There are a variety of costs involved with getting a mortgage besides the cost of the house itself. When considering how much you can afford, keep in mind that there will be both upfront and monthly costs that you need to calculate for.
Consider each of the below costs when determining your price point:
Down payment: This is the upfront payment made in cash and will vary based on the amount financed. For a loan with an LTV of 80%, your down payment will be 20% of the purchase price, and no upfront MIP will be required. For an FHA loan, the down payment is typically 3.5% of the purchase price and you will likely have to pay MIP at the time of closing.
Closing Costs: These are the fees that need to be paid at the time of closing for the services of the lender and other third parties, such as appraisal fees, title searches, title insurance, surveys, taxes, deed-recording fees and credit report charges. Closing costs typically range between 2% and 5% of the home price. Your lender should provide you with a loan estimate prior to closing which will include estimated closing costs.
DID YOU KNOW? Home buyers in the U.S. pay $4,876 for closing costs on average.
Maintenance/Repair Reserves: Most borrowers pay little attention to maintenance costs when figuring out what they can afford, but a major repair can arise unexpectedly. A good rule of thumb is to set aside 1-4% of the purchase price per year to create an emergency fund for any necessary maintenance.
Calculate Principal, Interest, Taxes and Insurance (PITI): There are various different expenses that make up your monthly mortgage payment, so be sure you understand the breakdown.
PRINCIPAL: The outstanding balance of the loan and the main component of the monthly mortgage payment. As monthly payments are made, the principal is reduced.
INTEREST: The rate that the lender charges for lending the money.
MORTGAGE INSURANCE (IF APPLICABLE): If you put down less than 20% or use an FHA loan, you will likely have to pay for mortgage insurance. Typically, this will cost 0.5% to 1% of the loan over the course of the year.
PROPERTY TAXES AND INSURANCE: Typically borrowers pay a set amount for taxes and homeowners insurance with every mortgage payment and the lender creates an escrow account for these expenses. An escrow account is used by a lender to pay certain property-related expenses.
HOA FEES (IF ANY): If the home you purchase is part of a Homeowner’s Association (HOA), you will have to pay certain fees directly to the HOA.
Establishing Your Price Point
Once you have a good understanding of all of the potential costs involved in purchasing a home, it’s time to establish your price point. A loan officer will be valuable in helping you arrive at this number.
The first step is to reach out to a lender for a pre-approval. You can apply online, over the phone or in person. One of the first things a lender will look at is your debt-to-income ratio. Many lenders (and particularly FHA lenders) impose 31/43 ratios, which means that a maximum of 31% of your income can go towards the purchase of the house (house-related debt, which accounts for monthly mortgage payments, property taxes, etc.) and 43% towards total debt, which takes into account all recurring monthly debts and can include the mortgage payment, credit cards, car loans, etc.
After reviewing your credit score, debt-to-income ratio, employment history and other financial information, a lender can pre-approve you for a home, which is essentially a promise from the lender that you are qualified to borrower up to a certain amount at a specific interest rate. Keep in mind, however, that a mortgage pre-approval does not completely guarantee your loan will be ultimately approved (additional documentation will be required upon an accepted offer) and is generally only valid for 60-90 days.
APPROVED PRICE VS. AFFORDABLE PRICE: USUALLY NOT THE SAME
Once you receive the pre-approval letter with an approved price, you might be surprised at how much you are qualified to spend, but this doesn’t mean you should go spending the full amount. In determining an approved price, the lender does not take into account certain other monthly expenses that you have to pay in addition to the PITI payments, such as your commuting expenses, any expensive hobbies or savings goals. Placing an offer with your full approved price is a risky endeavor, and you should consider all of your monthly expenses in determining a number that you can comfortably afford.
DID YOU KNOW? If you’re interested in seeing what you can afford, but not fully ready to buy, you can get pre-qualified with a lender which will require much less paperwork.
Choosing a Lender
Just because you’ve received a pre-approval letter from a lender, doesn’t mean you are required to use that lender to obtain your mortgage. Do your research, shop around and talk to at least three different lenders, as well as a mortgage broker. Be sure to compare rates, lender fees and loan terms. When speaking to a potential lender, try to get a sense of their customer service and responsiveness - the home buying process is stressful enough without having to hound a lender for answers!
Once you've reviewed your finances, we can send you lender recommendations for receiving a pre-approval and setting an actionable budget for your home search.
We're not your typical real estate agents.As former city dwellers, we appreciate the qualities that make city lifestyle so unique, from the convenience of walking to your favorite restaurant or corner store to the vast and diverse cultural and entertainment activities. But we’ve also experienced the challenges and frustrations that are motivating you to seek change. During our transition from the city to the suburbs, we had the same thoughts, concerns and questions, prompting us to create a better way to navigate the suburban home search process for others.
The Riolo Team is a team of real estate brokers affiliated with Compass. Compass is a licensed real estate broker and abides by equal housing opportunity laws. All material presented herein is intended for informational purposes only. Information is compiled from sources deemed reliable but is subject to errors, omissions, changes in price, condition, sale, or withdrawal without notice. No statement is made as to accuracy of any description. All measurements and square footages are approximate. This is not intended to solicit property already listed. Nothing herein shall be construed as legal, accounting or other professional advice outside the realm of real estate brokerage.
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