How To Afford a New Home
Buying a house in this economy seems like an insurmountable goal for a working man, because banks aren’t giving out loans to many prospective homeowners these days. But with the housing market deflated, that means housing prices have gone down significantly.
If you can figure out how to afford a house right now, you’ll save tens of thousands of dollars off the same house you might buy five years from now. So here’s a short lesson on how to buy a house.
1. Save Up a Down Payment
Down payments usually require between 10% to 20% of the appraised value of a house. Just because a house has a selling price, you’ll need to find out the appraised value of the house and then save up the money for the down payment.
If you don’t have that kind of money, you’ll have to pay PMI or private mortgage insurance. This means the house payment you pay every month will be more, though that PMI is tax deductible.
If you can’t save up the money for the down payment on a house, you’re not going to be able to afford the house payments for the next 10-30 years.
2. Ask About a Combination Mortgage If Your Down Payment Falls Short
People who can’t afford the 10% to 20% down payment, but who have a steady income and good credit can get a combination mortgage from a mortgage broker. A combination mortgage is two mortgages: the first for 80% of the home and the second for the amount required to cover your down payment.
The rate on that second mortgage will be higher (slightly), but it is tax deductible and usually cheaper than a mortgage with a PMI.
3. Improve Your Credit
Strengthen your credit rating and continue to strengthen your credit rating. Our site has several articles on credit card repair you can read to help you do just that. Once again, before you even consider buying a home, know you’re going to need a good recent credit history.
4. Determine How Much You Can Borrow
Next, gauge how much you’ll be able to borrow. You’ll need to borrow what you can’t pay on the down payment of the house. Figure out the “ratio” your ratio lender is going to use when they make your mortgage loan.
A ratio is given in two numbers and involves two percentages. The first percentage is how much of your gross monthly income goes towards your house payment. The lenders will generally figure you can afford a house payment the size of a certain percentage of your monthly income (commonly 28%), which should cover your monthly housing expenses.
The ratio lenders figure if the second percentage (commonly 36%) of your monthly income goes toward your outstanding debts combined with your housing payment, you can afford the house you’re buying. The ratio will be stated by two numbers, in the case of the 28/36% as a “28 and 36 ratio”.
Determining how much you can borrow will probably be somewhere close to how much you can pay off on a 28 and 36 ratio according to your monthly income and outstanding debts. It should be mentioned that, the fewer outstanding debts you have, the more likely the mortgage lender is to lend you money.
Let me give an example.
If you make $4,000 a month, your 28% would be $1120 a month. Your 36% would be $1440 a month. The difference in the two is $320, so the amount of your outstanding monthly debts could not exceed $320.
5. Calculate Your Housing Expenses
There are other housing expenses you’ll need to afford. These include home insurance, annual real estate taxes and closing costs. (Note: If you are a member of a credit union, their closing costs for you are likely to be lower.) Closing costs tend to be between 3% and 6% of your home’s price. Once again, all these expenses will need to fit under that 28% of your monthly income.
6. If You Already Own a House, Determine How You’ll Buy The New Home
Once you figure all this up, figure out if you’ll need to sell your old property to afford your new home. If so, then you’ll have to sell that first home before you can buy the second one. Any offer you make on a new home is called a “contingent offer”, which is less desirable for the person or company selling you your new home.
7. Get Pre-Approved For the Amount You Can Pay
Get pre-approved for the amount of money you can use to buy a house. This gives you a firm idea what you can afford and you won’t make the mistake of looking at homes over your price range. Remember to make your inquiries to different lenders for pre-approved credit within a two-week period, so the inquiries don’t hurt your credit report.
How To Buy a House
Now that you know you can afford a new home, it’s time to set off on the housing market, find a house to buy and buy a house.
8. Shop For Houses
Now comes the fun part, or torturous part, depending on your situation.
Shop for houses. Look at as many as you can in your time limits. Sign up for a Multiple Listing Service. Find a good real estate agent. Map out the area you want to live in. Visit houses to see what’s on the market in that area in your price range. Have a house you’re unsure about through an appraiser.
Remember, before you take the plunge, you’ll want to look at the community you’ll be living in, besides just your property. Figure out if the home you’re buying will also suit your proximity to shopping, your school needs and your recreational wants.
9. Make a Formal Offer
Make a offer on the home you want to buy. This requires you to include earnest money with your offer. The offer puts you in escrow for 30 to 90 days after you sign your offer, upon which you’ll forfeit your earnest money (usually $1,000 to $5,000). The only way this doesn’t apply is if your don’t get final mortgage approval on the house.
When you sign your offer, make sure that final acceptance is dependent on a suitable home inspection for all the bad things that can happen to a home. The last thing you want is to buy a home and later find out it’s in a flood plain, it has dry rot, mold, pests or one of a dozen other homeowner nightmares.
10. Close Escrow
Close on your home by signing all documents in the title office. You’ll want to sign and possess a deed to the house as well as the title to the house, which are two different documents. The deed proves you own the house, while the title shows there isn’t another claim or lien against it.
Have a real estate lawyer look over your closing documents and be there to represent you at the signing. This may cost a few hundred dollars for a few minutes work, but it’s a precaution that’s well worth the money.