What You'll Learn
- How much home you may be able to afford
- Your down payment is not the only cost you need to plan for when buying a home
- Having a financial cushion for emergencies is critical with homeownership
One of the first steps in the homebuying process is fully understanding your finances. It’s not as fun as shopping for homes, but it’s important and necessary to help you determine how much you can afford.
Start by asking yourself the following questions and gather all your supporting documentation:
- What is your annual gross income? You can get a very rough estimate of your affordable home price range by multiplying your annual gross income by 2.5. For example, if your annual gross income is $50,000, you may be able to afford a home worth $125,000 (this varies depending on current interest rates, your debt, and credit history). If you are looking to buy a condominium, mortgage rates may be slightly higher and you’ll have to budget for the cost of your monthly condominium fee.
- How much have you saved for a down payment and other costs? You'll have to make a down payment of at least 3%– and generally between 5 and 20% – of the purchase price to qualify for a mortgage. Also, when you get a mortgage, you’ll need to pay closing costs that include an appraisal fee, credit report fee, tax services fee, government recording charges, and your lender’s origination fee. Typically, these range from 2 to 5% of your purchase price.
- How much do you spend each month? You will need to account for your current living expenses, all planned future expenses, and add the costs of home improvements, maintenance and repairs. In 2013, owners spent an average of $2,500 for home improvements.
- What is your financial cushion? You’ve got the money for the down payment and closing costs, but you’ll also need financial reserves for life’s unexpected emergencies such as an illness, temporary job loss, or necessary home repairs such as a broken hot water heater. You should also consider any future major expenses such as a wedding or college tuition.
How do lenders determine how much they’re willing to lend you? They evaluate the four Cs: Credit, Capital, Capacity, and Collateral
Your mortgage payment (principal, interest, taxes and mortgage insurance) should be less than 28% of your monthly gross income
Example: If Bill makes $50,000 per year, his monthly mortgage payment should not exceed $1,167.
You can get a rough estimate of what you can afford by multiplying your annual gross income by 2.5
You can expect to spend 2 to 5% of the purchase price on housing-related fees and expenses
Lenders determine how much they’re willing to lend you based on your capacity, capital, collateral and credit