Buying a home is exciting, but knowing how much home you can afford can be confusing. There are new terms to learn, and right now there are new laws being put into place regarding mortgages. When you’re shopping for a house, be sure to shop for what you can afford, not necessarily what you really love.
Debt Ratio
Banks are concerned about your debt ratio. This is the amount of debt you have compared to your assets. Your total debt is divided by your assets to arrive at this important number. For example, if you owe $5,000 on credit cards and $20,000 on a car, this would be your total debt. Your assets might include $10,000 in a savings account and the car that is worth $19,000. The $25,000 in debt is divided by the assets to arrive at a debt ratio of 86%. When the debt ratio exceeds 100%, it means that you simply have more debt than assets.
Good Credit and Bad Credit
Your debt ratio is one small part of the mortgage application. How your credit looks plays a major role in what kind of mortgage terms you will receive. When your bills are paid on time, and your debt ratio is low, you will enjoy lower interest rates and the possibility of a smaller down payment. Higher debt ratios, poor payment history, past due balances on accounts and other credit issues will leave you with higher interest rates and the very real possibility that you won’t be approved for a mortgage at all.
New Mortgage Rules
The housing crises left people shaken. Fear of a repeat has led lawmakers to make drastic changes to the ways banks issue mortgages. Many people bought more house than they could truly afford, and when the economy took a dive, they were unable to make the payments. Low down-payments and a great deal of flexibility with bad credit are receiving the brunt of the blame. Here are a few of the changes that are heading towards the banking industry, and the house-buying public.
• Higher down payments – The banks want to know that they can get back their investment in the house if you don’t pay. One way to make that happen is to require higher down payments. The worse your credit is, the more cash up front you will have to come up with.
• Stricter Credit Standards – A few years ago you could buy a house even if your credit had some dings. Those days are over. Late payments won’t be allowed, and neither will past-due balances. Currently, your bank account and your credit report both have to show that you can afford the mortgage payment.
• Subprime ARMs – Once a way to get into a bigger house than you really could afford, subprime ARMS are falling to the wayside. While you can still get a one, the qualification standards will be now based on the fully indexed and amortized rate. When the payments go up, the banks want to know that you’ll still be able to pay them.
How Much Mortgage you can Afford
The size of your house depends on the size of your current monthly payments, your income, and your down payment. Take the amount of your paychecks and deduct all monthly payments, excluding your current rent. Car notes, credit card payments, utilities, taxes, and retirement contributions should all be deducted, along with any other regular expenses. The amount you have left is technically what you will have to put towards a mortgage.
When considering the mortgage payment, take into account that part of that money will have to go towards property taxes and homeowner’s insurance. It’s also important to remember that you don’t want to be house-poor. You will still want to go out to eat and take a vacation once in a while. Don’t choose a house that will leave you strapped every month with no way to handle emergencies. Choose a home that you can comfortably pay for, and you will be much happier in the long run.