, but an adjustable rate mortgage (ARM) is not a total free for all. With most ARMs, the rate stays the same for a specified amount of time, then begins to change each year.
A 3/1 ARM, for example, keeps its introductory interest rate for three years, then the rate adjusts annually. So it’s not like your mortgage payment would be a moving target month to month.
Even so, not knowing year to year how much you’ll be paying creates too much instability for many homeowners. Sticking with a fixed rate keeps things simple. You may be wondering who would want an ARM, anyway?
Here are some times to consider it:
When you plan to sell the property quickly: Most ARMs offer introductory rates below a fixed rate. If you plan to sell the property before the introductory rate expires, you can save month to month while you own the property. This may be the case if you plan to flip the house.
When you expect to have more money in the near future: An ARM’s lower introductory rate (and resulting initial lower payment) can help you buy a more expensive house than you may be able to afford with a fixed rate. If you’re expecting to start earning more in the next few years, an ARM can give you this flexibility. An ARM may also be a good fit if you’re about to pay off another loan, creating more flexibility in your monthly budget.
If economists expect a decrease in rates on the horizon: These things can be too hard to predict, but if you’re buying a house during a period of high-interest rates and you think rates could be going down soon, an ARM could set you up to enjoy lower rates in future years without having to refinance. You should check with a financial advisor to get the best idea about future rate projections.
Remember, too, that an ARM doesn’t have to leave you completely exposed to the whims of the market. Many adjustable rate loans offer caps on rate fluctuations or caps on payments.
These caps work pretty much like you’d expect. With a cap on your monthly payments, for example, even a skyrocketing interest rate will increase your payment only up to the maximum amount allowed by the loan’s cap.
Be careful with these caps, though. Just because you’re insulated from excessive payments doesn’t mean you’re insulated from the interest charges.
Sooner or later you’ll have to pay those charges. Chances are your bank would add them to your mortgage balance, meaning what you owe could keep increasing even as you make your scheduled payments.
Conventional vs. Government Loan
So far we’ve discussed conventional loans which banks, credit unions, and mortgage finance companies offer. You fill out an application, the loan officer checks your credit score, and you usually need to put some money down.
Not everyone can qualify for a conventional loan. Maybe your credit score isn’t quite high enough yet. Maybe you can’t come up with a five-figure down payment.
Enter the federal government, which helps homebuyers through a variety of programs, giving people with lower credit scores and people with limited financial flexibility another route to home ownership:
FHA Loans: With an Federal Housing Administration loan, the federal government removes the risk to the mortgage lender. If you defaulted on your mortgage, the federal government would re-pay the bank. (You’d still lose the house, but the bank wouldn’t lose money.) Because of this guarantee, banks can offer borrowers with lower credit scores lower interest rates, lower down payments, and lower closing costs.
USDA Loans: The federal Department of Agriculture also guarantees mortgages, leading to favorable terms for eligible borrowers. These loans often come with income requirements and a higher standard for credit scores than an FHA loan.
VA Loans: The Department of Veterans Affairs backs mortgages for active duty military personnel along with veterans and immediate family members of veterans. These loans often require no down payment, no credit minimum to apply, and the ability to negotiate the payment with help from the VA if necessary.
This list simply hits the high points for government loans. Other programs include loans to help make your home more energy efficient and loans to help Native Americans buy a house. You can find a more comprehensive list here. The question is, should you get help from Uncle Sam to buy a home? When you need the help, it’s a no-brainer. If you’re living paycheck to paycheck and just can’t find a way to save $20,000 for a down payment, these programs can help get you in a home so you can stop paying rent and start building equity.
IF YOU CAN GET A CONVENTIONAL LOAN, THOUGH, YOU SHOULD BE AWARE OF SOME DRAWBACKS TO FEDERAL PROGRAMS:
Caps on loan amounts: If you’re spending more than $424,000, you’ll have to go conventional.
Private Mortgage Insurance: With a conventional loan you can avoid paying for PMI by putting down 20 percent of the new home’s value. You can also stop paying PMI when you’ve paid off at least 20 percent of the home’s value. FHA loans require PMI for the life of the loan.
Must be owner occupied: You couldn’t turn your property into a rental — at least not until you pay off the mortgage — if you got a federally subsidized loan.
Condition requirements: If you’re buying a fixer-upper, a federal loan may not approve your purchase because of problems like lead-based paint that may be present in older homes. I’ve heard of home buyers having to get a house painted before the government would OK the loan. Not a deal breaker, but a potential hassle.
When you need help getting into a home, and you plan to live in the home, a federally backed loan program is a great benefit.
If you don’t need the help and you’d like more control over the process, go for a conventional loan first.
Finding the Right Mortgage Lender
Surveys consistently show about 75 percent of recent homebuyers have one thing in common: They applied for only one mortgage loan.
These same new homeowners probably wouldn’t have bought the first smartphone or the first pair of boots they came across in a store.
So why take the first mortgage that comes along?
I have a hunch the answer has something to do with how hard it is to apply for a mortgage. All the paperwork and the income documentation and the disclosure of personal financial records.
Who wants to do that over and over?
Why Does it Matter Who Loans the Money?
Here’s another reason people often apply for only one loan: They think the mortgage lender will sell their loan to another bank anyway.
And they’re right.
Many loans get kicked around between three or four banks before they’re paid off.
To me, though, this is a reason to get the most favorable terms you can find, which you can do by applying for several loans.
Why? Because while your lending institution may change as the years go by, the lending terms will remain the same: your interest rate, your term length, etc.
How to Shop Around for Lenders
Thankfully, the good ‘ole Internet makes comparing mortgages a lot easier. You can find details, get quotes, compare features, etc., without going to all the trouble of applying for the loan.
Many different kinds of financial institutions offer mortgages, so first things first: narrow down your choices.
REMEMBER, YOU’LL BE TALKING ABOUT YOUR INCOME, SHARING BANK STATEMENTS, AND TALKING ABOUT YOUR FUTURE PLANS:
Do you want to sit down and talk about your options? If so try a neighborhood bank.
Are you OK handling the transactions entirely online? An online-only bank or lender like Rocket Mortgage can offer great rates.
Do you plan to get a federally subsidized loan? Be sure you find a lender authorized to handle such a loan.
Do you want to deal with people you already know? Go to your primary bank.
Are you searching for the best rates at a neighborhood bank? You may find them by joining a local credit union.
When you know what kind of organization you’d like to deal with, compare three or four different organizations.
Some institutions may have special programs if you’re a first-time buyer, an investor, planning to make the property environmentally self-sustaining. Other places might have promotional rates or may be able to waive the loan origination fee.
Basically, treat your new mortgage with the same scrutiny you’d expend on new curtains or your next summer read.
Getting Pre-Approved for Your Mortgage
After you have found the right lender, it’s time to start the pre-approval process, assuming, of course, you’re ready to move into home ownership.
Some homebuyers skip this step and simply apply for a mortgage after finding the right house. I wouldn’t call that wrong or irresponsible, especially if you’ve bought homes before.
However, if you appreciate more certainty in life, a pre-approval from a mortgage lender will be right up your alley.
Once you’re pre-approved you’ll know how much money your lender will let you spend. You’ll have a much better idea about your monthly payments, too.
For many buyers this can be helpful knowledge as they tour homes and consider variables. For example, if you loved a particular home but it needed a new roof, knowing your pre-approved limit could help you negotiate with the seller.
It’s kind of like grocery shopping. When you know exactly how much money you can spend on food, you tend to make more informed shopping decisions.
Remember this while you’re shopping, though: Your pre-approval amount may exceed your actual budget. Just because your bank says you can finance up to $200,000 doesn’t mean you could afford the payments on a $200,000 loan.