By Megan Wild, author of Your Wild Home
It feels like you’ve been working toward it your whole life. If you actually owned a vision board, a sweet house for sale would sit at the very top. In reality, however, instead of vision-boarding, you’re clipping coupons, buying bulk, clocking in work hours and saving up.
Thanks to all that, and more than a little personal perseverance, you believe you might finally be ready to take on the home buying market.
Here’s what you should know before jumping in.
Monthly Mortgage Amount
It’s not uncommon for potential homeowners to begin house hunting at a purchase price point based on savings. This method neglects to take into account critical mitigating factors such as income, debt, property taxes, hazard insurance and monthly expenses.
nstead, consider establishing the amount of monthly mortgage you can afford to pay. There are two ways to determine this figure, and both revolve around total household income. One is to develop a front-end ratio, which, according to most industry standards, is 28 percent of your after-tax income.
The other is to take 36 percent of your gross income and subtract monthly expenses for a back-end ratio. Make sure to remove current rent and utility payments from your expense list. They are irrelevant to future planning. Do include:
- Student loan payments
- Health insurance premiums
- Credit card balances
- Car payments
- Child support and alimony obligations
Mortgage lenders look closely at either front or back-end ratios to determine how much money they are willing to lend. Play it safe and use the lower ratio to establish your budget.
Property Taxes and Hazard Insurance
If you know which geographic location you are most interested in, fine-tune your home buying budget analysis by adding projected property tax and home insurance figures. Tax amounts are a matter of public record. You’ll find them included in real estate listings as a matter of status quo. Consider an additional source funding allowance for possible HOA — homeowner association — fees.
National hazard insurance rates stand at an average 0.5% of overall home value, but you can determine more site-specific rates with local real estate insurance calculators.
Front- and back-end ratios aren’t the only thing mortgage lenders look at when considering a mortgage application. If you have significant debt or missed payments on record, your credit rating may considerably compromise loan potential. Check your credit score immediately. It’s better to begin repairing it from the get-go if necessary. A good rule of thumb is to show a consistently high rating for one year or more before applying for a home purchase.
Also, reduce debt realistically. Pay off past-due bills, concentrating on high-interest balances first, and prioritize on-time payments from here on in. Take a look at your debt-to-income ratio and try to keep it lower than 50%. Lenders traditionally only go up as high as 41-43% in consideration.
While it’s important to keep credit card balances low, it remains beneficial to hold long-term accounts, including car and student loans, in good standing over time. Eliminate costly debt, but maintain steady payment fulfillment. There’s no need to cut up your credit cards and revert to cash-only transactions. Credit is still king!
Home Management Costs
If you currently rent space — or are living with your parents — you probably don’t pay separately for services like garbage disposal, landscaping and snow removal. As a potential homeowner, all that’s about to change.
Get a general idea of home management costs in your area by asking for prices from residential service businesses. Remember that new home service contracts sometimes sound too good to be true. Go ahead and add 5-10% on to initial quoted figures. Often rates are hiked up substantially after the first year.
You have determined the exact amount of monthly mortgage you can comfortably afford and are diligently working to maintain good credit — but don’t forget to pay yourself! Determine the difference between your current living expenses and what you anticipate owing as a homeowner every month. Put that money in an account specially reserved for a down payment.
You’ll find your economic transition to homeownership in motion and well-paved!