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How much can you afford?
How Much Can You Afford?
Understanding how much you can afford is one of the most important
rules of home buying. Depending on your individual situation,
your budget can affect everything from the neighborhoods where
you look, to the size of the house, and even what type of financing
you choose.
Bear in mind, however, that lenders will look at more than just
your income to determine the size of the loan. Likewise, you may
find that there are some creative financing options that can help
boost your purchasing power.
Loan prequalification vs. preapproval:
One of the best ways to determine your budget is to have your
real estate agent or lender prequalify you for a loan. Prequalification
is different from preapproval, because it is only an estimate
of what you'll be able to afford. On the other hand, preapproval
is a more formal process where a lender examines your finances
and agrees in advance to loan you money up to a specified amount.
What factors are important to lenders?
Banks and lending institutions will use several criteria to determine
how much money they'll agree to lend.
These include:
Your gross monthly income
Your credit history
The amount of your outstanding debts
Your savings--or the amount of money you have available for a
down payment and closing costs
Your choice of mortgage (i.e. 30-year, FHA, etc.)
Current interest rates
Two important ratios
Lenders also use your financial information to figure out two,
very important ratios: the debt-to-income ratio and the
housing expense ratio.
Debt-to-income ratio:
Many lenders use a rule of thumb that the amount of debt you are
paying on each month (car payment, student loan, credit card,
etc,) shouldn't exceed more than 36 percent of your gross monthly
income. FHA loans are slightly more lenient.
Housing expense ratio:
It is generally difficult to obtain a loan if the mortgage payment
will be more than 28 to 33 percent of your gross monthly income.
Down payments make a difference:
If you can make a large down payment, lenders may be more lenient
with their qualifying ratios. For example, a person with a 20
percent down payment may be qualified with the 33 percent housing
expense ratio, while someone with a 5 percent down payment is
held to the stricter 28 percent ratio.
Other ways to improve your purchasing power:
Gifts:
If you're having trouble saving money, many lenders will allow
you to use gift funds for the down payment and closing costs.
However, most lenders require a "gift letter" stating the gift
doesn't have to be repaid, and will also require you to pay at
least a portion of the down payment with your own cash.
Negotiating Closing Costs:
Through negotiation, some sellers may agree to pay all or most
of your closing costs (for example, if you agree to meet their
full asking price). If you choose to try this, make sure to ask
your real estate agent for advice.
Loan Programs:
Many local governments have special loan programs designed to
help first-time homebuyers. Loans may be available at reduced
interest rates, or with little or no down payments. Check with
your local housing authority for more information.
Loan Types:
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because
of low initial interest rates. Others opt for 30-year loans because
they have lower monthly payments than 15-year loans. There are
significant differences between different loans, so make sure
to discuss the pros and cons of different loans with your agent
or lender before making a decision.
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