Can You Afford to Buy a New Home?

Buying a home is likely the largest purchase you may make. Understandably, making such a large decision can create some anxiety, apprehension, and lots of questions.

Is now the right time to buy? Can I afford to take on a mortgage? What are other expenses to consider with homeownership? Our aim is to calm stress and answer some of those questions in this article.

Most home purchases involve taking out a mortgage loan to finance the home. You will want to be prepared for the initial costs, such as the down payment and closing costs. Once you get through the initial purchase, you will be responsible for the ongoing monthly mortgage payments, homeowners’ insurance, property taxes, and in some cases private mortgage insurance and association fees. A home requires maintenance, which you will want to be sure is in your budget as well.

Determining your affordability.

One of the first steps in determining whether you can afford a home is to review your budget and lifestyle to see what you are comfortable paying on a monthly basis. A good starting point can be to look at what you pay now for housing and make a list of all your other monthly bills, target savings, and expenses. A mortgage is a long-term loan, often as long as a 30-year term. Consider your future goals along with looking at your financial picture now. Are you building a family? Will you need to buy a car soon? Are your student loans in deferment? Are you on the market for any other large ticket item that will add to your current debt obligations?

If you need a starting point, or some help with this step, there are credit and budget counselors that specialize in exactly this. They can be a good resource and starting point for your road to homeownership and determining if it is right for you.

The second part to determining your affordability is to meet with a lender to go over your finances and ensure what you’ve come up with, and what works for the mortgage, align. This is an important step in getting pre-approved.

What to expect with a lender.

A lender will review what we call the three Cs of lending; credit, capacity, and collateral.

The lender will need to pull your credit report to determine your credit score and payment history and determine the programs that may be the best fit for you. Many programs have a minimum credit score, which your lender should be able to discuss with you prior to the credit pull. This can be one of the most nerve-wracking parts of the process but is a necessary step to know where you stand. A credit pull is usually valid for 120 days and gives the lender valuable information that they need to help move your pre-approval forward.

Capacity is how much you have available monthly in your budget to spend. When you meet with a lender, they will look at something called a debt-to-income (DTI) ratio. Your debt-to-income ratio is the percentage of your monthly gross income (before taxes and other deductions are subtracted) which can be used to pay monthly obligations. To determine your DTI ratio, your mortgage lender will add up the estimated expenses for the home you hope to buy which will include the mortgage payment, estimated property tax, homeowners’ insurance, as well as private mortgage insurance and association fees (if applicable). They will also ask about your other monthly debt payments; car loans, student loans, credit card minimum payments, to name a few. They will then divide the total debt payments, including the proposed housing expenses, into your gross monthly income. A lender will typically want to see your DTI at or below 45%.

The last C, collateral, relates to the home you are purchasing and what the price or value is in regard to the loan amount you are seeking. Some programs may have minimum down payment requirements, while others may allow you to put 0 down. If this is your first time buying, there may also be grants or assistance options available to use toward the required down payment. Your lender will be the best resource to guide you through all of the available options so that you understand what will be expected during the process.

With uncertain times, interest rates can be a factor in what your affordability will look like. Be sure to ask your mortgage lender what rate lock options look like and when you can secure your rate, so that it is one less variable during the process.

Determining your out-of-pocket expenses.

It is important to understand the upfront costs involved with getting a home. On top of down payment, closing costs are another part of the puzzle that you will want to be prepared for. Some fees are fixed costs, like the appraisal or a lender’s origination fee, while others can vary based on the price of the home and the state you are purchasing in. A lender should be able to get you an estimate once you have applied and are pre-approved. They will need to know the price, down payment, credit score, city/town, and loan program that you are looking for.

There may be instances when grant funds or assistance may help to cover some of the closing costs, but even if you are able to obtain assistance for your purchase, there are items up front that you will want to be prepared to have on hand.

When you go under contract to purchase, a seller will want to obtain a deposit. The deposit amount can vary, and it is best to discuss that with the seller or realtor you are working with, so you know what to expect. As a rule of thumb, it tends to be around 1% of the price. The deposit will be credited at closing toward to the bottom line of what is due at closing.

You should also be prepared to pay an up-front inspection if you choose to have one. The costs for the inspection can vary based on the type of inspection you choose to have done. An appraisal is another cost to be prepared to pay prior to closing. A lender will generally want to collect the appraisal fee up-front during the process, which can run from $650- $1,000 depending on the property type and location. Another item to expect out-of-pocket prior to closing is homeowners’ insurance. This will need to be in place on the day of closing and is usually expected to be paid for before closing. Discuss with your lender if the full year will need to be paid prior, or if you are able to pay it monthly to your agent directly. The requirements can vary with each lender and loan program.

Don’t stop now, keep asking questions.

Is this the right time? Once you’ve determined what you can afford to pay on a mortgage each month, how much you will need for the down payment, and closing costs; you should have a clearer understanding if now is the right time for you to start this journey.

What will my payments and costs look like? Your lender will be there to support you along the way as you find a home that you are interested in. Use them as a resource to understand the payments and costs involved.

Make sure you’ve buffered in a monthly savings plan for future maintenance on the home. If your refrigerator needs repair or your septic system needs pumping, you want to ensure you are ready for those unforeseen expenses.

Taking on a mortgage obligation can be scary, but there are many steps you can take along the way to ensure that you can afford to make this important investment before you set your heart on a new home.

*Need help with the calculations? Check out our Payment and Closing Cost Calculator.