So you think you’re ready to buy a home. Not many of us have a crystal ball that reveals the next thirty years of our lives. How are we to decide what we can afford when most mortgages are written for a thirty-year term? Your mortgage decision should be based on your personal goals rather than an actuarial average. A smart mortgage lender can help you navigate the complexities of the mortgage market and craft a plan that will let you sleep at night in that new dream home you’re thinking of buying.
Your Past Experience With Debt
Individually many begin contemplating how large a mortgage they can handle by considering their history with credit card, auto and other simpler forms of debt. Experience can be a good guide. How you handled paying off an auto loan over five years can offer insight into how you might handle a thirty-year mortgage. Were you always scrambling to make payments on time, or did you plan ahead so that the pressure of monthly payments wasn’t even an issue?
Your Existing Housing Situation
Your existing housing situation should also be considered when determining how much of a mortgage to take. You might be moving from a rental property to a home that you propose to buy. You might want to switch from one property that you own to another. Or maybe you want to buy an investment property.
If you are thinking of moving from rental space to owned space, it goes without saying that you need to be sure that you don’t actually prefer to stay in your maintenance-free rental residence. Buying a new home, whether to live in it or as an income property, and borrowing the money for it, is a big deal for most people. Overlooking details, such as mowing the lawn, fixing faucets, and replacing carpet can be expensive.
Prospects for the Real Estate Market
Many real estate experts consider the Chicago real estate market to be undervalued. With home prices and interest rates low, now seems like a good time to buy and to possibly consider a larger mortgage. However, if the real estate downturn of the past eight years has taught us anything, caution is required.
Home sales in Chicago declined 3.7% in 2014, after robust growth in 2013. However, according to the Illinois Association of Realtors, median home prices in Chicago increased by 4.2% after several years of flat or declining prices.
Few want to remember the housing bubble that began with the recession of 2006, but we think there are lessons to be learned. The big banks and others in the lending industry would like you to forget that poor lending practices were a primary cause of the mortgage bubble. Consumers were sometimes directed into mortgages that they could not afford. As a result of this abuse, government responded with aggressive regulation that forced most of the marginal mortgage brokers and lenders out of the business.
Unfortunately, the new regulations didn’t perform exactly as hoped. The overly-tight restrictions cut off many capable families from the mortgage market by drastically reducing the banks’ willingness to lend.
The bottom line is that there’s no guarantee that the housing market will head straight up, so you need to find both mortgage and real estate professionals whose counsel you trust.
Going Beyond the Standard Mortgage Questions
Most lending institutions offer advice about the mortgage affordability question, but the quality of that advice varies greatly. The basic qualifications for a mortgage are fairly straight-forward with criteria such as income-to-debt ratios driving the conversation. However, as you consider what future unknowns might impact your ability to service a mortgage, it becomes obvious that there are some devilish details you wouldn’t want to miss.
One of the most obvious details to consider is whether your current income stream is going to be reliable in the future. Are you starting from a position of job security? Do you expect it to last? Those same questions apply to any co-borrower. Some amount of projected income into the future is essential, the more the better. What if you get laid off? What if you get asked to relocate? Then what will happen to your recently mortgaged home?
Once beyond the question about the reliability of the income stream, a comprehensive understanding of your budget becomes essential. Line items—like household education, health care, utilities, maintenance, transportation, entertainment including dining out and a myriad of other categories—should be considered as you do a personal assessment of how your lifestyle might be impacted by a new mortgage. Knowing these running costs is likely to be very important to answering the question of how much money you can and want to afford in a mortgage.
Personal savings are an important factor in determining how much of a mortgage you can afford. Lenders may require, or you may decide on, as much as 20- or 30 percent down payment. And there are other costs associated with closing (more later on these). Lenders’ online and in-house calculators, like ours found here, can help determine and sort these details.
When you buy a home, the mortgage isn’t its only expense. There are a number of associated buying costs as well as some potentially surprising ongoing fees that follow. Up front, mortgagees should expect to pay for the above-mentioned credit report, an overall home appraisal, probably a termite inspection, possible other insect-related inspections and a general home inspection. There are also a mortgage application fee, an origination fee, the above-mentioned down payment and other closing costs.
Moving costs are inevitable. Temporary rentals for living or storing things are often part of the deal. And once the new home becomes yours, over and above costs that usually pertain to renters, there will be the property taxes (either due separately or included with the mortgage repayment schedule), some likely private mortgage insurance, homeowner’s insurance, the new utilities, possibly dues to a homeowner’s association and inside- and outside maintenance. Once the sale is consummated, repairs for anything that doesn’t work also become the new owner’s responsibility. These surprises may be considered like any other unintended consequences.
The Tax Implications of a Mortgage
Another aspect of home affordability which is beyond the scope of this article is the impact of your mortgage on your income tax bill. The home mortgage interest deduction is a powerful incentive for homeownership in addition to the opportunity to build equity in the home. Consult your tax preparer to understand how this deduction might lower your income tax. Also potentially deductible are points, or discount points, which the mortgagee pays up front in order to reduce the amount borrowed and the rate levied.
Thus the size of mortgage a borrower can afford includes all these other things that are connected to it. It makes sense to review and assess these costs ahead of time and turn them into non-surprises. That due diligence will help peg the actual affordable amount of the mortgage.
*The information contained in this section is not tax advice. You should consult your tax expert for your specific situation.
The Type of Mortgage Impacts Your Borrowing Capacity
Fairway offers a variety of mortgage options that are directly related to the amount of money you can borrow. Learning what they are and which ones you might qualify for is important. Generally mortgages are either fixed-rate or adjustable-rate. Fixed rate loans allow more accurate calculation of future costs since the interest rate and principal are steady throughout the life of the mortgage. The interest rate and consequent monthly payment for adjustable rate mortgages can change, usually annually after an initial introductory period. Fairway also offers VA (Veterans Affairs) mortgages. Because the Department of Veterans Affairs can guarantee part of the mortgage, Fairway can offer a lower interest rate. Depending on location, Fairway may be able to offer down payment assistance programs.
An important variable in the cost of a mortgage is the length of it. Mortgage periods tend to vary from fifteen to thirty years. Longer loans require lower monthly payments but the resulting interest paid will be higher. Fairway offers schedules showing the difference in their overall costs to the mortgagee over time.
4 Things to Consider When Deciding How Much to Borrow
- Check your credit. Since your credit rating can affect the rate a lending institution offers to you, get your free credit report and check it for accuracy. Correct any errors which you may find. If at all possible, pay down credit card balances or reduce the number of accounts you have open.
- Track your expenses. It’s best to have a comprehensive budget worked out, but at the very least, get a handle on major fixed costs such as car payments, health insurance, student loans, and tuition payments if you have kids in school.
- Estimate your down payment. If you can manage to pay a 20% down payment, your mortgage rate will be lower than if you offer less and this will pay off handsomely over the long term. A down payment of less than 20% usually means you will be required to buy mortgage insurance as well. However, with today’s low interest rates, it could be smarter to borrow a larger percentage of the purchase price especially if you anticipate higher earnings in the future that might allow you to prepay principal. Your mortgage broker should be able to help you plot alternative scenarios.
- Assess your job security. Be honest with yourself about your prospects before making a long term loan commitment. We don’t live in our grandparents’ economy where jobs were guaranteed to be life-long. Could you weather a period of unemployment without risk of losing your home? Are you likely to be relocated? Selling and moving costs can be daunting, and fewer employers compensate these costs nowadays.
In conclusion, many additional costs pertain to buying and owning a new home over and above those associated with either owning or renting the old one. Calculating all these costs and balancing them against all the income and savings available to support them make answering the mortgage affordability question both personalized and much more reliable.
Team Beata Bukowski can help you determine how much of a mortgage makes sense for you. Call us today for a no-obligation consultation.