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Are you probably asking yourself the question: How Much House Can I Afford?
Homeownership is undoubtedly one of the biggest financial decisions people make in a lifetime. The pride of ownership that comes along with it is fulfilling, and this also gives you and your family a sense of stability and security.
Since this is about making an investment in your future, you must then be asking: How much house can I afford?
Homeownership does bring a lot of responsibilities, so it’s wise to make sure you’re ready for it before you buy for the first time.
A higher percentage of people will prefer buying a home through a mortgage, unlike cash. Why? Cash buying could limit your options if other needs arise down the road, think renovations or repairs. Thus, it might make no sense to tie up a lot of cash to purchase real estate.
Cash buyers need to be sure to leave themselves plenty of liquidity. Thus, by opting to go with a mortgage, you can give yourself more financial flexibility, and be able to free up funds for other investments.
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What Is A Mortage?
A mortgage is a loan taken out to buy property or land. Thus, mortgages are a way to buy a home without having all the cash upfront.
Qualifying For A Mortgage
To qualify for a mortgage, lenders will consider the 5 Cs of credit to determine a potential borrower’s creditworthiness.
The 5 Cs of Credit refer to Character, Capacity, Collateral, Capital, and Conditions.
The applicant’s credit history will impact their character. Thus, lenders look into an individual’s track record of managing credit and making payments.
Past defaulted payments imply negligence or irresponsibility.
For assurance that you can take on a mortgage comfortably, lenders look at your income, current job stability, savings, employment history, and monthly debt payments, such as credit card charges among others.
The DTI ratio involves comparing your total monthly debts (for example, your mortgage payments including insurance and property tax payments) to your monthly pre-tax income.
Depending on your credit score, you may be qualified at a higher ratio, but generally, it is recommended that housing expenses shouldn’t exceed 28% of your monthly income.
For example, if your monthly mortgage payment, with taxes and insurance, is $1,500 a month and you have a monthly income of $6,000 before taxes, your DTI is 25%. (1500 / 6000 = 0.25)
You can also reverse the process to find what your housing budget should be by multiplying your income by 0.25.
In the above example, that would allow a mortgage payment of $1,500 to achieve a 25% DTI. (6000 X 0.25 = 1,500)
Lenders also consider your readily-available assets, including your investments, savings, properties, and other assets that you could sell fairly quickly for cash such as land, jewelry, etc.
These reserves prove that you can comfortably take on the mortgage.
Actually, borrowers who can place a down payment on a home typically find it easier to receive a mortgage.
In fact, larger down payments result in better rates and terms and help a borrower avoid the requirement to purchase additional private mortgage insurance (PMI), preferably, a down payment of 20% or more.
Usually, borrowers are required to pledge certain assets, such as the title of a parcel of land or financial assets and securities such as bonds, under their name as collateral.
Lenders will take these into account as security against the loan.
The conditions of the mortgage, such as its interest rate and amount of principal, influence the lender’s desire to finance the borrower.
Also, external conditions, such as the state of the economy, industry trends, or pending legislative changes.
How Much House Can I Afford?
Owning a home is fantastic; and buying the home of your dreams can be much fun and exciting.
However, before getting caught up in the excitement, ask yourself this question: How much house can I afford?
If you went house hunting and the backyard was a stunner, and the bathroom was fabulous, the tough truth is that if you can’t pay the mortgage for that house each month, then your home might be a burden!
Actually, many people recommend keeping housing expenses to 30% or less of your income.
Apart from considering what you can pay each month based on your income, you must be careful in your planning to ensure you don’t find yourself in a situation where your monthly payments eat up most of your income.
This results to a situation where you’re “house poor,” , thus making it a lot harder to afford your home’s upkeep or progress towards your other financial goals.
To get it right before you make the decision to go house hunting or looking into the real estate listings, consider the following recommendations:
- Detail your monthly budget, including all your household and housing related costs, and monthly savings among others.
- Set aside an amount for home repairs and maintenance. That ensures you’ll be able to afford repairs and even upgrades when necessary, without going for other home maintenance loans.
The 1% rule advises setting aside 1% of the home’s value for annual maintenance and repairs. So, if your house is worth $280,000, that’s $2,800 a year or $235 a month for maintenance.
- Next, deduct the amount of monthly house maintenance from the amount you budgeted for housing costs. The amount left over is what you can reasonably afford to pay as a monthly mortgage payment.
For instance, if your monthly housing (remove household costs) budget is $2000 and your house maintenance budget is $235, then you can comfortably afford to pay $1765 mortgage.
Can A Mortgage Calculator Help?
Based on your income, knowing how much you can reasonably afford to pay towards your mortgage each month is fundamental. But that is only one part of the financial puzzle.
The easiest way to calculate your monthly payment is to use a mortgage calculator.
Using a mortgage calculator allows you to play around with the variables to see what effect each one has on both your monthly payment and how much interest you pay over time.
The goal is to minimize the total amount of interest you’ll pay over the life of the loan, while keeping the mortgage payment at an amount you can comfortably afford each month.
To use the Monthly Mortgage Calculator, you’ll need to provide a few numbers to get the most accurate estimates of what your monthly mortgage payment could end up being:
If you would like to calculate all-in payments with other factors like PMI, homeowners insurance, property taxes, points & HOA fees please use this advanced calculator:
Mortgage Calculator Terms & Results Explained
Home price: the amount you are to pay for your new home.
Down payment: the amount you’re paying upfront toward the total cost of the home, usually, in the early stages of the agreement. It’s recommended to pay up a down payment of 20% of the home’s price to avoid paying private mortgage insurance (PMI).
Loan term: the period of time you’ll be paying off your loan. Usually, many prefer 30-year mortgages.
APR: This is the financing cost of the loan that you’ll pay over time with each monthly payment, expressed as a percentage (annual percentage rate, to be specific).
HOA fees: If your home is a part of a homeowners association (HOA), you may have to pay an additional monthly fee.
Mortgage size: This is the total amount you’re financing, including the purchase price of the home (minus any down payment) and sometimes closing costs or other fees.
Mortgage interest: This is how much it’ll cost you over time to borrow this amount of money. In other words, this is how much the lender will charge as payment for giving you the mortgage.
Total mortgage paid: This is how much you’ll pay back to the lender in total (the amount you borrowed plus the interest that will accumulate).
Estimated monthly payment: This is how much you’ll pay to your lender each month.
Property taxes: How much you’ll owe the government in property taxes. Our calculator’s default is on the high end of what you might pay, but you can get a more accurate estimate by finding out the specific rate for your potential property.
Homeowners insurance: Lenders require that you purchase homeowners insurance, and we have it set to the typical cost. Again, you can get a better estimate by entering a more accurate number for your situation, if you know it. (It’s worth getting a couple of quotes.)
What Costs Are Included in a Monthly Mortgage Payment?
Your monthly payment will be split up into three separate elements by your lender:
- Principal: This portion goes toward paying down your mortgage balance, the original amount you borrowed.
- Interest: This portion goes into the lender’s pocket. It’s their fee for lending you the money.
- Escrow: This goes into a “holding fund” (an escrow account) that your lender or mortgage servicer uses to pay your property taxes and homeowners insurance. They use this holding fund to make sure these crucial bills get paid. Once your mortgage is paid off, you’ll have to pay your property taxes and homeowners insurance on your own.
The above costs are included in every person’s monthly mortgage payment.
However, depending on your situation, you may also need to budget for these fees:
- PMI: If you make a down payment of less than 20% with a conventional mortgage, you’ll need to pay an additional payment for private mortgage insurance. Certain other loans, like FHA or USDA loans, also require a similar monthly payment (mortgage insurance premium, or MIP) regardless of the size of your down payment. These costs will usually be added to your monthly mortgage payment.
- HOA fees: As noted above, if your new home is within a homeowners association (HOA), condominium, or co-op, you’ll need to pay its fees either monthly or quarterly. Often, this cost won’t be included in your mortgage payment, and you’ll need to pay it on your own.
Lowering Your Monthly Mortgage Payment
If your home mortgage bill feels like it’s crushing you, you want to lower the monthly payment.
Here are ways you can lower your mortgage payment:
1. Maximize Your Down Payment
Your down payment amount makes a big impact on how much home you can afford.
The more cash you put down, the less money you’ll need to finance. That means lower mortgage payments each month and a faster timeline to pay off your home loan!
2. Avoid PMI
Generally speaking, it is worth taking the extra time to save for a big down payment. This will help you avoid paying PMI.
PMI ( private mortgage insurance ) refers to insurance that lenders require borrowers to have when getting a mortgage yet they don’t have enough equity in the home.
To avoid this extra expense, home buyers are required to come up with a 20% down payment when buying a home.
However, if you bought your home with a down payment that’s less than 20 percent, that means you might be paying PMI that adds hundreds or thousands to your mortgage each year.
3. Clear your PMI ASAP.
When you close on your home, you’ll have the option to pay your private mortgage insurance upfront if you didn’t put 20% down.
Instead of having to pay extra on your mortgage year after year, you can just take care of PMI by paying a one-time fee.
4. Get a Longer Loan
Suffering under the hefty monthly payments that come with 15-year or 20-year mortgages? Then extend your mortgage into a conventional 30-year term to cut your monthly payment.
While this works, it increases your interest rates. Good enough, you can still choose to make additional payments on the mortgage as if you were paying a 15-to-20-year loan.
Such extra payments will help you satisfy the loan more quickly, without obligating you to make massive payments-especially if there’s an emergency that requires cashing in.
5. Refinance Your Mortgage
Refinancing a mortgage involves getting a new home loan to replace your existing one.
Thus, you may be able to save money especially if you can refinance into a loan that has a lower interest rate than you’re currently paying.
Most homeowners opt for a straight rate-and-term refinance that can allow them to pay less in interest or reduce their monthly payments, thus, giving them a comfortable repayment term.
Some want a lower monthly payment to free up money for other expenses, such as college tuition while others go with a cash-out refinance, in which they borrow more than they owe on the home and use the cash to retire credit card debt, pay for home renovations or some other major expense.
So, should you refinance? That will depend on the age of your loan, and the difference between your current and potential new interest rate.
Home loans amortize, meaning, you pay mostly interest towards the beginning of the loan term and mostly principal towards the end of the term. Thus, the interest rate is most important towards the start of a term.
This means, the newer the mortgage, the more you should consider refinancing. You can use this Refinancing calculator to compare your remaining loan term against the interest you will pay if you refinance.
6. Appealing Your Property Tax Assessment
It can be hard to balance the desire for a beautiful home with the desire to pay as little tax as possible.
However, you can reduce your property tax burden by avoiding making any improvements right before your house is due to be assessed, and checking out if your neighbors pay less tax than you but own a similar home to be in line for a tax reduction.
If you’ve done all you can and haven’t managed to get your tax assessment office to see things your way, you can consider appealing your assessments, which is a key step in lowering property taxes.
7. Rent out Part of your Home
Renting out part of your home to a trusted tenant comes with additional income for you. Thus, this can reduce the cost of your monthly mortgage payment.
A good place to start is on Airbnb, so you can make more money with your home.
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Buying a house is typically your biggest financial decision and it needs to be the right one. If you want to settle your family in your house, then you should consider asking yourself the important question ‘How Much House Can I Afford?’.