| THE BUYER'S VIEW
Can You Afford a Home?
Consider the following factors to determine whether or not you can
afford to purchase a home:
• How much money have you saved for a down payment?
• What is the status of your current
income and expenses, such as car payments?
• Do you have
a good credit history?
• What are the current interest rates
on mortgages?
• What are your priorities and lifestyle? |
Q. How much home can I afford?
A. This is one of the first things to consider when buying a
home. First of all, knowing what you
can afford will narrow your range so you will not waste time by looking
at homes that cost too
much. First-time buyers often become disappointed when they find the home
of their dreams only to discover they cannot afford it.
Unless you are paying cash for a home, how much home you can afford depends
on your
income, your assets, your expenses and debts (including automobile or
education loans and
outstanding credit card balances), prevailing interest rates on mortgages,
the cash needed for a
down payment (10 to 20 percent of the purchase price), and closing costs
(four to six percent of the purchase price).
Q. Is there a formula for determining what I can afford?
A. The prevailing rule says that a home should cost no more than
2.5 times your annual income.
Thus, if your income is $50,000, your price limit would be $50,000 multiplied
by 2.5, or $125,000.
Typically, a lender expects you to pay no more than 28 percent of your
gross income for housing, which includes the loan payment, property tax,
home owner's insurance, and estimated utility costs. A lender will look
at your debts. As a general rule, your total indebtedness, including monthly
housing expenses, should not exceed 36 percent of your gross income.
Along with these guidelines, consider your lifestyle and priorities. If
costly vacations,
dining out, and entertainment are important to you, you may want to buy
a less expensive home
than the lender says you can afford. Many people, however, find that they
are willing to give up
some luxuries or even stretch their budget for the home they want.
Use the following worksheet to help calculate how much of a mortgage a
lender would be
willing to grant you. Remember that your total debts plus potential housing
costs cannot exceed 36 percent of your gross income.
Gross Monthly Income
Borrower Co-Borrower Total
Base income $______ $________ $_____
Overtime $______ $________ $_____
Commissions $______ $________ $_____
Dividends/Interest $______ $________ $_____
Other $______ $________ $_____
Total $______ $________ $_____
LIABILITIES: Monthly Unpaid Months left to pay
Payments Balance
Automobile loans $______ $________ _____
Student loans $______ $________ _____
Personal loans $______ $________ _____
Credit cards $______ $________ _____
Other $______ $________ _____
Total Monthly
Payments $______ $________ _____
You can also easily locate Internet-based calculators that can automatically
calculate these figures
for you, though they may not all use the same values.
Q. How much money will a lender provide for my home purchase?
A. The total loan amount a lender will agree to provide is directly
tied to your income and
expenses. As a homeowner, you will be paying a monthly loan payment, along
with the cost of
insurance, property taxes, utilities, and maintenance. A lender looks
for a solid history of income, employment, and credit. The lender also
will review your expenses, including automobile payments, credit-card
debt, education loans, child support, alimony, etc. If you are borrowing
money for your down payment, the lender will treat the interest payments
on that loan as expenses.
Q. What do I need for a down payment?
A. Some people may qualify for special government-insured loans
offered through the Federal
Housing Administration (FHA) or Veterans' Administration (VA). The down
payment needed for these loans is minimal. You can learn more about the
programs at http://www.hud.gov/hudqa.html and http://www.homeloans.va.gov/.
But, unless you can qualify, you will need a down payment equal to 20
percent of the purchase price to avoid paying the extra cost of Private
Mortgage Insurance (PMI). With less than a 20-percent down payment, banking
regulations require the buyer to carry PMI. This insures the lender against
nonpayment of the difference between the customary down payment and the
down payment actually paid. The charge for PMI may be as much as $50 or
$60 per month, although the amount declines as the loan ages and you begin
to pay off more of the principal.
Q. Do I have to pay PMI for the life of the loan?
A. No. The federal Homeowner Protection Act, which went into
effect in the summer of 1999,
helps consumers understand when they no longer need to pay private mortgage
insurance—and
thus save thousands of dollars over the length of a home loan.
Once you’ve build up at last 20% equity in the home—meaning
that the money owed is
less than 80% of the home’s value—the lender is no longer
at risk, and you can ask that the
insurance be cancelled.
Under the new federal law, the lender must cancel the insurance when the
mortgage
balance falls below 78% of the home’s original purchase price. However,
because homes usually appreciate in value, you may be able to cancel it
earlier—and federal law now requires the lender to tell you annually
that you have the right to cancel if you meet certain criteria, such as
rising home values increasing your equity.
Sometimes canceling PMI occurs as part of refinancing your loan, when
it’s clear that your
home has increased in value to the point where the balance of your loan
is less than 80 percent of the home's value. Be aware, however, that even
outside of a refinancing situation the insurer will need written support
from a certified appraiser as to the value of your home. The value assessed
by a municipality for real estate tax purposes is seldom considered in
evaluating home equity.
Q. What will I need for closing costs?
A. Along with the down payment, you will need between four and
six percent of your loan amount to pay for closing costs, unless you are
obtaining an FHA or VA loan. These costs include fees for your attorney,
the lender's appraisal, lender's title insurance, title search, escrow
deposits for property taxes and/or homeowner's insurance, as well as other
expenses such as recording fees. If you are obtaining a loan, the law
requires the lender to provide an estimate of these costs at the time
you apply.
Q. Is the seller responsible for any costs?
A. Yes. The seller is responsible for paying the commission on
the sale and must pay any taxes
owed on the property, any money due his or her lender, and any liens that
may be outstanding on the property. Usually, the seller is required to
pay the cost of a title insurance policy for the buyer that insures the
buyer against any defects in the title to the property.
The seller is sometimes required to pay "points." Points are
the difference between
prevailing interest rates and the rate the buyer is actually paying for
his or her loan. For example, if the prevailing rate is eight percent
and the actual rate being paid by the buyer is seven percent, the seller
would pay one point, or one percent, of the amount of the buyer's loan.
Q. How do interest rates affect my choice of a home?
A. The interest you pay on your loan is part of the cost of owning
a home. For example, a one
percent increase in the interest rate on a $100,000 loan adds approximately
$75 to your monthly loan payment over the life of a 30-year loan. Obviously,
the lower the interest rate, the more you can afford to borrow. Be aware
that home interest rates can change quickly. They usually are the last
rates to decline when other interest rates are falling and are among the
first to rise when other rates are climbing.
Q. Should I pre-qualify for a loan?
A. If you are unsure about your price range and, especially,
if you are a first-time buyer, prequalifying for a loan can help smooth
the purchase process. You will know exactly what you can afford and avoid
the disappointment of being unable to buy the home you thought you could
afford.
To pre-qualify for a loan, you will need to go through most of the steps
entailed in applying
for the actual loan. If you decide to pre-qualify, be sure to do so through
a loan originator, that is, an actual lender. A mortgage broker, who brings
together borrowers and lenders, cannot prequalify you for a loan.
Q. I want to buy a home but my credit history is poor. Is there
anything I can do?
A. Yes, there are several options. First, before you attempt
to buy, you will want to improve your credit record by paying your bills
on time and by curtailing your borrowing.
Second, credit-reporting agencies can and do make mistakes. Major credit-reporting
companies such as Equifax (http://www.equifax.com/), Trans Union (http://www.transunion.com/),
and Experian (formerly TRW)
(http://www.experian.com/experian_us.html) maintain computer files on
your financial history.
Credit-reporting agencies are authorized by law (see http://www.ftc.gov/os/statutes/2summary.htm)
to disclose credit information to any person or
organization with a legitimate business need for the information. On the
other hand, the law also
gives you the right to examine your own file. A summary of the report
must be made available to you free of charge; however, there is a fee
if you request a full credit report. If you believe your credit report
is in error, you may challenge the report by explaining the error in writing.
The information must be verified by the agency if it is kept in the report.
If you discover inaccuracies and you can prove them, you can demand that
the agency correct them within a reasonable period of time. If there are
no errors, you have the right to include a letter of explanation of up
to 100 words in your report. The agency must include your statement, or
a clear and accurate summary of it, in all future reports. For example,
if you were unable to pay a loan because you were out of work or suffered
a severe illness, you could add this information to the report. You may
want to consult your lawyer if you are unable to have your report changed
as required by law. (See the "Consumer Credit" section for more
details.) Credit-reporting agencies are allowed to retain negative information
in your report for seven years and bankruptcy information for 10 years.
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