Shopping for homes is terrifying enough, but when you add in the process of everything it takes to actually buy the home you want, it’s like living inside a bubble of anxiety.
Many have questions such as:
- How do mortgages work?
- How much is a bank willing to lend out?
- When is the right time to buy a house?
- What will the down payment consist of?
- How do you know which home is the PERFECT home?
Mortgage payments generally consist of four elements: principal, interest, taxes, and insurance.
Many question how much they can afford when they are shopping for a new home. While the general rule of thumb has been to keep one’s price point at right about two and a half times their gross income, there are other aspects to consider.
For instance, both front end and back end ratios. Your front end ratio is what is specifically allocated to your mortgage payment from your gross income every month (as mentioned earlier, this also involves the principal, interest, taxes, and insurance) and should not be higher than 25% of your income.
Next, your back end ratio. This, in essence, is your debt-to-income ratio and compares how much you owe in debt (credit card payments, child support, and other outstanding loans) and what your gross income is.
Most lenders will not approve a mortgage if your DTI exceeds 34%. A simple way to calculate this is by multiplying your gross income by.34 and divide that by 12. So if your yearly income is $100,000; your monthly DTI should not exceed $2,833.00. Keeping your DTI as low as possible leaves any home buyer in the best situation when shopping for a home.
Income is just one aspect of the home buying process and the other is the risk that lenders evaluate.
While there is a formula that mortgage lenders use to calculate a home buyer’s risk, it’s important to remember that a home buyer’s credit score plays a huge part in that calculation. The higher the score, the lower the risk, and that leads to lower interest rates and so forth.
Finally, the down payment.
This is usually 20% of the cost of the home, but many lenders are willing to negotiate and come down to about 10%. A higher down payment means that banks will have to finance less with the mortgage loan. The more a home buyer puts towards a down payment, the better they look to the banks. Lenders also need to know the term of the loan. For example, a ten-year mortgage is going to have higher payments, but it is likely that the total cost will be less expensive as compared to a thirty-year mortgage.
When shopping for homes, it’s important to have a price point and understand the necessary budgeting guidelines. A home buyer should keep their credit score intact by minimizing their DTI and other unnecessary expenses.
Many are asking if now is the right time to purchase a house. Since, the Fed did lower rates back in March of this year. There are reasons to exercise caution since interest rates have very little to do with the actual costs of purchasing a home. Here’s what Drew DeWitt, Senior Vice President of Investments at Ivy Equities had to say about buying a home in today’s environment:
“Lower interest rates mean lower monthly mortgage payments on your home loan; therefore, you technically can pay more since your monthly costs are lower. However, it also means that there is a greater risk in the economy in general. The FED drops rates to spur growth when there is risk of unemployment and people not being able to make their monthly mortgage payments. As a result, banks will tighten their lending standards, and it may be harder to actually secure a mortgage despite the lower rates. This is where people get confused.”
For those homebuyers that are lucky enough to be employed in a field that hasn’t been affected by the economic downward turn caused by the coronavirus, and have the resources that are deemed as necessary; now is the perfect time to start looking online and getting familiar with what the market looks like.
It’s important to look through your finances, and prepare a budget for the moment when home buyers are ready to purchase their house. It is a good time to start looking and finding a good rate.
DeWitt continues to predict that not only will home prices continue to drop within the next six months, but interest rates will also remain steadfast at new lows to help drive our economy out of the path of an impending recession.