Shopping for a mortgage, you might encounter lenders who pre-qualify you for a higher loan amount than you expected. Many lenders work with standard debt-to-income ratio calculations which don’t take into account other costs of home ownership. If you take the highest loan amount, you risk maxing out your available funds and becoming “house poor,” without liquidity. Here are four steps to follow when deciding how much you should spend on a house.
Step 1: Understand what percentage of your income should go toward your mortgage
Take a good look at your monthly income and expenses. This will help you understand how much you can spend on a house. Keep in mind that you’ll need to account for taxes, insurance, repairs and renovations, along with increased utility expenses. That sounds like a lot, but remember that some are upfront costs, some are recurring, and other costs only happen once in a while. The first step is understanding how much you can afford to spend on a mortgage.
Determine your debt to income ratio (DTI). One of the first financial factors a lender will review is your DTI. To determine your DTI, take the total amount you pay in recurring monthly debt and divide that by your gross monthly income before taxes (not your take-home pay). This number is the percentage of income required to make debt payments each month. Be sure to include income and debt for everyone on the loan application. If your spouse, partner, or roommate is a party on the mortgage loan, their gross income and recurring debts also play a factor. Recurring debt can include:
- Student loans
- Car loans
- Credit cards
- Bank or department store credit card
- Personal line of credit with a bank or other financial institution
- Personal loans from any source
- Child support or alimony payment
Use the 28/36 rule to determine what you can afford. According to this rule, also used by lenders, most people can afford to spend as much as 28% of their gross monthly income on a mortgage and up to 36% on debt payments and still manage other typical recurring expenses. Some lenders may approve you for a mortgage if your finances fall outside this ratio, but they will likely charge extra fees and a higher interest rate to cover the increased risk, making your mortgage more costly.
What’s a “comfortable” mortgage payment vs. an “aggressive” one? Lenders rely on industry benchmarks and historical data to determine that a 25-33% DTI will allow borrowers to “comfortably” pay their mortgage and still save consistently for retirement, college, or a home repair fund. At the other end of the spectrum, lenders may still offer a loan to a borrower with a DTI between 33-40%. This DTI range becomes “aggressive” for lenders and puts them at higher risk. And it’s not much better for borrowers at this range. With a DTI of 33-40%, you would need to keep a close eye on all of your expenses at all times. It could be challenging for a borrower with a DTI between 43-50% to get a mortgage. At 50%, you’d be better off paying down your debt to improve your DTI.
With a DTI under 33%, you’ll qualify for better terms and interest rates because you represent a low risk of default. The better your DTI, the more confident lenders will be that you’ll stay on track with your payments and pay back the mortgage. As your DTI approaches the 50% rate, you’ll see less favorable interest rates and terms to cover the potential risk to the lender.
Step 2: Know all your costs when buying a house
It’s not all about your home’s purchase price. To secure a loan, most lenders require some amount of downpayment. To finalize the purchase and paperwork, you will pay additional closing costs. Below are the common costs of buying a house.
Your down payment is your “skin in the game.” It commits you to the mortgage with a significant upfront investment. Among the various loans available, you can find down payment requirements ranging from 3-20% of the home’s purchase price. Most experts recommend that you put as much money as you can into your down payment. Most conventional loans require 20% as a down payment, however, sometimes it’s simply not possible to save up a 20% downpayment. To work with a down payment less than 20%, you’ll need to qualify for an FHA, VA, or USDA loan.
A downpayment of 20% has two key benefits:
- Your total loan will be for a lower amount, so you will owe less in both principal and interest, resulting in a lower monthly mortgage payment. Because you’ve put a significant amount of money down against the worth of the home, you could be saving tens of thousands of dollars in interest payments. As you ask yourself how much to spend on a house, be sure to factor in your down payment. .
- When you put 20% down, you don’t pay for private mortgage insurance (PMI). Lenders require PMI to safeguard them if you default on the loan. Typically, once you have repaid 20% of your loan, you can ask the lender to remove the PMI payment. If you start with 20%, you avoid this extra payment altogether.
Remember to factor in closing costs. These fees cover the title company’s work to ensure you have a clear title. If the seller has unpaid debts (outside his or her mortgage) attached to the house, these liabilities could hold up the sale of the home. Closing costs also cover the fees for appraisals, title insurance, attorney fees, and fees charged by the county to record the property transfer from the seller to the buyer. Expect to pay between 3-6% of the home’s total purchase price for closing costs. For example, purchasing a $200,000 home, you can expect to pay somewhere in the range of $6,000–$12,000 in closing costs.
Step 3: Project the costs of owning a home
What does it cost to own and maintain a home? Your mortgage payment is the largest ongoing cost of homeownership. With most 30-year or 15-year conventional loans, homeowners will have a fixed-rate mortgage. This means a fixed monthly payment for the term of the loan. That amount will not change unless you refinance your terms with the lender. A longer mortgage term will often result in a lower monthly payment, and it will take longer to repay. A shorter mortgage term will involve a higher monthly payment and the home will be paid off sooner.
For renters becoming homeowners, utility bills could bring sticker shock. As a homeowner, you can expect your utility bill to be almost four times higher than what you paid as a renter. Some renters even pay the landlord a flat fee for gas, electricity, sewer, and water. If you rent a house already, you may not see this as big of a change. As a homeowner, you pay for each service based on usage. For example, your water usage goes up when you take care of a lawn or garden.
Homeowners need to pay property taxes and insurance. County property taxes commonly cover funding for local government, public schools, roads, emergency services, and libraries. Depending on where you live, your property tax rate will vary. You can look up property tax by county to include in your estimated homeownership costs.
Private Mortgage Insurance (PMI) pays the lender if you default on your mortgage. It applies to buyers whose down payment is less than 20%. You can typically expect your PMI payment to be between 0.5 – 1% of your loan amount per year. For example, on a $200,000 mortgage, your PMI payment would be $1,000 – $2,000 per year, or $83- $163 per month in addition to your mortgage.
If you live in a community with a homeowners association (HOA), you will need to pay a monthly fee to the association. These fees typically cover property maintenance, amenities, and security. HOA fees range between $100-$1,000+ depending on the type of property and its location.
Your home will need repairs and renovations over time so you may want a home maintenance savings fund. A good rule of thumb is to save 1-4% of your home’s value for yearly maintenance and home improvements. Such as, for a $200,000 home, the homeowner should save between $2,000-$8,000 a year for maintenance or significant home improvements.
Step 4: How much should you spend on a house? Calculate the “right” amount
A home affordability calculator estimates how much home you can afford. Four main factors are taken into consideration:
- Where you live
- Your annual income
- The amount you’ll apply as a down payment
- Monthly recurring debts and spending
Use the how much house can I afford calculator to get a sense of the right amount. To determine how much mortgage you can afford to pay each month, start by looking at how much you earn each year before taxes. Consider all your earnings for the year, which could include salary, wages, tips, commission, etc.
Suppose you have a spouse or a partner with an income that will also contribute to the monthly mortgage. Make sure to include that in your gross annual income for your household. Then take your annual income and divide it by 12 to determine your monthly income.
Here are some examples of a comfortable or aggressive purchase price based on different incomes, debts, and down payment amounts.. These examples are not location-specific. Visit the home affordability calculator where you can enter income, debt, location, and come up with a down payment that reflects your situation. Keep in mind you may need to pay PMI if your down payment is less than 20% of the purchase price, this will add an extra $83-$163 to your monthly mortgage payment. The examples below use a 4% interest rate for the estimated mortgage payment.
Make sure you take some time to understand all costs associated with homeownership – and how they affect one another. Examine your DTI to determine if you can afford a loan at a good rate or be better served by paying off debt first. Then estimate your monthly mortgage payment along with other recurring costs to see how much you should be spending on a house.
Even if you haven’t been following real estate news, you’ve likely heard about the current sellers’ market. That’s because there’s a lot of talk about how strong market conditions are for people who want to sell their houses. But if you’re thinking about listing your house, you probably want to know: what does being in a sellers’ market really mean?
What Is a Sellers’ Market?
The latest Existing Home Sales Report from the National Association of Realtors (NAR) shows housing supply is still very low. There’s a 2-month supply of homes at the current sales pace.
Historically, a 6-month supply is necessary for a normal or neutral market where there are enough homes available for active buyers. That puts today deep in sellers’ market territory (see graph below):
What Does This Mean for You When You Sell?
When the supply of houses for sale is as low as it is right now, it’s much harder for buyers to find homes to purchase. That creates increased competition among purchasers which can lead to more bidding wars. And if buyers know they may be entering a bidding war, they’re going to do their best to submit a very attractive offer upfront. This could drive the final price of your house up.
And because mortgage rates and home prices are climbing, serious buyers are motivated to make their purchase soon, before those two things rise further. That means, if you put your house on the market while supply is still low, it will likely get a lot of attention from competitive buyers.
The current real estate market has incredible opportunities for homeowners looking to make a move. Listing your house this season means you’ll be in front of serious buyers who are ready to buy. Let’s connect so you can jumpstart the selling process.
You don’t need a real estate license to find your dream home, but it does help to become familiar with real estate jargon you might encounter during the process. When searching for a home or applying for a mortgage, you may hear your real estate agent or lender use any of the terms or acronyms below.
Keep this four-part guide handy — you’ll be fluent in the language of home buying before you know it.
Real estate terms to know when you’re searching for a home
Affordability or home affordability refers to the amount of money you can comfortably afford to spend on a home. Home affordability takes into account your income, down payment, and monthly debts. Try this affordability calculator to see how much house you might be able to afford.
Approved for short sale
A term that indicates that a homeowner’s bank has received an offer from a buyer and has determined the reduced listing price on a home meets their short sale criteria based on the seller’s circumstances and how much is owed.
Buy-rent breakeven horizon
A concrete point at which buying a home makes more financial sense than renting one.
Market conditions that exist when homes for sale outnumber buyers. Homes can sit on the market for a long time, and prices tend to drop.
Comparative market analysis (CMA)
An in-depth analysis, prepared by a real estate agent, that determines the estimated value of a home based on recently sold homes of similar condition, size, features and age that are located in the same area.
Or comparable sales, are homes in a given area that have sold within the past several months that a real estate agent uses to determine a home’s value.
Days on market (DOM)
The number of days a property listing is considered active.
The price of a home, as set by the seller.
Multiple listing service (MLS)
A database where real estate agents list properties for sale.
Market conditions that exist when buyers outnumber homes for sale. Bidding wars are common. Prices are often higher than average.
The sale of a home by an owner who owes more on the home than it’s worth. The owner’s bank must approve a lower listing price before the home can be sold.
Study these real estate terms when you’re applying for a mortgage
Adjustable-rate mortgage (ARM)
An adjustable-rate mortgage, or ARM, has an introductory interest rate that lasts a set period of time and adjusts every six months thereafter for the remaining loan term. After the set time period your interest rate will change and so will your monthly payment.
One of two debt-to-income ratios that a lender analyzes to determine a borrower’s eligibility for a home loan. The ratio compares the borrower’s monthly debt payments to gross income.
Banks, savings and loans, and credit unions. These institutions underwrite as well as set home loan pricing in-house.
Debt-to-income ratio (DTI)
A ratio that compares a home buyer’s expenses to gross income. Try this debt-to-income calculator to learn more.
One of two debt-to-income ratios that a lender analyzes to determine a borrower’s eligibility for a home loan. The ratio compares total housing cost (principal, homeowners insurance, taxes and private mortgage insurance) to gross income.
A three-page document sent to an applicant three days after they apply for a home loan. The document includes loan terms, monthly payment and closing costs.
Loan-to-value ratio (LTV)
The amount of the loan divided by the price of the house. Lenders reward lower LTV ratios.
A fee, charged by a broker or lender, to underwrite and process a home loan application. An origination fee is not a single fee. It’s a set of lender-specific fees that are part of your costs when closing a mortgage loan.
A thorough assessment of a borrower’s income, assets and other data to determine a loan amount they would qualify for. A real estate agent will request a pre-approval or pre-qualification letter before showing a buyer a home.
A basic assessment of income, assets and credit score to determine what, if any, loan programs a borrower might qualify for. A real estate agent will request a pre-approval or pre-qualification letter before showing a buyer a home.
A process a lender follows to assess a home loan applicant’s income, assets and credit, and the risk involved in offering the applicant a mortgage.
Learn these definitions before shopping for a mortgage
A home loan not guaranteed by a government agency, such as the FHA or the VA.
A certain portion of the home’s purchase price that a buyer must pay. A minimum requirement is often dictated by the loan type.
A government-sponsored enterprise chartered in 1938 to help ensure a reliable and affordable supply of mortgage funds throughout the country.
Federal Housing Administration (FHA)
A government agency created by the National Housing Act of 1934 that insures loans made by private lenders. The Federal Housing Administration is part of the U.S. Department of Housing and Urban Development.
A rehabilitation loan backed by the federal government that permits home buyers to finance money into a mortgage to repair, improve or upgrade a home.
Loans from private lenders that are regulated and insured by the Federal Housing Administration (FHA). FHA loans are different from conventional loans because they can be approved for borrowers with lower credit scores and may allow for down payments as low as 3.5 percent of the total loan amount. Maximum loan amounts can vary by county.
A mortgage with principal and interest payments that remain the same throughout the life of the loan because the interest rate does not change.
A property repossessed by a bank when the owner fails to make mortgage payments.
A government agency chartered by Congress in 1970 to provide a constant source of mortgage funding for the nation’s housing markets.
One who originates, sells, and services mortgage loans and resells them to secondary mortgage lenders such as Fannie Mae or Freddie Mac.
A licensed professional who works on behalf of the buyer to secure financing through a bank or other lending institution.
Mortgage interest rate
The price of borrowing money. The base rate is set by the Federal Reserve and then customized per borrower, based on credit score, down payment, property type and points the buyer pays to lower the rate.
A combination of loans bundled to avoid private mortgage insurance. One loan covers 80% of the home’s value, another loan covers 10% to 15% of the home’s value, and the buyer contributes the remainder.
A prepayment penalty is a fee some lenders may charge if you pay off some or all of your mortgage early. Not all mortgages carry a prepayment penalty. Be sure to read the fine print carefully.
Prime rate is the interest rate charged by a lender to customers who are the least likely to default on their loans. The most credit-worthy customers (mainly large corporations), receive the best or lowest rate that the lender would offer any of its customers. Each lending institution sets its own prime rate. Typically, most consumers’ mortgage interest rate is going to be higher than the prime rate.
Principal, interest, property taxes and homeowners insurance (PITI)
The components of a monthly mortgage payment.
Private mortgage insurance (PMI)
A fee charged to borrowers who make a down payment that is less than 20% of the home’s value. The fee, 0.3% to 1.5% of the yearly loan amount, can be canceled in certain circumstances when the borrower reaches 20% equity.
Prepaid interest owed at closing, with one point representing 1% of the loan. Paying points, which are tax deductible, will lower the monthly mortgage payment.
Real estate terms you might hear when you’ve chosen a home
American Society of Home Inspectors (ASHI)
A not-for-profit professional association that sets and promotes standards for property inspections. Look for this accreditation or something similar when shopping for a home inspector.
A homeowners insurance policy that pays the replacement cost of a home, minus depreciation, should damage occur.
Fees associated with the purchase of a home that are due at the end of the sales transaction. Fees may include the appraisal, the home inspection, a title search, a pest inspection and more. Buyers should budget for an amount that is 2% to 5% of the home’s purchase price. Read more about closing costs here.
Conditions written into a home purchase contract that protect the buyer should issues arise with financing, the home inspection, etc.
A security deposit made by the buyer to assure the seller of his or her intent to purchase.
Mortgage escrow account
An account required by a lender and funded by a buyer’s mortgage payment to pay the buyer’s homeowners insurance and property taxes. A portion of your monthly payment goes into the escrow account to cover taxes and insurance. If your mortgage doesn’t have an escrow account, you may pay the property-related expenses directly.
A state in which an escrow agent is responsible for closing.
A visual evaluation performed by a licensed home inspector to look for any potential defects or items of note related to the property, building(s), and the systems in a home. Inspection occurs when the home is under contract or in escrow.
A policy that protects the structure of the home, its contents, injury to others and living expenses should damage occur. Learn more about homeowners insurance here.
A period of time (typically 30 days or more) after a buyer has made an offer on a home and a seller has accepted. During this time, the home is inspected and appraised, and the title searched for liens, etc.
Insurance that protects the buyer and lender should an individual or entity step forward with a claim that was attached to the property before the seller transferred legal ownership of the property or “title” to the buyer.
Fees imposed by the state, county or municipality on transfer of title.
A period of time (typically 30 days or more) after a buyer has made an offer on a home and a seller has accepted. During this time, the home is inspected and appraised, and the title is searched for liens, etc.
A buyer’s final inspection of a home before closing.
Words to know when you own a home
Repayment of a mortgage over the loan term through regular monthly installments of principal and interest, based on an amortization schedule. If you have made your required monthly payments, at the end of the loan term (e.g., 15 or 30 year mortgage), you will own your home.
A deed is the legal document that establishes ownership of real property, and is also used to transfer the ownership of real property to another person or entity.
A percentage of the home’s value owned by the homeowner.
Homeowners association (HOA)
The governing body of a housing development, condo or townhome complex that sets rules and regulations. They charge dues used to maintain common areas. Learn more about HOAs here.
A lien is any legal claim upon a property for a debt or a non-monetary interest in the property. A lien is a security interest that can give a creditor the right to take possession of a property secured by a loan, such as a mortgage, when the borrower defaults on the loan obligations. Most lenders will require title insurance to protect their interests should there be outstanding liens on the property securing their security interest.
Property tax exemption
A reduction in taxes based on specific criteria, such as installation of a renewable energy system or rehabilitation of a historic home.
The act of paying off one loan by obtaining another. Refinancing is generally done to secure better loan terms, such as a lower interest rate.
The government’s legal claim against property when the homeowner neglects or fails to pay a tax debt.
Try This Guide to Help you Navigate Your Way Through A Stress-Free Transaction… Complimentary Spring Buyers Guide Please Click Here!
If you’re thinking of selling your house this year, timing is crucial. After all, you’ll want to balance getting the most out of the sale of your current home and making the best investment when you buy your next one.
If that’s the case, you should know – you may be able to get the best of both worlds today. Here are four reasons why this spring may be your golden window of opportunity.
1. The Number of Homes on the Market Is Still Low
Today’s limited supply of houses for sale is putting sellers in the driver’s seat. There are far more buyers in the market today than there are homes available. That means purchasers are eagerly waiting for your house.
Listing your house now makes it the center of attention. And if you work with a real estate professional to price your house correctly, you can expect it to sell quickly and likely get multiple strong offers this season.
2. Your Equity Is Growing in Record Amounts
According to the most recent Homeowner Equity Insight report from CoreLogic, homeowners are sitting on record amounts of equity thanks to recent home price appreciation. The report finds that the average homeowner has gained $55,300 in equity over the past year.
That much equity can open doors for you to make a move. If you’ve been holding off on selling because you’re worried about how rising prices will impact your next home search, rest assured your equity can help fuel your move. It may be just what you need to cover a large portion – if not all – of the down payment on your next home.
3. Mortgage Rates Are Increasing
While it’s true mortgage rates have already been climbing this year, current mortgage rates are still below what they’ve been in recent decades. In the 2000s, the average mortgage rate was 6.27%. In the 1990s, the average rate was 8.12%.
For context, the current average 30-year fixed mortgage rate, according to Freddie Mac, is 3.85%. And while recent global uncertainty caused rates to dip slightly in the near-term, experts project rates will rise in the months ahead. Doug Duncan, Senior Vice President and Chief Economist at Fannie Mae, says:
“For homebuyers, we believe that borrowing costs will likely rise with the increase in mortgage rates….”
When that happens, it’ll cost you more to purchase your next home. That’s why it’s important to act now if you’re ready to sell. Work with a trusted advisor to kickstart the process so you can take key steps to making your next purchase before rates climb further.
4. Home Prices Are Climbing Too
Home prices have been skyrocketing in recent years because of the imbalance of supply and demand. And as long as that imbalance continues, so will the rise in home values.
What does that mean for you? If you’re selling so you can move into the home of your dreams or downsize into something that better suits your current needs, you have an opportunity to get ahead of the curve by leveraging your growing equity and purchasing your next home before prices climb higher.
And, once you make your purchase, you can find peace of mind in knowing ongoing home price appreciation is growing the value of your new investment.
If you want to win when you sell and when you buy, this spring could be your golden opportunity. Let’s connect so you have the insights you need to take advantage of today’s incredible sellers’ market.