1. Are you ready to buy?
No big down payment, no maintenance or repair costs, no downside to potentially lowered home values, lower utility and insurance costs and the freedom to pick up and move out and move on are the just few advantages of renting. Faced with higher prices, stricter lending standards and especially competition from all-cash buyers, many new home buyers have no option but to rent. It is especially true for homes priced under $150,000 that is at fierce competition with investors looking to flip a few months later or simply invest and rent them out.
2. How Much You can Afford?
The absolute first step to considering buying a home (unless you are buying with cash) is to get pre-approved for a loan by a bank or mortgage broker. The lender will set the amount you can afford to finance and from there you can decide how big of a house you can buy. A pre-qualification letter from one lender is sufficient to get started and to get a good idea of what one can afford before starting to look for a new home.
Lenders look at debt to income ratios to determine how much they can safely lend out.
2A. CONVENTIONAL LOAN
For conventional loans the monthly housing expense can not exceed 28% of your combined gross income and total recurring debts cannot exceed 36%. The lender looks at both and the most restrictive formula is applied to find the allowable monthly payment on a home loan. The formula is DEBT/INCOME <= 28% for housing expenses and <= 36% for total combined recurring expenses.
The housing expenses includes the following: 1. Principal, 2. Interest, 3. Property Taxes, 4. Insurance also known as PITI and homeowner association dues if applicable. The recurring expenses would include car payments, other loan payments, child support payments and credit card payments. If you are earning $100,000 annually at 28% you can afford $100,000 X 0.28 = $2,800 / month using the housing expenses only and $3,600 with additional monthly expenses added on to the housing debts. These figures assume that down payment, if you have one, is paid separately from these figures.
Working backwards is the way to go because from there the lender can calculate for you the monthly payment you can comfortably live with considering all other expenses you will have. This monthly payment will vary depending on your pre-approved interest rate. Therefore, it is important to shop around and get quotes from at least 3 different lenders as their terms, closing costs and interest rate will vary. There are hundreds of lenders to choose from. If you are working with a Real Estate Agent, they too can recommend a reputable company they work with. Remember, that your credit score will not get impacted when shopping for a loan and doing credit checks in the same 3-4 week window. The credit agencies account for this in their credit score ratings and if done in a short window additional credit checks for a mortgage will not have a negative impact on your credit score.
2B. FHA LOANS
For FHA loans the housing-expense-to-income ration is 31%, while the maximum proposed total monthly-debt-to-income ratio is 43% but unlike conventional loans above the FHA ratios remain constant and are not dependent on loan’s LTV or Loan to Value ratio.
2B. VA Loans
The VA uses only the total-monthly-debt-to-income ratio, which the VA has set to 41% of the borrower’s income.
3. You don’t need 20% Down payment
20% down payment will certainly avoid paying for what’s called a Private Mortgage Insurance (PMI) which is required for a conventional loan. However, FHA, VA and USDA insured loans have as low as no down payment. VA insured loans allow for 100% financing without a down payment while FHA insured loans allow for just 3.5% down payment. Even on a conventional loan the PMI will drop as soon as the borrower reaches 20% home equity on the house and appreciation is one of the parameters used in its evaluation. This means that a conventional loan with loose the PMI as the equity of the home goes up.
3. Work with a Realtor
Realtors get compensated from the seller’s proceeds when the buyer closes on the house. Buying a home requires dozens of forms, reports, disclosures, and technical documents and a knowledgeable expert will help you prepare the best deal, and avoid delays or costly mistakes. Also, there’s a lot of jargon involved, so you want to work with a professional who can speak the language. Sometimes properties are available but not actively advertised. A REALTOR® can help you find opportunities not listed on home search sites and can help you avoid out-of-date listings that might be showing up as available online but are no longer on the market. A REALTOR® is also connected with systems to get immediate notifications on new properties that match your criteria and needs, while most online systems may not get these updates till days or weeks later. Don’t miss an opportunity to buy your dream home by relying on outdated information and not knowing how to work through dozens of forms.
4. Narrow Down Your Location
For a young couple that may be planning to have a family or to sell the house a few years down the road makes location a very important consideration. Homes in locations with good schools will sell faster but demand higher price than homes where school ratings are lower. Homes further away from a city will have lower asking price but this can be offset by the cost of gas and wear and tear on your car. Consider for instance 30 mile round trip to work with a car that gets 20 mpg. For a full time commuter that would calculate as 260 days x 30 miles / 20 mpg x $2.50/gal which amounts to $975 annually or $81 monthly on gas alone and 7,800 miles of wear on your car. Adding depreciation on your car, oil changes, tire replacement and others the extra distance does come at extra cost.
If you are looking to purchase a house in the Raleigh area, also read my tips on finding a new home in a hot market.