Everyone can imagine their “dream home.” For some, it’s a bungalow with a white picket fence. For others, it’s a sprawling mansion.
It’s easy to dream. But how do you determine if your ideal home is just a dream or if it’s your “reality home?”
Knowing how much home you can afford is an important question most potential homebuyers need to answer, especially if you’re considering your first house purchase.
If you don’t know how much you can afford right now, don’t feel bad. Most people need help to come up with a number. The best place to start is to understand the components of your future monthly mortgage housing expense.
If you have a mortgage, your monthly housing expense is made up of:
- Principal and interest - the cost of financing your home.
The monthly amount of principal and interest will depend on 1) the amount you borrow, 2) the interest rate on your mortgage, and 3) the length of the repayment term.
There are a few things to consider here. In most cases, longer repayment terms have lower payments but higher interest rates. While the payment is low, your overall cost of borrowing over time can be higher because of the higher rate and the longer it takes your principal to reduce.
As an example, a mortgage of $100,000 with a 30-year term and 4.0% rate gives you a base payment of $478.00 per month. The total of your payments over 30 years is $171,868.
If you opt for a 20-year term with a 3.75% rate, the payment is higher at $593 but the total of your payments over 20 years is $142,293. The shorter term saves you $29,575 in total payments. That’s a lot of money and something to seriously consider when setting the budget for your new home purchase.
- Property taxes
Too many people stop once they calculate their mortgage payment. Don’t do that. Remember that escrow for property taxes and homeowner's insurance will be included in your monthly amount.
Property taxes are due twice a year, and the cost will vary depending on where you live and the services that the community offers. It’s important to find out recent property tax amounts before buying. The seller or your real estate agent can provide this information.
- Homeowner's insurance
Homeowner's insurance is a requirement when you borrow to purchase a home. After all, the lender wants to know that you will be able to pay the balance of your loan should you have a fire or a natural disaster destroy your home. (Let’s hope that never happens to any of us. But it does happen.)
The cost of homeowner’s insurance will also vary by community. Reach out to your local insurance agent to get an idea based on the communities you're shopping in and your credit score. Insurance companies use your credit score as a predictor of future insurance claims.
- Homeowner's association dues
These fees come into play if you’re buying a condominium or in some single-family home neighborhoods. Homeowner’s association dues are the fees a community charges for the maintenance of common areas and general upkeep of shared buildings. These typically aren’t included in the total monthly payment, but lenders will consider HOA dues in the total expenses when qualifying you for a mortgage.
Don’t be caught off-guard. Make sure you inquire about any association fees before finalizing negotiations for your home. The dues can mean a substantial increase in your monthly housing costs.
- Private mortgage insurance
If you don’t have a down payment of at least 20% toward the purchase of your new home, you may also need to consider the cost of Private Mortgage Insurance (PMI) or Mortgage Insurance Premium (MIP). This insurance protects the lender in case you default and it’s included in your payment when required.
The PMI/MIP amount will vary on several factors, but it’s mainly affected by credit score, down payment, and term. For example, the higher your credit score, the lower the monthly PMI/MIP will be.
Are you a first time buyer? Genisys “Your First Mortgage” provides a low down payment option that does not require private mortgage insurance. Check it out.
Now that you’ve considered the main components of your monthly housing expense, how do you translate that number into a home purchase price you can afford?
A good rule of thumb is that your house payment should be around 25% of your gross (before taxes) monthly income.
- Take your annual salary or earnings, divide it by twelve, and that would give you a monthly amount.
- Take that number and multiply by .25 or take 1/4 of the monthly amount.
Try to get a mortgage amount, rate, and term to fit within this figure for an affordable payment that will allow for life's unknown surprises.
Genisys’ Mortgage Qualifier Calculator can help you easily determine how much you can afford using a variety of the factors discussed in the article.
Think about any future income changes.
Once you’ve completed the calculations discussed, you’re still not done. Now it’s time to get real.
What changes could come that would affect your income? Could a spouse stop working outside of the home to stay home with the kids? Do you receive overtime or bonus income each year and do you expect that income to continue? What happens to your ability to make your monthly house payment if it doesn’t? Is your work seasonal?
After you close on your new dream home, you don’t want to have the nightmare of struggling to make your monthly payments. Think carefully about how this payment will affect your day to day life. Will you still have money to go on vacations, pay for schooling, or meet other money demands?
Once you’ve taken all these factors into consideration, stop and think, “How much do you want to pay for the next twenty or thirty years for your home?” It’s an important decision, one worth taking the time to think about carefully before acting.
Genisys Credit Union has several Mortgage programs to fit most needs, including a mortgage geared for the 1st Time Homebuyer. Visit the mortgage page on our web site or contact us when you are ready and let us help you find out how much you can afford.
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