There is a factor you have to keep in mind when trying to determine the price range you can look at for a house, condo or townhouse. That is what a lender may approve you for.
Lenders generally use 2 simple ratios in their basic determination of what you can afford. (For FHA loans and VA loans these ratios are higher and in some cases for conventional loans these ratios may be higher, but for the sake of this article we’ll use the lowest ratios. You’ll need to find out from your lender or mortgage broker what ratios will be used for your loan.)
The first is your monthly mortgage payment in relation to your monthly income (after taxes). The most common number used in conventional loans for this is 28%. So if you make $10,000 a month after taxes, the lender would consider you could afford up to a $2800 monthly mortgage payment (PITI).
The second is your monthly mortgage payment plus all your other monthly financial obligations (credit card payments, car loan payments, student loans, alimony, child support) in relation to your monthly income (after taxes). The most commonly used number in conventional loans for this is 36%. So if you make $10,000 a month after taxes and the total of all your other monthly financial obligations is $700, the lender would consider you could afford up to a $2900 monthly mortgage payment (PITI).
The lender will take the smaller of the 2 numbers from the two calculations and so in the example above they would allow you up to a $2800 monthly mortgage payment.
Deposit, Downpayment and Closing Costs
There are a few other things you need to keep in mind when preparing to buy a house, condo or townhouse.
When you get a contract on a property you will need to pay a ‘good faith deposit’. This payment usually is made at the time your offer is accepted and in this area it is generally about 1% of the price of the property (although sometimes a buyer may want a higher deposit to make sure you are serious about buying it).
The next thing you need to be prepared for is the downpayment. This is the percentage of the price that you will be paying personally at closing.
The percentage of the purchase price that will be your downpayment will depend on the type of loan you are getting and the type of property you are buying. For conventional loans you would need a higher downpayment for an investment property than you would for a second/vacation home and that would be higher than for a primary residence. FHA loans require a much smaller downpayment than conventional loans.
You will need to have the money for the downpayment (and closing costs) in your account for a certain amount of time prior to the closing. Where you get the money for your downpayment (and even the good faith deposit) can also affect whether or not you qualify for a loan. It can be a problem if you get this money as a ‘loan’ or ‘gift’ from a family member but you should go over this with your mortgage broker.
And please remember that it is important that you do not do anything that will affect your qualifications for a loan like buying a car or running up your credit card balances. Because if you do get preapproved for a loan and then do anything of those things before closing, you might not get a final approval.
Closing costs refer to the fees you pay to close on the property that are in addition to what you are paying for the house, condo or townhouse. There are prepayments of taxes and insurance, fees to record documents, etc. that are all included in the closing costs. You should be able to get a good faith estimate of these from your mortgage broker within 3 days of applying for a mortgage loan (this is required by law) and a more accurate breakdown on the day before closing. A rough estimate of what closing costs may run for a buyer is about 3-5% of the purchase price.
You will need to have this money also in your account for closing costs.
On the day of closing you will need to either have the funds wired to the title company or attorney’s office that is doing the closing or bring a cashier’s check for the balance of the downpayment and closing costs that need to be paid after applying the good faith deposit you made at the beginning. I’m finding now that in most cases a wire transfer is being required.
I recommend you work with a competent mortgage broker or loan officer before you start actively start looking at properties so that you can get prequalified for a loan and have a trained professional who can help you with all financial preparations and questions you may have.
Finally, there are some other expenses you will have to pay for that are not part of the closing costs. First are the inspections of the property you are buying. A home inspection can run from $200 to over $500 depending on the size of the house, condo or townhouse and whether it is a house with a pool, seawall, dock or boat lift. If you choose to get a mold inspection, that will be an additional amount of about $500 or more depending on how many air quality samples need to be taken. Finally there is the appraisal of the property and that will probably be around $350-$400.
Hopefully this report gives you some information you can put to use and will make your home purchasing experiencing go as smoothly as possible.
I don’t want you to be discouraged in any way by the information presented here but wanted you to be aware of what you may encounter as you move toward purchasing a house, condo or townhouse so that you don’t have any big surprises. If you work with a good mortgage broker I think you will find that the whole process of dealing with the financing will not be a problem for you.
Now why don’t you start your search for the house, condo or townhouse that is right for you in the Local MLS.