Most people dream of owning a home. When you have your own house, you can do whatever you want—unlike growing up, where your father might have said, “This is my house; you’ll do what I say.” Perhaps that freedom is a significant motivator for you in making the decision to buy a house.
Aside from your desire to have freedom, many other external or situational factors can go into the home-buying decision, such as getting married, expanding the family, a new job, and others. However, you should also ask yourself the following question to ensure that the time is right: Where are you financially, and can you afford to make such a commitment?
As a general rule, most financial institutions counsel potential homebuyers to spend no more than about 30% of their monthly gross income on a home mortgage. Lenders will look at two percentages — the housing ratio and the total-obligation ratio. Your housing ratio is the percentage of your gross monthly income that will be earmarked for your housing expenses. Again, 26–30% is the upper edge of the comfort zone. The total-obligation ratio is the piece of your income that covers both your housing expenses and any other known debt, such as credit cards, child support, and auto loans. For this ratio, the goal should be no higher than 36%. These numbers will give you an idea of the amount of money for which you may qualify with a bank or other financial institution.
Remember that there are also closing costs and other fees. These can range from about 2–4% of the price of the home. You will have some property taxes as well as homeowners insurance.
Add to this improvements or repairs that you want to get done before you move in (e.g., maybe you want to take out the worn out carpeting and replace it with new flooring before all of your furniture is in the house). If you are in a planned community, you could have an HOA fee every month, which could be anywhere from $20 up to several hundred dollars. These are the fixed costs that encompass your monthly expenses for living in your home.
Home ownership has some additional costs that you don’t think of until something doesn’t work. This could be the air conditioning that fails in the middle of the summer, or the water heater that gives out right before you get ready for work. Some people start a “rainy day” fund for these expenses; if you don’t, this is another item that will increase your obligations for that month or the term you need to pay this expense.
Down Payment and Mortgage Insurance
The amount of money or cash that you put down on your house — that is, the size of the down payment you bring to closing — is extremely important. If your down payment is less than 20% of the purchase price, you will more than likely be required to pay mortgage insurance. Mortgage insurance is an agreement that insulates the lender from the losses sustained if the buyer defaults on a home mortgage. If you are planning to put less that 20% down, the PMI (private mortgage insurance) will also be added into your ratios to determine your total monthly obligations. Your lender can give you the exact figure, but PMI premiums can be anywhere from $50 to $100 a month. That figure is added to your monthly mortgage payment with the taxes and homeowners insurance (if it is placed in escrow).
Mortgage lenders are now being held to a higher standard following the economic downturn and the mortgage crisis. As a result, it may take longer to go through the loan underwriting process, and you may be asked to provide additional information on specific purchases or activities. For example, cashing a check at a casino may be a red flag, even if you just wanted cash to dine at the nearby restaurant. A high credit score is a good start these days, but that will not exempt you from this scrutiny by the lender and the loan underwriter.
Home buying is exciting and will be one of the most important decisions you make. If you can barely qualify and things look tight, hold off for a while. Try to save up a nest egg. Make sure you have at least 10% for your down payment, 20% would be even better. Don’t let your dream home make your life a nightmare every month when it comes time to pay your mortgage.