Imagine you have just completed a search that included
hundreds of hours of looking at the exteriors and interiors of
houses. You have sized up siding, reviewed roofing and perused the
petunias. And finally, you have found the house of your dreams.
Now imagine that this house of your dreams costs
much more than you can afford.
If you are house hunting and have not done an important
piece of homework, you could be in for this kind of heartbreak.
The first thing you need to know when shopping for a
home is how much you can spend.
A general rule is that
you can purchase a house valued at twice your annual
income, but this does not take into account your
debts, a large down payment, or other factors which
can add to or detract from the amount you can
afford.
The purpose of this page is to help give you a more
specific idea of what priced house you can afford. It will address
what you are worth and what you owe on a regular basis (your assets
and liabilities) and what costs you would most likely encounter once
you bought your new house. In general, you will be examining the
same things a lender looks at when deciding how large a mortgage you
can afford
Can I Buy This House?
Lenders and Realtors will not tell you how much house you
can afford. Instead they will calculate how much they believe an
institution will loan you. This is two totally different amounts. A
lender wants to loan you the maximum loan it feels you will repay. It is up to you to decide how much house you can afford. Only you
know what future plans you have for children, retirement, and
employment. Even the most affluent among us can get into trouble if
they purchase more home then they can afford.
The first question you must ask yourself is "what can I
afford to spend on a home?"
In order to answer that question, you will need to look at
the costs involved in buying and owning a home.
Completing the worksheets below should save time while
shopping for a home because it will narrow your choices based on
costs. When you finally do talk with lenders, you will have
some answers for many of their questions, speeding
up your loan's processing.
It should be noted, however, that today many lenders will
qualify you in advance for a mortgage, even before you begin to shop
for a home. Many lenders advertise this service in the local
newspaper, but contact any lender to see if this is possible.
Down Payment
Lenders expect home buyers to have enough money available
to make the down payment (usually up to 20 percent of the asking
price for the house) and to pay their share of the closing costs ( 3
percent to 6 percent of the loan amount). You should figure this
amount (which will depend on what you decide you can afford) into
your home buying budget. The down payment and closing costs are
usually made up of money drawn from your total assets.
Your Mortgage
A mortgage is the loan you take to buy the house. Most
people do not come close to having enough cash assets lying around
to purchase a home. That makes a mortgage essential.
With a few exceptions, most mortgages are typically repaid
in 15 or 30 years. Almost all require monthly payments. Lets suppose
you are purchasing a $150,000 home and that you are putting 20% down
on the house. You’re down payment would be $30,000 ($150,000 X
.20) and your mortgage (the amount of loan you will
need) would be $120,000.
If the only mortgage options available to you were a 15 or
30 year fixed rate (fixed rate means the interest rate will stay the
same for the entire term of the mortgage) your payments would look
like this:
$120,000 15-year mortgage @ *7.00 percent = $1,079 per
month
$120,000 30-year mortgage @ *7.25 percent = $ 819 per
month
*Interest rates are generally a little lower on a 15-year
fixed.
One of the first things you should notice is how much
higher your payment will be on the 15-year fixed. That is because
you are paying that loan off in 1/2 the time. Even though your
payments are considerably higher, look at the difference in the
amount of interest you will pay on the loan at the end of its term:
Mortgage Option Total Payments Total Interest
15-year mortgage $194,147 $74,147
30-year mortgage $294,700 $174,700
Even though you are paying much less in
interest over the life of the loan on a 15-year fixed, this loan may
not be the better loan for you. If the lower payments on the 30-year
loan allow you to qualify for the loan, buy a better property, or
possibly to save more money into a retirement account, the 30-year
fixed may be the better option. Besides, if you want to pay less
interest over the life of your loan, you can always pay extra on the
principal. Just make sure there is not a pre-payment penalty built
into the loan program that you choose. If you have a pre-payment
penalty there will be certain penalties that will apply if you pay
down your principal balance early. Restrictions such as this
must be clearly spelled out in the loan papers that
you sign.
Determining the size of the mortgage loan that you can
afford can be a little tricky. Once you have determined the total
you feel you can afford to spend monthly for housing, you then have
to know the costs involved, including the mortgage payment, which
combined will equal your housing cost. In addition to the
mortgage payment you must also calculate the cost
for property taxes and insurance, as well as any
association fees and even maintenance costs.
First lets start with the mortgage payment. You can figure
the size of your mortgage payments yourself by using the chart
below. Multiply the relevant number by the size of your mortgage
expressed in thousands of dollars. For example, if you will be
taking out a $150,000 30 year mortgage at 6.75% you would multiply
150 by 6.49 (see the table below). This would give you a mortgage
payment of $973.50.
Monthly Mortgage Payment Calculator
Your housing expense will be totaled using the following
example:
Item Estimated Monthly Housing Expense
Mortgage payment $_____________________
Property taxes + $_____________________
Insurance + $_____________________
Improvements, maintenance, and
Other + $_____________________
Home-ownership expenses (pre-tax) = $_____________________
Tax Savings - $_____________________
Home-ownership expenses
(after-tax benefits) = $ ____________________
Private Mortgage Insurance
In the event that you do not have a 20 percent down
payment, lenders will allow a smaller down payment - as low as 5
percent in some cases. With the smaller down payment loans, however,
borrowers are required to carry Private Mortgage Insurance. Private mortgage will require an initial premium payment of 0.5
percent to 1.0 percent of your mortgage amount plus an additional
monthly fee depending on your loan's structure. On a $75,000
mortgage with a 10 percent down payment, this would mean a premium
of $338 to $675 for the first year and an extra $15 to $20 a month
in subsequent years.
What Are Your Assets?
The first thing you have to examine when deciding how much
you can spend on your new home is how much you are worth, taking
into account your income, savings, investments and other holdings
such as Individual Retirement Accounts (IRAs) or Keogh plans, the
cash value of your life insurance, pensions or corporate savings
plans, and equity in real estate. Lenders will need this
information before deciding to extend you the loan.
Often, the amount you earn may not be as important as how
you earn it. Bonuses and commissions can vary greatly from year to
year, and lenders are reluctant to depend on them if they make up a
large part of your income. There are similar problems when a large
portion of your salary is based on overtime pay, and you rely on it
to qualify for the loan. To get a realistic view of what your
income level actually is, average your income
(including bonuses, commissions and overtime) for
the past two or three years.
As a last resort, pensions and corporate thrift plans can
provide another source of down payment money. Most plans or policies
give you the option of either withdrawing your money with no
repayment or borrowing against the cash value. Though it is not the
best policy for most home buyers to borrow from these sources in
addition to borrowing mortgage money, they can often get rates
substantially lower than those on many other kinds of loans. Remember - if you borrow against the cash value of your life
insurance or employee thrift plan, you will be making principal and
interest payments for these separate from your mortgage. You
should estimate these payments under installment
loans on the worksheet inside.
While turning your savings, investments and other holdings
into cash (making them "liquid"), remember that you will probably
have to pay tax on most of it. One source of tax-free money often
overlooked is a gift, or money given by a parent or other relative
that need not be repaid. A person may give another person up to
$10,000 per year without either party being taxed. Your parents, for
example, could give you and your spouse up to $40,000 tax free.
Liabilities
Your liabilities are those expenses for which you are
responsible each month. These include outstanding loans, such as
student, auto, personal and so on, as well as credit card balances. When calculating your liabilities, use the entire balance for your
credit cards, as if you had to pay them off entirely this month.
That way, you give yourself some breathing room
should you run up an unusually high balance during
your mortgage term.
You should estimate these payments under liabilities on
the worksheet.
Emergency Funds
It is always wise to put a little money away "for a rainy
day" - especially when you are paying off a mortgage. If something
arises such as unexpected medical costs or substantial auto repairs,
you would want to be able to pay those expenses without jeopardizing
your ability to meet your mortgage payments. Most financial experts
suggest that you always have six months income on hand in case of
emergency.
Annual Income
When calculating your annual income, remember to take into
account all sources. You may, for example, get dividends from
investments, alimony or child support payments. Calculate your
annual income below.
Annual Expenses
This list should get you started, but you may have special
expenses that are not listed here. Remember that when you buy your
house you will no longer have to pay rent, and your utilities costs
will change. You can use this money for your mortgage payments or
other operating costs associated with your new home.
The Costs of Home ownership
Of the costs of home ownership, the ones listed on the
next page are the most important. Homeowners insurance premiums
usually run about $300 to $500 per year, and property taxes and
maintenance costs will vary, of course, depending on the size, age
and condition of your new house. Estimates for the costs of
utilities, maintenance and improvements can be
obtained from Realtors, local utility companies and
others.
Some home buyers will also have an additional cost of home
ownership if they are buying into a condominium or a co-op. Condo
and co-op fees are additional amount usually paid monthly on top of
the mortgage payments. Some homeowners will also incur a home owners
association fee for their block or neighborhood. These fees vary
greatly from location to location.
Net Worth Worksheet
|
| Assets and Liabilities
|
|
|
Annual Expenses
|
|
| |
|
|
Rent
|
_______
|
| Add up your assets and subtract your total
|
|
|
Food
|
_______
|
| liabilities.
|
|
|
Clothing
|
_______
|
| |
|
|
Transportation
|
_______
|
|
This is your net worth.
|
|
|
Medical/Dental
|
_______
|
| |
|
|
Insurance Premiums
|
|
| Assets
|
|
|
Life |
_______
|
| Cash on Hand
|
_______
|
|
Auto |
_______
|
| Savings Accounts
|
_______
|
|
Renters |
_______
|
| Cash Value of Stocks
|
_______
|
|
Other |
_______
|
| Mutual Funds
|
_______
|
|
Tax Payments
|
_______
|
| Bonds
|
_______
|
|
Utilities
|
_______
|
| Life Insurance Cash Value
|
_______
|
|
Savings
|
_______
|
| IRAs
|
_______
|
|
Tuition/Day Care
|
_______
|
| Keogh Plan
|
_______
|
|
Alimony/Child Support
|
_______
|
| Employee Savings Plans
|
_______
|
|
Loan/Charge Acc. Payments
|
_______
|
| Pensions
|
_______
|
|
Recreation/Entertainment
|
_______
|
| Real Estate
|
_______
|
|
Other
|
_______
|
| Other
|
_______
|
|
Total Annual Expenses
|
$_______
|
| Total Assets
|
$_______
|
|
|
|
| |
|
|
Estimated Operating Costs
|
|
| Liabilities
|
|
|
Homeowners Insurance
|
_______
|
| Installment Loans
|
_______
|
|
Property Tax
|
_______
|
| Credit Card Balances
|
_______
|
|
Maintenance/Improvements
|
_______
|
| Student loans
|
_______
|
|
Utilities
|
_______
|
| Other Debts
|
_______
|
|
Condo/Co-Op/Homeowners
|
|
| Total Liabilities
|
_______
|
|
Association Fees
|
_______
|
| |
|
|
Other
|
_______
|
| Subtotal Your Total Liabilities
|
|
|
Total Estimated Operating
|
|
|
from Your Total Assets.
|
|
|
Costs
|
$_______
|
| This is your net worth
|
$_______
|
|
|
|
| |
|
|
Add Your Annual Expenses
|
|
| Emergency Funds
|
|
|
Operating Costs And Then
|
|
| (Six Months Income Sug.)
|
_______
|
|
Subtract Them From Your
|
|
| |
|
|
Annual Income. |
$_______
|
| Subtract Your Emergency Funds
|
|
|
|
|
| From Your Net Worth. This
|
|
|
Add back in the costs for
|
|
| is the amount you have for
|
|
|
rent, utilities and
|
|
| down payment and closing
|
|
|
renters insurance. You
|
|
|
costs. |
$_______
|
|
will be able to spend this
|
|
| |
|
|
money on your new house.
|
|
| Annual Income
|
$_______
|
|
The total is the amount
|
|
| Gross salary
|
_______
|
|
you can spend per year on
|
|
| Alimony
|
_______
|
|
your new house. |
$_______
|
| Child support
|
_______
|
|
|
|
| Interest
|
_______
|
|
Divide this amount by 12
|
|
| Dividends
|
_______
|
|
to get a monthly mortgage
|
|
| Tax refunds
|
_______
|
|
payment amount. |
$_______
|
| Other
|
_______
|
|
|
|
| Total Annual Income
|
$_______
|
|
|
|
