An Overview: Understanding and Budgeting for Home Loans

When buying a new home, the guiding principle is to never go for a home loan that you cannot afford. It tells you why you need to budget carefully for your home. However, affordability differs from one customer to another. The price of the home also depends on your geographical location. 

Homes are among the most significant purchases that a person can make in life. Evaluating affordability calls for going beyond the pre-approval letter of your home loan. Apart from looking for the amount that the lender is willing to offer you, it is crucial to consider the other expenses. It can help you during potential foreclosures or during hardships when you cannot afford the installment. 

Key Takeaways 

  • Setting a budget for buying a home calls for more than just affording the monthly installments 
  •  Calculate the debt to income ratio
  • Owning a home involves a broad range of ongoing costs such as repair expenses, property insurance, homeowners insurance, etc. 
  • If you raise a substantial down payment, you will not require a private home loan insurance 
  • There are national mortgage programs such as VA and FHA mortgages that are designed to help people who are buying homes for the first time. 

Go for a Property That You Can Afford

When assessing the affordability of the house, consider the size and condition of the property. Large is not always good, more so if the cooling and heating systems can break your budget. Your dream home could be a quaint home that sits on top of a picturesque hill. However, steep driveway and shoveling that long during the winter can be an expensive nightmare. 

You may find a beautiful condo from the outside just to realize that you need to renovate all the rooms. Go through the utility bills of the house that you wish to buy. Besides, hire a construction expert to estimate the fixes that you need to make. If you plan to fix these things by yourself, be realistic when it comes to what you are able to handle in terms of time and skills set. 

Home Owning Expenses to Add On Mortgage 

Getting a preapproval for your home loan is the first essential step in the mortgage process. However, it is worth noting that this is not the only thing to consider. Home loan repayment is not the only recurring expenditure that you will be having. 

Owning a home comes with other recurring expenses that you need to anticipate as a buyer.  You cannot ignore things like the maintenance costs, repairs, utility, and the home owners’ insurance. Under maintenance, you will need to cut the lawn, shove the snow, and rake leaves. Below are the other expenses to add to your home loan budget. 

  • The 28% Rule to Get Started 

The 28% rule is the easiest way to calculate your mortgage budget. This rule dictates that your mortgage should not be over 28% of your gross monthly income. The FHA (Federal Housing Administration) is more generous because it allows you to spend 31% of your gross income on home purchase. 

However, if you have other debts, you should put them into consideration to determine the amount you can comfortably afford. Lenders look at your prospective income to debt ratio before determining affordable installments. The lender has to make sure that he is not giving you installments that are beyond your means. 

  • Property Taxes

The other budgeting consideration when applying for a home loan are the property taxes. Home loans can appear to be affordable on paper but that may not be the case in reality. Therefore, you need to include all these costs and any other regular expenses while determining what you can afford. Property taxes can significantly increase your obligation. Get to know the amount of tax that is applicable to your property before going for a loan. 

  • The Down payment 

The down payment always dictates the loan amount that you can afford. Most lenders prefer home buyers who are willing to make a minimum deposit of 20%. If your down payment is below the required amount, you can still get a mortgage but take additional private mortgage insurance.  This increases your monthly mortgage payments by approximately 0.5% to 1%. 

The private insurance mortgage installment depends on the home size, your credit score, potential of the property to appreciate in value, etc. Higher down payments tend to bring down the interest rate that you will pay.

The down payment you have also determines the house that you will purchase. Huge down payments imply you will afford more expensive homes and vice versa. The buyer should also set aside the closing cost that can range from 2% to 5% of the buying price. It all depends on the State that you reside in. Having a big down payment will also help you to realize your return on investment sooner. 

  • How Much Can You Afford

The 28% rule is the guiding principle whenever you are buying a new home. The mortgage installment should not cost over 28% of your gross monthly earnings. However, this rule does not apply for all the homeowners. FHA allows consumers to spend up to 31% of their gross income on mortgage payments. 

  • The Down Payment Needed

Sellers will always state the minimum amount of down payment that you need to deposit for your home purchase. Conventional mortgages require 20% of the selling price but if you are going for an FHA loan, you may only need to pay a deposit of 3.5%. 

  • “House Rich but Cash Poor”

This phrase means that your home has more equity than the cash that is in your bank account. It implies that most of the money you have is tied up in your home vs. the accessible liquid assets. If you need quick access to cash, you may be unable to get it because you have invested most of your money in the home. But, if you have so much home equity, you can use a home equity loan or an equity line of credit to access it. 

Bottom Line 

Virtually everybody has the dream of owning a home. However, in the absence of proper financial considerations, getting a home loan can become a nightmare. Therefore, you have to make a smart financial plan to be able to move forward. You also need a glimpse of the cost- Benefits of MODT

The first step is to make sure that you are chewing what you can bite. Consider several factors, including the monthly installments to determine your most affordable installments. If you don’t make upfront calculations, you may find yourself house rich but cash poor and this will result in financial pain. Therefore, take enough time to cost out your dream before signing the sale agreement.

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