Or, call me at: 
As a mortgage guy, I often work with home shoppers whose first question when qualifying for mortgage financing is how much house can I qualify for? Or, what’s the most house I can get with my down payment and income? When I crunch the numbers, I usually try to work in a cushion because I know from experience that many shoppers are bent on stretching their budget and getting the most home they possibly can.
Real estate agents can play a part in pushing the price range a bit as well. It seems to me that whenever I watch the home buying shows on HGTV, for instance, the real estate agents are always showing buyers at least one home that is at or just beyond their maximum price. This is not to say that real estate agents want to get buyers into financial trouble, it’s just important for buyers to remember how agents are paid. The higher the purchase price, the more commission the agent makes. Real estate agents have a direct financial interest in getting buyers to purchase a more expensive home.
Paying more than 5%? Stop throwing money away! Click for a free rate quote.
Mortgage borrowers qualifying under Fannie Mae guidelines are allowed to have a maximum debt-to-income ratio of 45%. In other words, no more than 45% of gross monthly qualifying income can go to debt service and home-related expenses such as taxes, insurance, HOA fees, and mortgage insurance. There often is some wiggle room in this guideline with extenuating factors, but this is the general rule. Now, just because Fannie Mae says buyers can go up to a 45% DTI does not mean they should. I always advise clients to shop for homes well below their maximum price. Having the extra wiggle room in the monthly budget makes homeownership more enjoyable and allows some extra room for the unexpected expenses that inevitably come up. Buying less house, rather than the most possible, particularly if you are a first-time homebuyer, is just good financial management. The following scenario will show why.
Consider two couples who are around the same age, debt-free, making the same income of $56,400 per year ($4,700/month gross), and have $80,000 to put down for their first home. Couple #1 is intent on getting the home of their dreams, even if it means stretching themselves a bit. They purchase a home right at the top of their price range (with $4700/month gross income, the payment makes their DTI 45%) and opt for a 30-year fixed loan at 4.875% to get the lowest payment possible while locking in their rate for the life of the loan. Couple #2 is more conservative and wants to buy less of a house, have more wiggle room in the budget, and pay off the loan more quickly. They choose a house worth far less than Couple #1 and opt for a 15-year fixed loan at 4.25% (typically shorter-term loans have lower rates).
The following is a summary of the scenario so far:
Note that Couple #2’s payment is $758.50 lower than Couple #1’s payment. Now let’s assume Couple #2 chooses to roll this payment difference back into their loan. Even if they don’t do this, they’ll still pay off the house in half the time Couple #1 will, but they have other financial goals and they want to pay off the home as fast as they possibly can.
After 8 short years, Couple #2 pays off their loan in full and celebrates by taking a 3-month trip to Europe. Once they get back, they begin making plans to move up to a nicer house and decide to continue making the same house payment they were before, but to their savings account instead of a lender.
If we fast forward to the 15-year mark, we discover that the net worth of both couples has increased significantly. Both homes have appreciated a steady 2% per year, but Couple #1 has more equity because they initially bought a more expensive home. Couple #2 hasn’t enjoyed quite as much appreciation in dollar terms, but with a steady 10% rate of return, their savings have accumulated into a sizable nest egg.
The following is a summary of both couples’ finances at this point in time:
It’s obvious both couples are doing pretty well, and Couple #2 has a much larger net worth even at this point. But Couple #2 is about to make their next financial move, which will catapult them far ahead of Couple #1.
Check back for part 2 of this post to see how things work out.
Paying more than 5%? Stop throwing money away! Click for a free rate quote.
Pingback: Carnival of Wealth #25 – Valentines Edition — Personal Dividends - Money+Lifestyle
Pingback: How Can I Buy a House After Bankruptcy? |