One needs to plan ahead as much as possible. A good place to start is how much house can you afford? Just because you’re pre-approved for $750,000 doesn’t necessarily mean you should buy in that price range. The last thing you want to be is house poor. This could happen if you buy at the top end of your budget. The house may look and feel nice, but if you’re struggling to make ends meet or furnish the house after the fact, then you’re going to run into problems down the road. Run the numbers and see what fits into your budget. Take into account your loan amount, principal, interest, property taxes, and home owner’s insurance. A few questions to ask yourself:
- What will the total monthly payments?
- Will you have an escrow account or pay out of pocket for taxes and insurance?
- Are you paying more or less for your current rent or mortgage?
- What will a 15 year vs. a 30 year term loan look like?
Don’t try to keep up with the Jones’s here and buy more house than you need.
Typically, there are tradeoffs with competing financial goals, such as saving for retirement or saving for a down payment. Where’s the immediate need and what is more important to you? You may have to back off retirement savings down to your employer’s match or stop completely. Then you can reallocate the funds to savings for a down payment for a year. Also, don’t blow your entire savings on a down payment. Leave enough for an emergency fund of 3 to 6 months in cash. This will provide a cushion should you lose your job or have an unexpected life event happen.
Check with your lender to see what kind of mortgages you qualify for and what issues may arise. Depending on various factors this will impact your down payment. For example, if you’re a veteran you can qualify for a VA loan, which requires zero down payment. An FHA loan has low down payment requirements around 3.5%. If you’ve recently started your own business and are self-employed, lenders typically require two years of tax returns to show income and success of the business. If you don’t have this, then you may not qualify, or will have to have your spouse be the only one on the loan. All of these things can impact your down payment and loan eligibility.
During underwriting a lender will look at everything. You want to have a handle on your debt to income (DTI), loan to value, credit score, wages, and balance sheet to name a few things. They will go through everything. These will affect how much money and what rates you’re eligible for with a lender.
You usually want your DTI to be around 36% for all debt payment in relation to your income, where 28% of that is a good rule of thumb for the mortgage. This is what lenders will look at. I’d recommend keeping this number even lower to free up cash flow for other goals such as retirement or kid’s education for example. You may need to develop a plan to get your credit on track or pay down debt. After this you can reapply with a lender to see if you can get more favorable loan terms.
PMI – Private Mortgage Insurance
You don’t necessarily need to put 20% down to get a mortgage. I do think this a good rule of thumb though. I always encourage people to do so if they are financially able. This way you don’t have to pay for PMI, or private mortgage insurance. You’ll also have more equity in your new home from the start. Otherwise, PMI will be an added expense to your monthly payment.
That being said, if you don’t have 20%, but have some money saved, or would feel more comfortable having more cash on hand, go for it. Just understand the risks involved. It all comes down to what you want to accomplish and knowing the moving parts financially. This ensures you’re in a good place monetarily before, during, and after you buy the home. Be sure to understand the opportunity costs and impact of these bigger financial decisions.
In summary, factors that can influence the size of your down payment include loan eligibility and requirements, financial goals, emergency fund, and how much house you can afford.
Mortgage Rates in 2022
In recent months the Federal Reserves has increased interest rates. The hope is that this will help combat inflation. This will also put downward pressure on the real estate market. The Fed has the ability to set short term rates but mortgage rates are typically associated with 10-year treasury rates. Rising interest rates will make for higher monthly payments. Be sure to budget accordingly.
As of September 26th, 2022 per the Wall Street Journal, 30-year fixed rates are at 6.71% and 15-year fixed rates are at 5.92% to give you an idea of where the current rates are at. As stated earlier, rates will vary based on numerous factors such as income, credit score, and loan terms to name a few things.