Have you ever watched a TV show about a couple trying to purchase a house? One of them restrings broken Ukuleles for a living while the other volunteers at the dog rescue, and they have a $900,000 budget. These shows, along with misinformation found online, often give first-time buyers an unrealistic idea of the kind of home they can get for their budget. So how does a first time buyer avoid getting in over their head on a home purchase?
Don’t rule out a starter home: The above referenced shows on cable TV about fixing, flipping, etc. there is often unrealistic expectations with first time home buyers. We are currently in a seller’s market so you’re not likely to get everything you want in your first home without stretching your budget. Unlike renting, a starter home allows you to build equity that can be used to help purchase the dream home when the time comes. I recently helped a client that bought their first home two years ago and was able to turn that equity into their forever home. This brings me to my next point.
Know your budget: And make sure it’s your current budget. One of the issues prior to the crash in 2007 was that many homeowners were projecting either future income or future equity. That is a recipe for disaster. Regardless of your long term plan you need to understand that things change, both in the markets and your personal life. Make sure you can handle whatever home payment you get into at your current employment and income. Understand that even with a fixed rate mortgage your payment can increases as property taxes and homeowner’s insurance can fluctuate.
Understand debt to income ratios (DTI): Debt to income (DTI) ratio is monthly debt/expenses divided by gross monthly income There are two numbers here to consider. The “front-end” ratio, which is your housing expense, and the “back-end ratio” which is the housing expense plus other monthly debts. The other monthly debts are the minimum payments on items on your credit report, tax liens, child support and alimony payments, etc. So while some programs will allow you to qualify for a loan with a DTI of 55 percent, it’s usually a bad idea when you consider what is NOT considered in the lender’s debt to income calculation:
Income taxes-your DTI is calculated on gross income
Auto expenses such as maintenance, insurance, gasoline
Utilities such as electricity, gas, cable/internet, cell phones
Child care or pet care expenses
Generally the guidelines call for a debt ratio maximum of 28/43. This means that the housing expense can equal 28% of your gross monthly income while the total debt ratio equals 43. BUT generally home buyers can be approved at ratios of 43/55. There are instances in which this is useful, such as if you have someone living in the home that is not qualifying on the loan but earns income. However, if all of your earned income is being considered going to maximum levels on your debt ratio is a terrible idea. Just because you can doesn’t mean you should.
Make sure you have some funds available after closing: Let’s say you’ve saved up $40,000 to put down on your house and you use it all to keep your mortgage payment within your budget. Sounds like a good idea right? But what happens when you close and decide you want to paint, buy a new refrigerator, need more furniture, or something breaks down in the house or your car? You end up putting things on your credit card, and it costs you more. If you’re already at the top of your budget the increased credit card payments could be difficult for you to meet. Although most loan programs don’t require you to have cash reserves to close on a home that you’re purchasing to live in, it’s always best to have a bit of a nest egg. Consider putting less down if you can do so without busting your payment budget, or buying something priced lower that requires a lower down payment to meet your budgetary goals.
–Mike Tizzano NMLS #1015837 is a Senior Loan Officer with Fairway Independent Mortgage