Are you planning on buying a new home soon? Buying a house is one of, if not the, largest item you’ll ever buy. You’ll pay on your mortgage for up to 30 years, but if you refinance at any point, you may pay on your home for even longer. Before you jump in and make an offer on a house or hire a contractor to build a home, you need to look over your finances carefully. If you buy a home that is outside of your price range, at best you’ll find yourself financially stretched too thin for comfort. At worst, you’ll end up selling your home or having it repossessed. How do you determine your budget? Here are a few tips.
Determine Your Debt-to-Income
Your debt-to-income ratio is often the key factor in determining if you can get a mortgage for the home you want. It’s also beneficial for you to determine this ratio before you start looking at homes so you know if you can actually afford the house you’re looking at. First, add up all of your debt. That includes your current housing costs, credit card payments, car loans, alimony, child support, and any other loans you have. Then divide this number by your gross monthly income (your income before taxes and other deductions). Convert the number to a percentage and you have your debt-to-income or DTI ratio.
Ideally, the number is going to be less than 36%. If it’s over, it’s going to be difficult for you to get a mortgage. Having a high DTI indicates that taking on more debt will make it very difficult for you to meet all of your obligations and still have enough money for essentials such as food and clothing.
Another way DTI comes into play in determining how much you should spend on your new home is by looking at how much your monthly house payment will be in comparison to your overall income. Add up the total cost of your monthly mortgage payment, including insurance, property taxes, and any HOA dues. Then divide that by your income and convert to a percentage. If this number is higher than 28%, you may be spending more than you can truly afford.
Can You Afford Closing Costs and Your Down Payment?
Buying a house involves more than just paying a mortgage every month. You also have your closing costs and down payment to consider. Closing costs are usually two or three percent of the overall purchase price, and often, you can ask the seller pay some or all of those costs as part of your negotiation. Your down payment may be as low as 3.5% or as high as 20%. It all depends on the type of loan you’re getting. FHA and VA loans have a much lower down payment requirement than a conventional loan. Can you afford these costs? You may be looking at $10,000 or more.
If you can make your mortgage payments without stressing but don’t have a large amount of cash on hand to make your down payment, there are some options. There are assistance programs that can help you with your closing costs, plus most lenders allow family members to gift you money for your down payment. Before you look into these options, though, you do want to make certain you can make your mortgage payments without any problem.
Will You Be Adding More Debt?
While your lender won’t take any potential future debts into account, you certainly should. Are you going to be helping one of your children pay for college soon, or are you or your spouse thinking about returning to school? Are you going to need to get a new vehicle in the next few years? Will you be having a child or changing careers? All of these things can lead to either a reduction in your income or an increase in debt. Be sure you carefully consider how these changes will affect your ability to pay for your home. Now may not be the time to buy.
Does the Home Need Repairs or Updates?
Finally, when you’re considering what to spend on your new home, be sure to take into account the inspection and any updates you want to meet. If the inspection turns up issues that impact the safety or functionality of the home, the seller should be responsible for making those repairs before you close on the home. On the other hand, minor items that are more cosmetic in nature may be left up to you. You’ll need to budget for these.
If the seller isn’t going to make all of the repairs necessary, make certain the purchase price reflects this. If you’re going to have to put $5,000 into the property before you can even move in, the purchase price needs to be lowered accordingly.