by: Sean Engmann
Realtor® at Compass
CA DRE# 02117899
Can You Afford to Buy?
Two of the first concerns that potential homebuyers have are whether they can afford to buy, and what they can afford to buy. For many people, the idea of homeownership seems unattainable due to the price, the need for a high down payment and the additional costs of homeownership.
As a homeowner, you are responsible for the following regular payments:
Monthly mortgage payment (principal plus interest)
• Property taxes typically between 1.1% and 1.25% of the purchase price (adjusted annually for inflation) each year.
• Homeowners and hazard insurance.
• Potentially private mortgage insurance if your down payment was less than 20%.
Don’t forget that as a homeowner you are responsible for maintaining your home. If you are buying a condo, some of these costs are covered by a monthly HOA, but it’s always a good idea to keep a rainy day fund to pay for unexpected repairs.
You Don’t Live in the Price of the Home, You Live in the Monthly Payment
From an affordability standpoint, the most important consideration is whether you can consistently and comfortably keep up with the payments. In many cases, through impound accounts, all these amounts are rolled into a single monthly payment. It follows that if you break the price down into the monthly payment, if you can afford the payment, you can afford the house.
It is important to set a monthly budget for your housing payment. Make sure to include a little extra to go toward unexpected repairs and improvements. From there, you can work backwards to determine the maximum amount you can set aside for a mortgage payment by subtracting the costs of taxes and insurance from your monthly budget. Although actual amounts may vary considerably, for the purpose of this exercise (in California at least), you can roughly estimate that your monthly taxes will be $100 per $100,000 of the price of the home and your monthly homeowners insurance will be 10% of your property taxes.
How Much Can I Afford – Interest Rates are Critical
The price range of the home you can afford is a function of the monthly mortgage payment you can afford and the interest rate. Interest rates are crucial because the lower the interest rate, the more expensive house you can afford with the same payment. Conversely, if interest rates rise, the purchasing power of your monthly payment falls. A rate change of even one percent can make a substantial difference in the “amount of house” you can afford, making it crucial to maintain good credit and keep tabs on interest rates.
What About the Down Payment?
The more money you can put down, the lower your monthly payment and, generally, the stronger your offer will look to potential sellers. The magic number that many people hear is 20%, so a good number of potential homebuyers who don’t have 20% saved don’t bother looking.
In fact, many people purchase homes with well less than 20% down and according to the National Association of Realtors, the national average down payment on a home was 12%, and only 6% for first-time home buyers. In hotter housing markets like Northern California that number's higher, but there are numerous loan programs available to help people access homeownership without having to put 20% down. The FHA insures loans as low as 3.5%, Fannie Mae and Freddie Mac offer conventional loans with as little as 3% down and the VA has zero down loans available to qualifying veterans. While housing prices and loan limits may limit access to these loans in expensive markets, there are many options available, so it's worth evaluating all options and discussing them with your Realtor or lender.
A good thing to consider is that the more money the borrower can put down, the more comfortable the lender in the safety of the loan, and generally, the less paperwork the borrower needs to complete to satisfy underwriting requirements. These requirements are important because lenders typically market mortgages on the secondary mortgage market. At 20% down, the approval process for most loans in somewhat easier and most lenders are comfortable not requiring private mortgage insurance.
As a homebuyer, consider the visual that the lower the amount of money you can put down, the higher the stack of paperwork that you need to complete to get the loan. The reason why offers with more money down are attractive to sellers is that the shorter the stack of paperwork, the lower the potential for problems that can derail the loan, which minimizes the chances of the deal falling through. While a large amount down is helpful, it is certainly not essential for obtaining the dream of homeownership.
Closing costs, and the cost of doing due diligence on the property while its in contract are other costs that are due up front and must be considered by prospective homebuyers. These include the costs of performing inspections, appraising the property, compensating the lender for the loan, buying points to pay down the interest rate on the loan and prepaying for taxes and insurance. These costs can vary based upon the timing and the type of the loan, but they are important because it requires saving more money than just the down payment.
If you are paying rent, you very likely can afford to buy, especially if you have good credit. Looking at affordability through the lens of your monthly payment is a good way to get beyond the sticker shock of the price of the house. There are also many options if you don’t have a huge down payment saved up. As a first step, it can be helpful to get a gauge of what you may be able to afford.
The next step is to contact a Realtor to discuss your needs further. Your Realtor will have great insight into the market and has relationships with a variety of top quality lenders who can help get you pre-approved for a loan and on your way to homeownership!
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