How Much Can You Afford?
Understanding how much you can afford is one of the most important
rules of home buying. Depending on your individual situation, your budget can
affect everything from the neighborhoods where you look, to the size of the
house, and even what type of financing you choose.
Bear in mind, however, that lenders will look at more than just
your income to determine the size of the loan. Likewise, you may find that
there are some creative financing options that can help boost your purchasing
Loan prequalification vs. preapproval
One of the best ways to determine your budget is to have your real estate agent
or lender prequalify you for a loan. Prequalification is different from
preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval
is a more formal process where a lender examines your finances and agrees in
advance to loan you money up to a specified amount.
What factors are important to lenders?
Banks and lending institutions will use several criteria to determine how much
money they'll agree to lend. These include:
- Your gross
- Your credit
- The amount of
your outstanding debts
- Your savings--or
the amount of money you have available for a down payment and closing
- Your choice of
mortgage (i.e. 30-year, FHA, etc.)
- Current interest
Two important ratios
Lenders also use your financial information to figure out two, very important
ratios: the debt-to-income ratio and the housing expense ratio.
lenders use a rule of thumb that the amount of debt you are paying on each
month (car payment, student loan, credit card, etc,) shouldn't exceed more
than 36 percent of your gross monthly income. FHA loans are slightly more
- Housing expense
It is generally difficult to obtain a loan if the mortgage payment will be
more than 28 to 33 percent of your gross monthly income.
Down payments make a difference
If you can make a large down payment, lenders may be more lenient with their qualifying
ratios. For example, a person with a 20 percent down payment may be qualified
with the 33 percent housing expense ratio, while someone with a 5 percent down
payment is held to the stricter 28 percent ratio.
Other ways to improve your purchasing power
If you're having trouble saving money, many lenders will allow you to use
gift funds for the down payment and closing costs. However, most lenders
require a "gift letter" stating the gift doesn't have to be
repaid, and will also require you to pay at least a portion of the down
payment with your own cash.
Through negotiation, some sellers may agree to pay all or most of your
closing costs (for example, if you agree to meet their full asking price).
If you choose to try this, make sure to ask your real estate agent for
- Loan Programs
Many local governments have special loan programs designed to help
first-time homebuyers. Loans may be available at reduced interest rates,
or with little or no down payments. Check with your local housing
authority for more information.
- Loan Types
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low
initial interest rates. Others opt for 30-year loans because they have
lower monthly payments than 15-year loans. There are significant
differences between different loans, so make sure to discuss the pros and
cons of different loans with your agent or lender before making a