What it takes to buy a home
Pat Mertz Esswein, Kiplinger’s Personal Finance, May 25, 2012, link
|Look at your budget and determine how a house fits into it. Fannie Mae and Freddie Mac recommend buyers spend no more than 28 percent of their income on housing costs. (Digital Vision / May 21, 2012)|
Tired of renting? It could be a great time to buy your first home.
In many cities, home prices have bottomed and rents have risen. Mortgage rates are still superlow. In fact, homes haven’t been as affordable since 1971. On the downside, in many cities buyers have fewer homes from which to choose and more competition for the best houses.
In Austin, Texas, newlyweds Mark and Ariane Corcoran bought their first home in March. They were renting in a popular downtown neighborhood, where they paid $1,200 a month for a 500-square-foot loft apartment, when they inherited enough money for a down payment. When they began shopping, they expected to buy a classic 1930s Austin bungalow. They found lots of prospects online but drove by most of them.
“Agents are really good at taking photos that exclude what they don’t want you to see, like the used-car lot out back,” said Mark.
They put in an offer on a $225,000, 800-square-foot home. But after the home inspection, they realized that it needed $20,000 to $30,000 in renovations and repairs and that they’d quickly outgrow it. They walked away during the state-mandated rescission period (during which a buyer can back out for any reason and get back any earnest money deposited).
Ariane identified their next prospect within an hour after the listing appeared online. It was a newly built, 1,600-square-foot home with three bedrooms, 2 1/2 baths, and a yard for the dogs. The builder asked $270,000, the couple offered $260,000, he countered and they paid $268,000. They put down 20 percent to avoid private mortgage insurance and snagged a 30-year fixed rate of 3.75 percent from a credit union. Their monthly mortgage payment is $1,524.
Before you take the plunge, consider the answers to questions often posed by first-time buyers:
Will I qualify for a mortgage? Lenders will scrutinize your “three C’s” — credit history (your credit score as well as a deeper dive into your record of debt repayment), capacity (income, savings and investments) and collateral (your down payment and the value of the property you want to purchase, as determined by an appraisal). Lenders will verify your employment (job, school or military) for the past two years and try to predict how likely it is that you will keep your job. If you’re weak in one area, strength in the other two areas or in a spouse’s bona fides may compensate. Or you may need to beef up your credit score, establish a more stable income history or save for a bigger down payment.
How much house can I afford? That depends on the monthly mortgage payment for which you qualify. Lenders apply payment-to-income ratios that you can also use for a ballpark estimate. Under the rules set by Fannie Mae and Freddie Mac (agencies that guarantee the loans made by lenders), your monthly mortgage payment shouldn’t exceed 28 percent of your monthly gross income (before taxes and other deductions). That includes principal and interest, real estate taxes, homeowners (hazard) insurance, and homeowners association dues.
Recurring monthly payments for all debts — mortgage, car loans, credit cards and student loans, even if they’re deferred — shouldn’t exceed 36 percent of your monthly gross income. (With student loans, it’s the monthly payments, not the total debt, that count.) The Federal Housing Administration, another loan guarantor, allows ratios for mortgage and all debts of 31 percent and 43 percent, respectively (it doesn’t include student-loan payments that are deferred for a year or more).
Lenders don’t factor in the cost of maintaining a home. To play it safe, budget for one-twelfth of 1 percent of the home’s value for monthly upkeep.
What will my interest rate be? The higher your credit score, the bigger your down payment and the lower the risk of default you pose to the lender, the better the interest rate you’ll get. You’ll secure the best rate — somewhere near the recent 30-year fixed-rate average of 4 percent — if you have a credit score of at least 740 and can put down 40 percent of the purchase price, says Ramez Fahmy, sales manager of Caliber Funding, in Bethesda, Md. Lenders add a quarter point to their best rate if you put 15 percent or 20 percent down, as long as your credit score is at least 740. But let’s say you put down less than 15 percent. With a credit score of 740 or higher, you’ll pay an extra quarter of a percentage point on your rate; with a score of 720 to 740, you’ll pay a half-point more; and with a score of 700 to 720, expect to pay a full point more. If your score is lower than 700, you’ll pay from 1.25 to 3.25 points more.
How much cash do I need upfront? Fannie Mae and Freddie Mac require a minimum 5 percent down payment. If you put down less than 20 percent, you’ll have to pay private mortgage insurance to protect the lender if you default. PMI costs about 0.5 percent to 1.5 percent of your loan amount per year, and the monthly cost factors into the debt-payment-to-income ratio. The FHA sets the bar at 3.5 percent down but requires an upfront mortgage-insurance premium, which is often rolled into the loan amount.