Making the Right House Price Choice

Before you start your home buying process, you need to decide on just how much house you can afford. Overestimating financial abilities and not understanding credit and mortgage products is what got millions of homeowners into so much financial trouble the past few years. The result has been record numbers of home foreclosures and bankruptcy filings.


Factors to take into consideration when deciding if you can afford a home are:

  • Your income and expected future income
  • Monthly fixed and variable expenses
  • Your credit score and history
  • Current mortgage rates
  • Current real estate market conditions
  • Your debt to income ratio, which determines how much mortgage you can afford

Salary Rate

If you get paid on a fixed salary, it is easier to budget your monthly expenses. A commission only job or part commission and part salary is a little more difficult to budget. If your income is expected to increase or decrease in the next few years that is something you need to take into consideration as well. It's a good idea to talk to a financial advisor too. 


Credit Scores and Credit History

Before you speak to a lender, you should check your credit report and credit score. The higher the credit score, the better interest rate you will be able to get and the lower down payment.  You also want to check your credit report for any errors.  With so much identify theft these days; it's smart to obtain your annual free credit report to make sure it is accurate. If you do find any errors, contact the credit bureau immediately and dispute the item or have it corrected.


Try and clean up any negative credit matters so that you they are deleted from your report. Your lender will ask to run your credit before you apply for a mortgage, so you want to make sure you have a good credit rating and payment history. If you do have less than perfect credit, it will be harder to get financing at an affordable rate. There are alternatives for buyers with bad credit such as rent to own programs or seller financing.  However, if you do have bad credit, you may want to wait at least 6 months or a year to give yourself time to repair your credit and improve your score.


Mortgage Abilities

Lenders look at your credit score, credit history and your debt to income ratio. To calculate your debt to income ratio, add up your fixed monthly expenses such as car payments, minimum credit card payments and any other regular debt obligations including monthly child support or student loans (you can exclude groceries or utilities), and your expected mortgage payment, including any private mortgage insurance, taxes and insurance. Divide this total by your gross monthly income.  The ratio should be no higher than 36%.  Lenders actually prefer if the total of your housing expenses alone don't exceed 28% of your gross monthly income. This way you will know if you can afford the mortgage or not. Even if on paper you can, and you feel it would be a stretch for you, then you should rethink the situation.


Before choosing a mortgage, you need to find out the following:

  • Interest rate
  • If there are any pre-payment penalties if you pay the mortgage off sooner
  • Whether there is a balloon payment
  • The costs of the mortgage, lender's fees, points, etc.

Ask questions. By law your lender has to give you a truth and lending statement and disclosures advising you of all the costs associated with your mortgage so that you understand what the true costs of your loan are and what you are signing.


There are different types of mortgage products. The most common are:  fixed rate mortgages, adjustable rate mortgages, reverse mortgages and various combinations of fixed and adjustable. It is a good idea to research the different loan products available to educate yourself so you can choose the right product.


You should have at least 6 months mortgage payments saved as a cushion to fall back on in case of an emergency, such as a job loss or illness.  It is important to make your mortgage payments on time so that you don't go into default and risk losing your home to foreclosure.  You can learn from the mistakes of millions of homeowners who lost their homes to foreclosure because they took on mortgages at sub-prime rates that readjusted to levels that they could no longer afford.


Refinancing

Some borrowers choose to go with an adjustable rate mortgage (ARM) because the initial interest rate is lower, the payment is lower and they can qualify for a larger loan. However, adjustable rate mortgages are short-term loans, and at some point the interest rate readjusts. If rates go up, your payment may become unaffordable. Of course, if rates go down, then your payment may be lowered. It is a gamble though.  Having a fixed rate mortgage gives you the security of always knowing how much your mortgage payment is every month.


If you have equity built in your home, then you may be able to refinance your ARM and get a fixed rate mortgage. But don't count on this when you choose an ARM, because if housing prices go down, as they have the past few years, you won't have enough equity, and will not be able to refinance your current rate loan. This is another reason why so many borrowers today have had to get mortgage modifications or risk losing their homes because housing prices declined, they could not sell their homes and could not refinance for lack of equity.


You should only refinance if you can lower your interest rate by at least 2% because otherwise it won't make enough difference in lowering your monthly payment. There are costs associated with refinancing such as appraisal, credit report, points, lender's fees, etc. so make sure that refinancing is really going to make a substantial difference in lowering your payment.


Owning a home is a huge commitment and investment. If you are not ready emotionally or financially, you may want to rethink the idea and postpone until you have saved more money, have paid off some of your debt or you get a salary increase. Don't get caught up in the frenzy to buy a home because rates are low and home prices are affordable. They need to be affordable for you.