Are you looking at buying a new house or refinancing your current one? With interest rates being so low, we are seeing lots of our clients asking questions that direction.
Before you get too far down the road of (re)financing a home, though, you will need to be as informed as possible. In this post, we’ll look at the financial aspect of buying or refinancing a home—how much should you spend, what you should consider in deciding your mortgage payment, the purchase price, and the ideal down payment.
Homeownership is a substantial investment and a long-term commitment—so it is important to become as knowledgeable as possible about the process of buying a home. In our next post, we’ll look at working with a real estate agent, the process of finding the right home for you, negotiating the best possible deal, and the various aspects of closing.
DECIDING HOW MUCH TO SPEND
Before deciding on the price range of the home you plan to buy, think about how much you want to pay out each month in mortgage payments. Use a mortgage calculator (online) to figure out what your payments would be and try to make as large a down payment as possible to reduce your principal loan amount.
THE MORTGAGE PAYMENT
A mortgage payment consists of the mortgage loan payment (principal and interest), property taxes (in most cases), and homeowner’s insurance. It might also include private mortgage insurance if your down payment is less than 20 percent.
Caution: The lender will set a maximum on how much you can borrow, but you use the maximum only as a starting point in deciding how much you will borrow.
Tip: To get an estimate of the maximum mortgage amount ask a real estate agent to help you get “pre-qualified” by a lender.
When deciding how much to borrow, be sure to take into account saving for your retirement, your financial goals, and your current lifestyle. If your monthly payments do not allow you to meet these needs, buying that particular home may not make financial sense.
Caution: To avoid having your dream home turn into a nightmare, calculate how much you realistically can spend on the monthly mortgage payment. Do not forget to add in the real estate taxes and mortgage insurance.
Lenders will be happy to pre-qualify you by giving you a preliminary limit on the amount they would be willing to lend you. This pre-qualification is not a commitment on the lender’s part; lenders will not commit to a mortgage until they have the property appraisal and all of your supporting documentation, but the maximum loan amount they are willing to offer can be helpful for planning purposes.
The maximum debt is based on your income and debt level. It depends on current interest rates, the term of the mortgage, and the property taxes. To get a rough idea, the maximum debt amount is usually about three times your annual gross income.
THE PURCHASE PRICE
Having decided how much of a monthly mortgage payment you can realistically afford, you are now ready to set a price range for your new home. Give this range to potential real estate agents during your first visit or use it to rule out homes that are out of your price range.
Tip: Don’t be afraid to look at homes that are 15 to 20 percent over your price range. In many cases, you will be able to negotiate the price down.
THE DOWN PAYMENT
Try to make as large a down payment as possible. There are two reasons for this: (1) lenders will generally not require you to pay for private mortgage insurance if you can come up with a 20 percent down payment and (2) the sooner you pay off your mortgage, the better off you will be financially.
To save the 20 percent down payment, you may need to go on an “austerity plan” for a year or two. Many home buyers also use cash gifts or loans from family members to meet the 20 percent figure. If you cannot save 20 percent of the purchase price, you will still be able to get financing, however.
In our next post, we will look at the process of working with a real estate agent, working with a mortgage service provider, and the ins and outs of home inspections.
Even with great interest rates, we know that buying a home (or refinancing one) can be overwhelming. That’s why you shouldn’t go it alone. We can help you know best practices and pitfalls to avoid—we’ve been helping our clients make the best financial decisions for decades! Give us a call and let us help you traverse the way to a great home!