Determining Your Mortgage Needs and Budget

1. The amount of money you will need for the initial purchase; this consists mainly of the down payment and other costs such as legal fees, inspection fees, and taxes.
2. The ongoing costs of paying back your mortgage, along with monthly operating costs for utilities, maintenance, insurance, and annual property taxes.

COSTS OF = Down payment + Mortgage
BUYING A Legal fees Utilities
HOME Inspection fees Maintenance
Taxes Insurance
Property taxes

One time costs Monthly costs
Most lenders say that your monthly housing expenses (mortgage payment and taxes), plus condominium maintenance fee, if applicable, should not exceed 30% of your monthly gross family income. This is called your Gross Debt Service (GDS) ratio. Some lenders will go as high as a 35% GDS, depending upon a number of variables.

Lenders also use a second calculation in qualifying you for a mortgage. It is called the Total Debt Service (TDS) ratio. Generally speaking, no more than 40% of your gross family income may be used when calculating the amount you can afford to pay for mortgage payment and taxes plus other fixed monthly expenses. These other fixed costs are your ongoing commitments and can include auto, student or personal loans, as well as revolving credit accounts such as VISA, MasterCard and department store accounts. Again, the 40% calculation may vary slightly among lenders.

Lenders look at both your GDS and TDS ratios, and usually select the smaller of the two amounts to calculate your gross income available for housing costs (mortgage payments and property taxes).
The lender will use the lower of the two amounts in determining the amount of income available for housing costs.

Once you have determined your income available for housing costs, subtract the estimated monthly property taxes for the home you may be considering. Property tax rates vary from region to region, but I can help you estimate the taxes for homes in your area. After you have subtracted the monthly tax amount, the remainder is the amount you have available for mortgage payments.

If you are thinking of purchasing your firs home, you probably have a lot of great ideas about what you would like – such as several thousand square feet of living space, a two-car garage, large fenced lot, one or two fireplaces and a panoramic view. But it may be time for a reality check.

Most first-time buyers want their dream home right away. However, that dream home likely sells for several hundred thousand dollars and the down payment is more that you earn in two years. Not to mention the mortgage payments, which are three times your monthly take home salary!

The best way to deal with this reality is to match your financial capabilities with the home that meets as many of your needs as possible.

Many first-time buyers purchase what is commonly known as a “starter home”. There is nothing wrong with this approach. In fact, it is good common sense to avoid buying a home that will stretch your budget to its breaking point. Remember the starter home is just that way – a way to get started in long-term real estate investment.

To see how much you can afford, you should take a close look at your financial situation. The vast majority of homebuyers lack the funds required to buy a home without assistance from a bank or other financial institution (commonly called a lender). So for most of us, buying our first home means combining our savings with money borrowed through a special type of borrowing arrangement called a mortgage.

Borrowing to purchase is not only acceptable, it is desirable. Even people buying millions of dollars’ worth of real estate take this route.

When lenders assess your ability to buy, they look at your ability to pay both types of costs in determining how much money they will lend you.

They use several factors in judging your ability to handle a mortgage, including your income, employment record and credit worthiness. However, one way you can estimate the price range you can afford is to look at the amount of money you have available for a down payment.

The most common mortgage is a conventional mortgage. In this type of arrangement, lenders will loan up to 75% of the appraised value (estimated market value) of the property or the purchase price, whichever is lower. The remaining 25% is the amount you will contribute as a down payment. If you want to buy a home that has an appraised value of $200,000, a lender may loan you 75% or $150,000 on a conventional mortgage when you contribute a down payment of $50,000.

If you plan to borrow funds through a conventional mortgage, multiply the money you have available for a down payment by four. For instance, if you have access to $40,000, you may be able to purchase a home with an appraised value of $160,000 ($40,000 X 4 = $160,000).

This assumes of course that you have sufficient income to make the payments on a $120,000 mortgage. Most lenders will not permit a borrower to take on a debt load the borrower cannot carry. That is why reputable lenders qualify potential borrowers before issuing mortgages.

If you are thinking of buying a home, give me a call, I will provide you with all the information you will require to make good decisions.

To determine your affordability price range, you must calculate two amounts, the amount of cash you can afford to put towards the purchase (the down payment) and the maximum amount of loan (mortgage) you can comfortably carry.

A mortgage covers the difference between the purchase price and your down payment. The larger the down payment, the less you have to borrow, the smaller your monthly mortgage payment and the lower your cost of interest over the term of the mortgage. So it probably makes sense to put down as much of your own money as possible.

The first step towards establishing a maximum mortgage limit is to calculate a monthly payment you can afford. Financial institutions do this by calculating your debt-service ratio.

To calculate your debt-service ratio, list all of your loans (car, personal loans, monthly credit card balances, etc.). The sum of these loan payments and your mortgage payment (including principal, interest and taxes) should not exceed approximately 40% of your gross income. The mortgage payment and taxes should not exceed approximately 30% of your gross income.

The size of the mortgage you can arrange, based on payments you can afford, depends on interest rates. The lower the rates, the larger the possible mortgage and the more affordable the housing is.

But there are other mortgage terms to consider as well. How open is the mortgage? Would prepayment be allowed? Is the mortgage affordable?

The usual source of mortgage funds is a lending institution that determines the maximum loan allowed. But there are other sources of funding too and I can assist you in choosing the best lender at the best rate and terms. Along with your Banker or Financial Advisor we can set a limit and stick to it.

For most people, changing employers will not really affect their ability to qualify for a mortgage loan, especially if they are going to be earning more money. For some homebuyers, however, the effects of changing jobs can be disastrous to a loan application.

Salaried Employees
If you are a salaried employee who does not earn additional income from commissions, bonuses, or over-time, switching employers should not create a problem. Hopefully, you will be earning a higher salary, which will help you better qualify for a mortgage.

Hourly Employees
If your income is based on hourly wages and you work a straight forty hours a week without over-time, changing jobs should not create any problems.

Commissioned Employees
If a substantial portion of your income is derived from commissions, you should not change jobs before buying a home. This has to do with how mortgage lenders calculate your income. They average your commissions over the last two years.

Changing jobs would negatively impact your ability to buy a home.

Bonuses
If a substantial portion of your income on the new job will come from bonuses, you may want to consider delaying an employment change. Mortgage lenders will rarely consider future bonuses as income unless you have been on the same job for two years and have a track record of receiving those bonuses. Then they will average your bonuses over the last two years in calculating your income.

Changing employers means that you do not have the two-year track record necessary to count bonuses as income.

Part Time Employees
If you earn an hourly income but rarely work forty hours a week, you should not change jobs. There would be no way to tell how many hours you will work each week on the new job, so no way to accurately calculate your income. If you remain on the old job, the lender can just average your earnings.

Over-Time
Since all employers award overtime hours differently, your overtime income cannot be determined if you change jobs. If you stay on your present job, your lender will give you credit for overtime income. They will determine your overtime earnings over the last two years, then calculate a monthly average.

Self-Employment
If you are considering a change to self-employment before buying a new home, don’t do it. Buy the home first.

Lenders like to see a two-year track record of self-employment income when approving a loan. Plus, self-employed individuals tend to include a lot of expenses on the Schedule C of their tax returns, especially in the early years of self-employment. While this minimizes the tax obligation, it also minimizes the income to qualify for a home loan.

If you are considering changing your business from a sole proprietorship to a partnership or corporation, you should also delay that until you purchase your new home.

The Best Investment
As a fairly general rule, homes appreciate about five percent a year. Some years will be more, some less. The figure will vary from neighborhood to neighborhood, and region to region.
Five percent may not seem like that much at first. Stocks (at times) appreciate much more, and you could earn over six percent with the safest investment of all, treasury bonds.

But take a second look…
Presumably, if you bought a $200,000 house, you did not pay cash for the home. You got a mortgage too. Suppose you put as much as twenty percent down – that would be an investment of $40,000. Your annual “return on investment” would be a whopping twenty five percent.
Of course, you are making mortgage payments and paying property taxes, along with a couple of other costs.

Your rate of return when buying a home is higher than most any other investment you could make

Stable Monthly Housing Costs
When you rent a place to live, you can certainly expect your rent to increase each year, or even more often. If you get a fixed rate mortgage when you buy a home, you have the same monthly payment amount for thirty years. Even if you get an adjustable rate mortgage, your payment will stay within a certain range for the entire life of the mortgage and interest rates aren’t as volatile now as they were in the late seventies and early eighties.

Imagine how much rent might be ten, fifteen or even thirty years from now? Which makes more sense?

Forced Savings
Some people are just not good at saving money and a house is an automatic savings account. You accumulate savings in two ways. Every month, a portion of your payment goes toward the principal. Admittedly, in the early years of the mortgage, this is not much. Over time, however, it accelerates.
Second, your home appreciates. Average appreciation on a home is approximately five percent, though it will vary from year to year, and in some years may even depreciate. Over time, history has shown that owning a home is one of the very best financial investments.

Freedom & Individualism
When you rent, you are normally limited on what you can do to improve your home. You have to get permission to make certain types of improvements. Nor does it make sense to spend thousands of dollars painting, putting in carpet, tile or window coverings when the main person who benefits is the landlord and not you.

Since your landlord wants to keep his expenses to a minimum, he or she will probably not be spending much to improve the place either.
When you own a home, however, you can do pretty much whatever you want. You get the benefits of any improvements you make, plus you get to live in an environment you have created.