With Zillow, Redfin and other platforms at your fingertips on your smartphone, it’s never been easier to start looking for homes on the market. You can type in a zip code and a string of homes for sale are served up to you.
But if you’re not a little intimidated by the process, you should be. There is so much to know to make a wise decision and the financial stakes are high. Purchasing a $250,000 home is completely different from buying a $1,000 Smart TV. For starters, there’s no refund policy!
Before house hunting, you need to answer this question: ”How much house can I afford?”
While it’s way more exciting to look at homes than your finances, the best place to start is with a mortgage lender. Until you know which price range your budget supports, it’s a waste of time to start looking at homes.
Don’t set yourself up for the emotional roller coaster of guessing what you can afford — only to find out your estimate is way off.
When applying for a mortgage for the first time, here’s what a mortgage lender will ask you to bring to your meeting:
1. Copies of your two most recent pay stubs.
2. Copy of your Federal tax returns and W-2’s for the past two years.
3. Copies of your bank statements for past two months.
4. Two Forms of Photo ID – driver’s license and Passport are preferred.
5. Landlord information for past three years.
With this information (along with your credit score, which the lender will pull and verify), you can leave the office with a “prequal letter” which indicates you have a high probability of getting approved for a loan up to a specific purchase price. You need this before you can make an offer on a home; and before real estate agents will take you to see any homes. That’s because it doesn’t benefit anyone involved in the process for an unqualified buyer to look at homes he can’t afford to buy.
How does the loan officer arrive at your pre-approved purchase price? There are two calculations that come into play: housing expense ratio and debt-to-income ratio.
The golden rule of lending is that your housing expense should not be more than 28%. That means that up to 28% of your gross annual salary can be spent on housing (including property taxes & homeowner’s insurance). If your annual salary is $75,000, you can afford to spend $21,000 a year or $1,750/month. A purchase price of $250,000 with a 5% down-payment on a 30-year fixed rate mortgage at 5% interest would be approximately $1,650/month.
There are lots of free mortgage calculators available online if you want to put in some different numbers to estimate your monthly payment.
To get your debt-to-income ratio, you simply add up your total debt obligations, such as car loans, student loans, credit cards, child support and alimony, and housing costs as defined above, and divide by your total income. Your lender will look for a debt-to-income ratio that’s no higher than 36%.
So, let’s say you have a car payment of $250/month, credit card debt with a payment of $250/month and a student loan debt of $100/month, in addition to the $1650/month in housing costs. Your total monthly debt is $2,250/month or $27,000 annually. Your Debt to Income ratio is 36 ($27,000 divided by $75,000). So you would most likely qualify for the $250,000 home assuming you have saved the $12,500 (5%) down-payment and have a decent credit score.
A mortgage officer is also intimately familiar with loan features, terms and qualifications needed to be approved. Believe it or not, there are a lot of types of mortgages to choose from: FHA, Conventional, Fixed rate, Variable rate, Veterans, 203K, etc. Yes, choices are a good thing, but it will be overwhelming to try to figure out which type of loan you should apply for without guidance.
Ruth Lyons is a realtor with Sachs Realty in Columbia. She’s been investing in real estate for decades and she works with both buyers and sellers. She loves demystifying the process so everyday people can buy and sell homes with confidence. You can reach Ms. Lyons at 443-745-4806 or rl@sachsrealty.com