By Mike Tizzano
“If Jimmy jumped off a bridge, would you?” If you’re around my age you probably heard that from your parents at some point in your childhood. We all had that one friend that tried to talk you into something that was a really bad idea. And if you were like me, you probably followed along at least once, and the results were less than desirable. In my case it typically resulted in bodily injury.
So what does any of this have to do with home financing? There are a number of real estate agents and lenders that act like Jimmy. You like a house but when the actual figures come in, the monthly payment and required cash to close are more than you are comfortable with. These “friends” will give you all kinds of advice as to why you should trash your budget goals and move forward with the transaction. In some cases they do have your best interest in mind, especially in a frenzied market in which there aren’t a lot of homes available for purchase. In other cases, they are just looking for the quick commission.
So how do you know how much house you can actually afford? Here are four things you need to consider when making that leap:
1. Don’t rule out a starter home: With all the shows on cable TV about fixing, flipping, etc. there are often unrealistic expectations with first time home buyers. We are currently in a seller’s market so you’re not likely to get everything you want in your first home without stretching your budget. This brings me to my next point.
2. Know your budget: And make sure it’s your current budget. One of the issues prior to the crash in 2007 was that many homeowners were projecting either future income or future equity. That is a recipe for disaster. Regardless of your long-term plan, you need to understand that things change, both in the markets and your personal life. Make sure you can handle whatever home payment you get into at your current employment and income. Understand that even with a fixed rate mortgage your payment can increases as property taxes and homeowner’s insurance can fluctuate.
3. Understand Debt To Income ratios (DTI): DTI is your monthly debt/expenses divided by your gross monthly income There are two numbers here to consider. The “front-end” ratio, which is your housing expense, and the “back-end ratio” which is the housing expense plus other monthly debts. The other monthly debts are the minimum payments on items on your credit report, tax liens, child support and alimony payments, etc. While some programs will allow you to qualify for a loan with a DTI of 55 percent, it’s usually a bad idea when you consider what is not considered in the lenders debt to income calculation:
a. Income Taxes – Your DTI is calculated on gross income
b. Health Insurance
c. Auto expenses: maintenance, insurance, gasoline
d. Utilities: electricity, gas, cable/internet, cell phones
f. Child care or pet care expenses
g. Emergency expenses
Generally, the guidelines call for a debt ratio maximum of 28/43. This means that the housing expense can equal 28 percent of your gross monthly income while the total debt ratio equals 43 percent. BUT generally, home buyers can be approved at ratios of 43/55. There are instances in which this is useful, for example, if you have someone living in the home that is not qualifying on the loan but earns income. However, if all of your earned income being considered is going to those levels on your debt ratio, it is a terrible idea. Just because you, can doesn’t mean you should. Don’t follow Jimmy off the bridge.
4. Make sure you have some funds available after closing: Let’s say you’ve saved up $40,000 to put down on your house and you use it all to keep your mortgage payment within your budget. Sounds like a good idea right? But what happens when you close and decide you want to paint, buy a new refrigerator, need more furniture, or something breaks down in the house or your car? You end up putting things on your credit card and it costs you more. If you’re already at the top of your budget, the increased credit card payments could be difficult for you to meet. Although most loan programs don’t require you to have cash reserves to close on a home that you’re purchasing to live in, it is always best to have a bit of a nest egg. Consider putting less down if you can do so without busting your payment budget, or buying something priced lower that requires a lower down payment to meet your budgetary goals.
Mike Tizzano NMLS #1015837 is a Senior Loan Officer with Fairway Independent Mortgage. Opinions stated in this article are solely that of Mr. Tizzano and do not necessarily represent the opinions of FIMC.
Copyright©2018 Fairway Independent Mortgage Corporation. NMLS#2289. 4750 S. Biltmore Lane, Madison, WI 53718, 1-877-699-0353. All rights reserved. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Lender. AZ License #BK-0904162