What Can You Afford?

Before you begin looking at homes, you will want to determine what you can afford. That depends on three things: down payment, qualifying for a loan, and closing costs.

Down Payment
A conventional loan typically requires a down payment. It is not uncommon for buyers to place a down payment of 10 to 20 percent of the purchase price. For example, on an $80,000 home, a down payment of $8,000 to $16,000 in cash may be warranted.

Government-backed loans require 5 percent or less as a down payment. Loans insured by the Federal Housing Administration (FHA) and the Veterans Administration (VA) are particularly useful to first-time buyers.

The thing to remember is that the higher your down payment, the lower the risk you pose for the lender and therefore the lender may be able to offer you better loan terms. The higher the down payment the lower your interest expense on the mortgage will be.

Qualifying For A Loan
The key is not what you think you can afford but how much a lender calculates you can afford. Be prepared to provide the lender with a two to five year financial history that contains the following:

Income - gross monthly income as well as employment history, education, and any secondary income such as bonuses, dividends, and child support. The lender may require a letter from your employer, W-2 forms, or, if you are self-employed, recent tax returns.
Assets - current checking account balances, savings accounts, stocks and bonds, certificates of deposit, other property, insurance policies, and pension funds.
Credit - debts on cars and appliances, debts on all credit cards, and history of debt repayment. Your lender may ask for a credit report, so you may want to clear up any known negative terms in advance.

A REALTOR® can help you determine what price range and monthly payment you can afford. The monthly payment typically consists of principal, interest, taxes and insurance - PITI, for short. The monthly payment is calculated based on the loan amount, the interest rate, the term of the loan, the costs of any insurance, and taxes.  You can get an idea of what your payment will be by using this mortgage calculator.

Closing costs
Purchasing a home involves a number of other parties and services. For example, the lender may require a survey and an appraisal to be completed. The title company will hire an attorney to prepare the conveyance document.  You may want to have an inspection completed. You can expect fees for such services as appraisal, survey, inspections, hazard insurance, loan origination (lender's administrative costs), credit report, document preparation, title search and insurance, recording fees, notary, attorney and escrow.

You will pay for some fees and the seller will pay for others. The costs will vary depending on each transaction. Most lenders will provide you with a good faith estimate of such costs. Your REALTOR® can also help you estimate what those costs might be.

One item at closing that is often confusing to first-time buyers is points. Points are an additional amount a lender charges up front for the loan. Points are interest collected in advance. One point is 1 percent of the loan amount.  Three points on a $70,000 loan amount, for example will be $2,100. By collecting points (interest) in advance, the lender actually increases his rate of return on the loan. For example, if market interest rates are at 8.5% for a 30-year loan with no points a lender might offer you an alternative loan at 8% if you pay some points.

Other costs
One additional consideration is the other costs associated with owning a home - namely, utilities and maintenance.  These costs will depend on the home you choose, but it's a good idea to budget for them in advance.