Can You Afford to Buy?

Here are some common questions and answers to help you make your homebuying experience smoother, more enjoyable (as it should be!), and to arm you with knowledge as we start the homebuying process together. 

Since I am a first time buyer, do I need money to purchase a home?

Oh, absolutely.  Earnest money is the first check a buyer will need to write to accompany his offer to buy a home.  Along the way in the purchase transaction, buyers pay for a home inspection out of his own pocket, and often, lenders ask for upfront fees such as payment for credit reports and an appraisal.

Based on FICO scores, debt/income ratios, and available cash, lenders will advise what loan products, if any, are available and if a down payment will be necessary.  A down payment is separate from earnest money, and could be paid from gift money from parents/other or even through the state!

Yes, that's correct,  if you qualify as a 1st Time Home Buyer, you can receive downpayment assistance and closing cost monies from the county you choose to live in. You can also qualify for below market value fixed interest rate loans!

Closing costs are not part of the financed amount of a purchase, and can add 3-5% on top of the sales price as "other costs" one incurs with a home purchase.  While there are VA and conventional loan products offering "100% financing," closing costs are still additional costs expected to be paid that can't be completely wrapped up in the loan.  (Note: Some fees, such as the VA funding fee, may be wrapped up in the loan.)

Now that it is a buyers' market in many parts of the country, sellers are more willing to pay for buyers' closing costs, home warranty, HOA fees paid for a year, and many more incentives.  A good real estate agent such as myself will be able to negotiate the right deal for you and you write this into your offer.  When the down payment is out of the way and closing costs are paid for by the sellers, the county or state, buyers can be refunded the earnest money at closing — and in the end, be out the inspection costs, which may be as little as a couple hundred bucks!  Because so many factors affect this process, it is worth it to discuss your opportunity to buy with a professional.

Are there any reasons I should NOT buy a house?

There are many reasons why you should not buy a house:

1) You can't afford it
2) It makes more financial sense to rent

3) You can only afford it with an adjustable rate, negative amortization loan

4) You plan on living in the house for less than 5 years

5) The market is rapidly declining

6) Too much debt

Other than those reasons, of course you should buy a house!

Whether you're a first-time buyer looking for the perfect starter house, or a seasoned pro trading up to your waterfront dream home, you are probably asking the same questions: Can I afford this? And is this the right move at the right time?

In a hot real estate market, some might say the question is not "Can I afford this home?" but "Can I afford not to jump onto the climbing real estate escalator?" Aside from building equity over time and benefiting from the tax breaks of home ownership every April 15, everybody pays rent - the difference is whether the landlord is you or someone else.

In a soft real estate market, just make sure that you're able to withstand a short term decline in home values before you buy. You don't want to have to sell when you're upside down (i.e. owe more than your home is worth).

If you can't afford to buy a home now (can't get a traditional mortgage). You can look into the rent to own concept. This is a bit risky for most people who cannot buy a home now.  Chances are very good that your situation may not improve over the next 12 months and you will have lost your investment in the rent to own option.

Planning to Make a Move

One of the best places to start is with a detailed expense breakdown. Analyze what you spend - at least get a full month's snapshot. You'll see where you may have wiggle room in your budget and what you can afford for housing. (Be sure to count all those little incidental expenses like dry cleaning and yes, those mid-afternoon Starbucks lattes count in the budget, too!)

Real Life Example 1

This sample budget belongs to a single, 35-year-old woman making $68,000 per year, renting a two-bedroom apartment. Her monthly pre-tax income is $5,667.

Monthly expenses:

The sample budget may not look like your expense snapshot, but by adding and subtracting your personal budget items with an eye toward true monthly out-of-pocket totals, you get a pretty good picture. Now, add in all of the expenses where the zeros are as well as the increased cost of your monthly mortgage payment (formerly rent). Maintenance costs like condo fees, utilities, the leaky bathroom sink that defies a simple trip to Home Depot to fix, property taxes, closing cost , and furniture for your new home all add to the bottom line.

Debt-to-Income Ratios

If you can comfortably afford the existing $1,600 rent (or existing mortgage if you are trading up), chances are you'll qualify for a mortgage in the same range, or even higher. Lenders will determine how much loan you can afford by using debt-to-income ratios - basically what's left in your budget after your monthly bills are paid. These include credit card payments, car payments, child support, etc.

• Housing ratio (or "front-end ratio"): Lenders want your total mortgage debt (PITI) and condo fees to be no more than 30 percent of your gross monthly income; 28 percent is standard.

• Overall debt ratio (or "back-end ratio"): These are revolving monthly payments, such as Visa, MasterCard, car lease or loan payments, student loans, child support, alimony, monthly utilities. (They do not include those lattes, but you might want to plug in your lifestyle expenses for your own sake.) The ratio should not be more than 36 percent.

Debt-to-income ratio standards differ from lender to lender, and vary based on a loan program, but most lenders will give more weight to your credit history as a factor in determining your particular situation. Here is typical ratio for a first-time buyer:

The mortgage debt of $1,596 is right in line with the current monthly rent payment in the example above. As long as the monthly debt obligations and household expenses are no higher than $2,000-2,300, this borrower should have no problem qualifying.

If your credit is stellar, you will be rewarded. Lenders may stretch these ratios to 38/45, allowing you to purchase more home and take advantage of more lending programs. And if you are a first-time home buyer applying for an FHA, or VA loan, you may also be able to qualify with a higher back-end ratio - up to 41 percent of your monthly gross income - and get approved for these federally-insured loans.

How It Works

So, back to the question:  How much home can I afford?

Keeping in mind the variables on debt-to-income ratios and the many lending programs available, here is a sample breakdown for a mid-range home. Note: The U.S. median home price is about $265,500.

You can research mortgage interest rates and property tax rates (usually by county) on the web to find averages for your area, and make the table more accurate for your situation.

Here is an example of a lower price-range home, purchased with the same loan terms and interest rate:

And the Other Costs ...

In addition to the monthly mortgage payment, remember to factor in the added costs of home purchase and ownership. Since this buyer above did not put 20 percent down, he will need to add mortgage insurance, also known as PMI, to his monthly payment. Buyers also incur closing costs of 2.5 to 3 percent of the total loan amount. This covers the cost of title searches, appraisals, legal fees, etc.

So what's left to apply to the down payment? Using the example above, our first-time buyer has $15,000 for the down payment on a $150,000 home, and the closing costs may come to $4,500. The mortgage total just increased to $139,500. Over the 30-year loan period, this brings the mortgage payment to approximately $866 per month. If your head is not already spinning, now tack on mortgage insurance (fees vary based on the loan), homeowners' taxes and condo fees (if applicable), bringing the total monthly payment to approximately $1,038. The good news is this is still well in the range of the acceptable debt ratio.

Keep Some Money in Reserves

Many buyers invest every cent they have into their new purchase, but it's a good idea to keep some emergency cash, or "leaky faucet money," aside in the event of emergency repairs or a job loss. So don't completely raid your savings; with home ownership, expect the unexpected.