When it comes time to buy a new home, you can’t help but dream about the place you want. You start scouring the internet, Pinterest, and magazines to get ideas and search real estate and builder sites to see what homes are available. As you scan all the options and prices you start to wonder….what can I really afford? Though you may be approved for a large mortgage, should you really overburden yourself with debt? To ensure you are making the right financial decisions, consider the following:
Your Future Goals
Think about how long you plan to live in the house and what other financial goals you will be facing in that time frame. Are you planning to have children? If you already have children, will they be going to private school, heading off to college, or possibly getting married? Are you thinking about going back to school? Are you going to need a new car (or two) in the near future? If you have a large mortgage, it may be difficult to save for other important life events.
There are a lot of different “rules” and recommendations when it comes to determining the percentage of income you dedicate to your mortgage payment. When a lender considers you for a loan, they calculate your debt-to-income (DTI) ratio. This ratio shows the percentage of gross (pre-tax) income you are using to cover your monthly debts (housing, credit cards, auto loans and any other debt). According to Bank of America, this ratio should be 36% or less.
Keep in mind that this ratio has more to do with approval than affordability. Just because you are approved for a certain loan amount, doesn’t mean it fits your financial goals. Make a decision based on your situation and future plans.
The Down Payment
Many loans only require a 3% down payment, with some even offering 0%, but if your down payment is less than 20%, your overall costs could rise. Paying 20% helps you avoid private mortgage insurance, which can cost up to 1% of your loan amount each year until you reach 20% equity. Putting down 20% also lowers your monthly mortgage payment, which can save you thousands over the life of your loan.
Keep in mind that you will have other ongoing costs related to homeownership as well, like taxes, insurance, and utilities. Any remodeling and upkeep also need to be estimated before you settle on a monthly mortgage payment. Then there is the unforeseen, which is difficult to budget, making it important to have 6-8 months of savings set aside for emergencies. Forbes offers some helpful tips on how much you should set aside for savings.
The 5-Year Rule
It is best to stay in your new home for at least 5 years in order to pay off some equity and make the closing cost worthwhile. In the first few years, almost all of your monthly mortgage payments go to interest charges. Typically, the five-year point is when you start making progress on the equity.
Buying a home is a big decision. While getting a house that fits your size and style needs is important, you also want to stay within the limit of your financial means. It can be tempting to buy more than you can really afford, but by thinking through the above tips, you are more likely to make smart choices that keep your future goals within reach. To learn more about your financing options, visit TBI Mortgage Company or call 1-800-647-9735 to speak to an experienced home loan professional.