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Just
because the bank will lend you the money doesn't mean
you should take it. Your lifestyle, your spending habits
and a host of other factors should be taken into account
in any homebuying calculations.
By Adriane G. Berg
The price you'll pay for your next
home isn’t just a mathematical computation. Yes, that’s
how mortgage lenders and brokers consider it, but it’s
not how you should do your own in-house arithmetic.
Assess your own lifestyle, deciding what amenities you’ll
need (and which ones you can live without to cut costs)
and how long you plan to live in the home. If you’re
planning to live in the house less than five years,
it should be looked at as an investment. Are you sure
the home will appreciate and the tax savings will more
than compensate for the extra monthly payments you’ll
make as compared with a rental unit?
Consider these factors before you make the single biggest
purchase of your lifetime.
What house offers the best resale value?
Before you decide to mortgage yourself to the hilt,
put your fantasies aside and take a hard look at the
potential resale value of the house you’re considering.
Some houses are worth the expense, others are just overpriced.
Time and again, the following attributes are bellwethers
of enduring appreciation:
- Good location. The smallest house in the best neighborhood is more valuable than the largest house in a less desirable neighborhood.
- Eay to maintain, and not a heat hog or a repair nightmare.
- Low taxes in comparison to neighboring areas.
- A desirable floor plan. Today, that means a large family, communal areas and a large kitchen, to name a few amenities.
Homes with these attributes are available
in every price range. Look at the multiple listings directories,
which are available from real estate brokers. The houses
are listed by price, starting with the cheapest in town
and ending with the most expensive. Then the next city
in the county is listed, in alphabetical order, again
by price.
Some brokerages and Internet-based companies are beginning
to offer multiple listing services via the Web. It’s always
worth looking at houses within a wide range, at least
$50,000 on either side of your target purchase price.
Why? Because you never know how underpriced or overpriced
a property may be or how negotiable the owners may be
for the home you want.
To determine your target purchase price you'll need two
figures:
- The down payment.
- The mortgage amount.
How much of a down payment can you
afford?
Most homebuyers underestimate the down payment they can
make, much to their future detriment. Aside from money
you’ve already saved to buy the house, you might be able
to borrow from family members, or better yet, convert
your "non-performing assets."
What might those be? Don't scoff at holding a yard sale,
taking clothes and furniture to consignment shops, or
selling appreciated works of art or other valuables that
no longer interest you. One of my biggest mistakes was
not holding a garage sale before I looked for a new home.
I was aware of all the furniture I no longer wanted, but
I was too lazy to sell the pieces early and add the proceeds
to my down payment. The result was unnecessary moving
expenses, storage charges and $100 paid to a liquidator
to remove a dining room set worth $1,000.
Then there's your pension and deferred compensation plans.
An Individual Retirement Account can now be tapped for
all of your contributions and up to $10,000 of earnings
you’ve accumulated penalty-free for the down payment of
a first home ($20,000 if you buy in Washington, D.C.).
Or borrow from your 401(k) or 403(b) and pay yourself
back. If you’re moving to a city, do you really need that
car? And if you’re only a small amount away from your
goal, the credit card can come in handy.
The question as you consider these options is, should
you take such drastic measures to make a high down payment?
If the home is a bargain, just barely out of your reach,
my answer is yes. Most young couples “under buy” and soon
find themselves ready to move. Frequent moving is a huge
financial strain. If you find a place that will serve
you for a few decades, you'll be a winner in the long
run, even if you went "house-poor," for a while.
With interest rates so low right now, you might want to
consider the opposite belief. You can now qualify to buy
a home valued at a higher price than you could have bought
only two or three years ago. If you put yourself on a
tight financial budget, you leave little room for savings,
investments or even your own extracurricular enjoyment.
Think about your lifestyle and if the home truly is worth
the tradeoffs you’ll have to make.
Remember that the down payment is just the start of your
costs
Mortgage interest expenses, despite the tax deductibility
aspects, cost a fortune. For every down payment dollar
you make, you have a dollar less to finance. While a whopping
97 percent of new homebuyers don’t put down 20%, it's
costing them all. If you make a 10% down payment or less,
the lender will require private mortgage insurance (PMI),
which adds about another $45 a month to your mortgage
payment for every $100,000 borrowed. A down payment of
20% or more won't require such insurance.
That has led some borrowers to seek out “piggyback loans,”
in which they essentially take out a second loan for a
shorter time period to avoid the insurance payments. An
example might be an “80-10-10,” in which you borrow 80%
of the required purchase from one lender and another 10%
from a second lender. Meanwhile, you supply the remaining
10% in your down payment.
And remember that one-time closing fees may eat into your
down payment, so you may need to stretch a bit no matter
what.
How much of a mortgage can you afford?
You're not the only arbiter of what you can spend for
a home. Your lender uses a set mathematical formula. Lenders
apply two calculations to judge how much you can afford
to pay monthly and base their loan limit on the lesser
of the two.
Together, the two percentages are known as the 28/36 rule.
The 28% figure is simply your mortgage payment as a percentage
of your household gross income. The 36% figure adds in
your monthly debt payments (e.g. credit cards, auto loans,
personal loans, etc.). Your lender will do both calculations
and give you a mortgage based on the lower of the two
results.
Let's say that gross monthly income for you and your spouse
is $4,000 and that you pay $500 per month on two auto
loans as your only debts. The first calculation would
qualify you for a monthly payment of up to $1,120. The
second calculation goes like this:
- Multiply your income times 0.36
- Subtract your non-mortgage debt payments
from the result
- What's left is your allowable mortgage
payment:
In our example, 36% of $4,000 is $1,440.
Subtracting the $500 in monthly auto loan payments, leaves
a maximum monthly mortgage payment of $940. At current
interest rates, that would allow you to borrow about $150,000.
If you want a more expensive house, and therefore need
a larger mortgage, take these steps before you apply:
Pay off all of your debt so you can qualify for a larger
loan and, if you can, increase your down payment. But
keep in mind that lenders today will allow you to borrow
far more than you can comfortable afford.
How can you buy a more expensive home?
Another way to buy a bigger house or one in a better neighborhood
is to buy a house that needs some repairs. If you were
born with a hammer in your hand and know how to pick a
neighborhood, don't pass up all the potential profit.
Fix it up and refinance it since lenders typically are
very conservative in how they value homes needing repairs.
But the financial rewards can be high since the government
now allows you to keep up to $500,000 in profit per couple
from the sale of a home every two years.
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