If you have started looking into buying a home, congratulations! Homeownership is hugely satisfying, and house hunting can be exciting. You’ll need to think about all of the features you want in a home, from the number of bedrooms to location to square footage.
As you start to browse homes for sale, you might be wondering about affording a house. There are some things to consider, including how much you have for a down payment and how much money you earn per month. We’ll walk you through the details so you can be armed with the information you need as you search for your dream home.
Knowing What You Need for a Down Payment
A down payment is the cash you will pay upfront for your home purchase. This is a percentage of the purchase price, so if you buy a home for $250,000 and put 10 percent down, you will need $25,000. Your down payment is your initial investment, and then a bank will loan you the rest, which is known as your mortgage.
The more money you put down, the better your chances for approval from a bank. However, there are some government programs that require as little as 3% down or no money down. There are also down payment assistance programs.
Consider other options in your circle for help with a down payment. Maybe you have a friend or a relative that can gift or lend you money.
When you put in an offer to buy a house, you will also need to make a deposit to the seller. This is called earnest money, and it shows the seller that you are serious. When you close on the house, the earnest money becomes part of your down payment.
Private Mortgage Insurance and Escrow
If you put less than 20% down on a home purchase, the bank will require you to get Private Mortgage Insurance (PMI). This is an extra amount that will be added to your monthly payment. It protects the lender in case you are unable to make payments in the future.
While PMI is going to increase your monthly payment, it allows people to get home loans when they have less than 20% in a down payment.
Also, when you put less than 20% down, the bank will require you to escrow for taxes and insurance. That means that instead of making your own tax and insurance payments when they are due, the bank will collect the monthly amount owed as part of your payment. The bank will then make these payments on your behalf.
If you have to escrow, you also need to make an initial deposit into an escrow account at closing. The bank wants to make sure it has the money it will need when the payment is due, plus a cushion for any potential increases.
Don’t forget to budget for closing costs! With a home purchase, there are additional costs that you’ll need to pay above your down payment. You’ll need an appraisal, title insurance, inspections, and more.
The bank will likely charge fees such as origination fees or closing fees. These can add up to thousands of dollars in some cases.
Affording a House: What the Bank Will Say
The bank is going to look at a few things when determining whether or not to approve your loan. First, the bank will look at your loan amount and your down payment. Next, the bank will look at your income and other debt.
Total Payment Per Month
Banks will look at your gross monthly income, or the amount of money you earn before taxes, and anything else is taken out of your paycheck. This will be determined by pay stubs or tax returns that you will need to provide.
The bank will then compare your gross monthly income to your total monthly housing payment. This will be the principal and interest of your loan payment, the real estate taxes you will pay on the home, your homeowner’s insurance, and any PMI. Typically banks don’t want this total monthly housing payment to be more than 28% of your gross income.
Other Debt Payments
Once the bank has compared your income and your total monthly housing payment, they’ll look at your other debt payments. These could be car loans, student loans, and minimum amounts due on credit cards. The bank will collect this information from your credit report.
The bank will add up all of these other debt payments to get an idea of the total amount you need to pay each month compared to your income. The combined total monthly housing payment plus other debt payments typically should not exceed 36% of your monthly gross income.
Your Credit Score
The bank will be looking carefully at your credit report, not only to determine your other debts but also at your credit history. The banks want to know that you make your payments on time for other loans and credit cards.
Your credit history is compiled into your credit score. Banks will rely heavily on your credit score in determining whether or not to improve your loan. A lower score is a signal to a bank that you have had some trouble making payments in the past.
The good thing is, you can raise your credit score with the right steps. If you have some time before you start looking to buy your home, you should do everything you can to improve your credit score before you apply for a home loan.
Different Mortgage Options
Different banks offer different types of mortgage programs. Some banks do their own mortgage lending. Others make use of programs such as Fannie Mae and Freddie Mac.
You can also choose the length of time to repay your loan, also known as the loan’s term. Home loans can be anywhere from 15 to 30 years in repayment. The interest rate you receive will depend on the term.
Loans with longer terms have lower monthly payments because the payments are spread over a longer period of time. However, you’ll also pay more in interest on these loans. Talk to different banks so you can know which mortgage option is right for you.
Your Other Monthly Expenses
Banks will only look at the payments that appear on your credit report. As you ask yourself about a home’s affordability, you’ll want to think about other obligations you might have that aren’t on your credit report.
For example, you may have child care costs and transportation costs. Think about utilities that you will pay and how much you spend on groceries. Your overall lifestyle will have a big impact on the affordability of your home.
Ongoing Maintenance Costs
Homes invariably have problems. From plumbing issues to roof repairs, they require constant upkeep. The biggest difference between homeownership and renting are the repair costs that are your responsibility.
One way to budget for maintenance or repairs is to use the “1% rule.” If your home is worth $250,000, plan to spend about $2,500 on home repairs per year.
Your ongoing expenses related directly to your home may also increase over time. The amount that you pay in property taxes and homeowners insurance will likely go up a bit each year.
If you buy a home that is more of a “fixer-upper” to save on initial investment, consider what the costs will be to do those repairs. You’ll also want to think about how quickly you want to make those improvements. If there are things that need to be addressed right away, see if you can get estimates from local professionals on potential costs.
Your Future Plans
The bank will also be unaware of your future plans and the impacts it will have on your monthly expenses. If you are planning a career change that will substantially impact your income, that is something to consider. Additional children or other major lifestyle changes will also affect your monthly costs.
Remember, your home is a long-term investment. Think about both your current and future needs when you’re evaluating the affordability of a home.
Preparing for Home Ownership
While this may seem like a lot of information to absorb, it will help you be prepared for what the bank will expect with a home loan and your own budgeting.
Affording a house is about more than just the monthly payment. A home affordability calculator can help you make the right decision.