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Buying a home? Here are 3 Pointers for Determining Your Budget

woman calculating her budget

The housing market is set to be even more competitive in 2020. If you’re considering buying a home this year, it’s more important than ever to arm yourself with the right information.

It’s important to be in good financial standing before you buy a home. But what exactly does that look like? What type of budget do you need?

Consider these three pointers when determining your budget.

Have a Good Credit Score

Your credit score ultimately dictates your interest rates, and don’t underestimate the importance of even a few tenths makes to an interest rate. Even an interest rate that is .5% more can equate to $20,000 plus, over the course of a 30-year mortgage.

Lenders use your credit score to determine how much of a “risk” you will be. They typically offer less appealing mortgage rates to people with poorer credit scores, due to the greater risk. A credit score between a 580 and a 669 is considered to be “fair.” It’s possible to get approved with this type of ranking.
However, your options won’t be great.

Anything from a 670 to a 739 is considered “good,” and more options are available with this type of score. The best mortgage rate options are given to applicants with credit scores of 740 or higher. When committing to a 30-year loan, it’s often best to wait it out until your credit score is at least in “good” standing, preferably better.

Understand How Lenders Calculate

Lenders use what are known as front-end or back-end ratios to calculate how much a person can afford in terms of a monthly mortgage payment. You can have an excellent credit score and an impressive down payment amount, but if the data a lender uses doesn’t show that you can afford your maximum, you likely won’t get approved.

The front-end ratio estimates your mortgage payment as a percentage of your total gross income. The back-end ratio calculates your mortgage as part of your total monthly debt in the form of a percentage. Front end ratios are typically 28%, and the back-end is 36%. But check with your lender before calculating these numbers on your own.

Choosing the Right Amount for a Down Payment

Your down payment is another key factor lenders use to calculate your interest rate on your mortgage. Your interest rate establishes the “true cost” of a home. The more money you have to put down on a home, the lower your interest rate will be.

Lenders calculate what is known as a loan-to-value ratio, which established the home’s value you owe once the downpayment you have is applied. For example, if you buy a home that costs $250,00 and you put down $25,000, your loan-to-value ratio is 90%, since you’re borrowing $225,000.

The general rule of thumb us having 20% of the total home cost to put down as a down payment. But that’s not always true, someone with excellent credit, a high income, and no debt could get approved for a decent loan with as little as 3.5% down. But higher down payments have benefits. They are more appealing to sellers in competitive markets, offer lower interest rates and mean you’ll pay less for your home.

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