You’re in the market for a new home. Whether you’re a first-time home buyer, seeking an upgrade, or venturing to a new city (possibly with a higher or lower cost of living than you’re used to) you have a lot to figure out. The cost of homeownership is not as straightforward as finding a mortgage payment equal to the rent you’ve been paying. Monthly payments form just one part of the puzzle. Consider all the factors that will cost you money, over the entire time you own your new home. Make sure you know what size mortgage you can truly afford before you commit.
Find Your Ideal Mortgage Payment Using Debt to Income Ratio
The first step is to sit down and calculate your projected monthly mortgage payment. We offer mortgage and home ownership calculators on our website to get you started.
A common guideline is that your mortgage payment should account for no more than 28% of your monthly income. This is your debt-to-income ratio, and it is one of the numbers that banks will use to determine whether you qualify for a mortgage and your interest rate.
The Consumer Financial Protection Bureau warns against fixating on how much you’ll qualify for with a mortgage. It’s important to keep in mind that your mortgage payments could change in the future, and that your circumstances could too. You don’t want to borrow so much that you don’t have money in the budget for other priorities, or to protect your family in an emergency.
How Does a Down Payment Play into What Size Mortgage You Can Afford?
A conventional mortgage typically includes a down payment of about 20% of the home’s purchase price. Some mortgage programs require less than 20%. Remember, though, if you have less to put down, you may be required to buy private mortgage insurance. This is calculated based on your credit score. This monthly payment is tacked onto your regular mortgage payment and can range from a few dollars to a few hundred dollars.
Consider Available Mortgage Programs
For first time buyers, there are several mortgage programs that can make home ownership a reality, instead of just a dream. Curbed.com outlines several of these programs:
- Traditional FHA: A traditional mortgage from the Federal Housing Administration allows a buyer to make a down payment as little as 3.5%. It allows individuals with less than perfect credit, or those who can’t qualify for a traditional mortgage to get into a home, but there are other non-negotiable requirements like mortgage insurance.
- Fannie Mae HomeReady: This mortgage program is designed for individuals with low to moderate income, with a limited down payment and a credit score above 620. There are other characteristics that come into play here. Fannie Mae’s mortgage insurance is required at first, but may be cancellable, when a buyer builds up 20% equity in their home.
- Freddie Mac HomePossible: Like the Fannie Mae HomeReady program, this one is designed for first-time home buyers and others who have low to moderate income. There are two mortgage options in this program that require anywhere from 3-5% down.
Plan for Any Balloon Payments
You’ll want to watch out for a mortgage that has a balloon payment at the end. That payment can be a bit of a surprise. It’s what’s left of the principal loan amount at the end of a mortgage term. If your monthly payments don’t cover all of the interest and start chipping away at the principal, or if a payment is late, it won’t cover interest on the late payment, and that can add up.
Balloon payments also come into play with two-step mortgages. You may agree to pay your mortgage at a certain interest rate, then it resets after a certain amount of time. At the time of reset, you may owe a balloon payment. According to Investopedia, a balloon payment can range from twice a normal mortgage payment up to hundreds of thousands of dollars!
A mortgage isn’t something that people should enter into lightly. It’s a big financial commitment. But, for most homeowners, it is a necessity. It can be tough to get a mortgage, and tough at times to pay one. So understand exactly how much you can afford before you get your heart set on a house.