Home buying

How Much Home Can You Afford To Buy?

How much home can you afford to buy? Before you begin house hunting, this is the major question you need to ask yourself.

Now that we have looked at Fourteen Ways To Finance Your Home, let’s take a look at how much home you can afford to buy. You don’t get far into any discussion of homebuying before someone mentions a special, time-honored formula for determining how much of your salary you should budget for mortgage payments, Unfortunately, one person tells you the top amount is 25%, another says he or she heard it is 28%. Then, yet another says that it is the cost that matters, never spend more on a home that two and a half times your annual income.

Actually, in matters like this, every person should be their own expert. The question you need to ask yourself and answer is: How much money do I have left over to spend on shelter each month after meeting all other expenses? If you haven’t run up any credit-card bills, aren’t making car payments, and have few expensive habits, you could well afford to put 30%-35% of your monthly salary into a mortgage payment, or buy a home that costs three times what you earn.

What matters are the monthly payments, your mortgage payments and home-related bills (or the maintenance costs if you buy a condo). To get an idea of how much you can set aside for mortgage payments, total up right now, all other expenditures you’d expect to make in an average month, leaving out rent (or our present mortgage payment if you already own a home). Subtract that total from your monthly take-home pay. Then subtract an estimate for property taxes and insurance, The result, a fairly accurate idea of what you can afford to pay each month.

Example: Suppose you have $700 available for housing. Subtracting, say $160 a month for taxes and insurance leaves you with $540. If the prevailing mortgage rate is 12.5%, you can afford a mortgage in the $45,000-$50,000 range.

To that mortgage amount, add the total cash you can afford to put into a down payment. The result is the maximum price you can afford to pay for a home.

The downpayment you will need varies from lender to lender. It can be as little as 3% or as much as 30%-40%. The key element is your ability to make mortgage payments. If your salary and other income are high enough, you’ll be able to make a low down payment, Otherwise, the bigger your down payment, the lower the mortgage and, consequently, the lower your mortgage payments.

Next Move: After these calculations, you are now in a better position to make good use of the real estate classifieds in your area. You’ve seen for sale signs on properties that interest you, but without any clear picture in mind about what your budget permitted you to buy. Now you know what to look for as you begin the process of looking for your home.

Happy house hunting!

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Rent With An “Option To Buy”

This is my least favorite option for purchasing a home, however, the rent with an option to buy is available for those that don't have the best of credit.

This has to my least favorite of all the ways you can finance a home. If there is a mortgage on the home you rent with an option to buy, what if the seller does not make the payments to the mortgage company? Where does your rent go and where does that leave you? Those are questions that can be answered in another blog post for another day.

This arrangement permits you to move into your home and live there as a “tenant” while you raise financing. Try for an arrangement that permits all, or at least some of the “rent” to be applied to the purchase price. Lock in a purchase price too, when you begin your tenancy.

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Zero Interest Mortgage

If you are looking to have your home built, the zero interest mortgage may be right for you. These mortgages are usually offered by builders. Check with your builder to see if they offer the zero interest mortgage

 

This type of mortgage is usually offered by builders and occasionally by individual sellers. The buyer makes an unusually large downpayment and then pays off the balance in monthly installments within a few years. Just as it’s named, there is no interest charged, however, the Internal Revenue Service will impute up to 10% interest in such cases. The result of good old Uncle Sam doing this is that the buyer is entitled to deductions for interest even though no interest is stated. Thanks so much Uncle Sam!

Builders and sellers offer such financing in desperation and invariably increase their prices accordingly. Such mortgages may not be much of a “bargain” if the price is substantially above what the builder would charge on a regular sale where you get your own financing.

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Seller Held Second Mortgages and “Wraps”

Seller held second mortgages and wraps are kind of tricky. Read on to make sure that if you take out one of these mortgages you won't get tricked in the end

 

Up to 70% of all existing home sales made during the early 1980’s mortgage interest crunch involved seller-held mortgages. I know it’s not the ’80’s anymore, but seller-held mortgages are still pretty popular.

Example: You want to buy a home for $70,000. You can make a downpayment of $20,000 and get a first mortgage for $40,000. That leaves you $10,000 short. You ask the seller to “take back a mortgage” for the $10,000 balance. In effect, the seller is accepting your IOU, secured by the home, for part of the selling price.

Wraparounds: In some cases, the seller may have had an older low-interest loan with a due-on-sale clause. Had the lender learned of the sale, it could have forced the buyer to finance the mortgage at market rates, possibly killing the sale. To prevent this from happening, some sellers continue to make mortgage payments on their first mortgages even after they have made a second mortgage arrangement with the buyers. This second mortgage is called a “wraparound” because it included (or “wrapped around”) the first, and it was often made at a high rate.

Major Drawbacks: A “wrap” may create problems about who actually has title to the property and may leave the buyer exposed to having to repay the old mortgage at once if the lender demands it.

You are taking a huge chance with this type of mortgage, so buyer beware.

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Shared Equity Plan

The shared equity plan is great for investors and buyers alike.

Similar to the Shared Appreciation Mortgage {SAM} the Shared Equity Plan entails that the monthly costs and the downpayments are split between the buyer and a partner. That partner will either be an investor, friend, or relative. In return, for such assistance, the buyer shares any profit from the home sale with the partner.

Shared equity works by providing you, the buyer, with a loan which will form part of the deposit for the property you want to buy. Then, as you would normally, you take out a shared equity mortgage on the remaining part of the property’s value.

Under some plans, the partner is considered the landlord and the buyer is the tenant, whose share of the monthly payments is considered rent. The partner gets investor tax breaks from this set-up.

The complexities of the Shared Equity Plan and yesterdays Shared Appreciation Mortgage and the possibility of the buyer’s having to sell the home at an inconvenient time in a falling market are major drawbacks to “sharing”.

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Shared Appreciation Mortgage {SAM}

Shared appreciation mortgage {SAM} is it right for you?

A shared appreciation mortgage or SAM is a mortgage in which the lender agrees as part of the loan to accept some or all payment in the form of a share of the increase in value (the appreciation) of the property.

Basically, the lender gives the buyer an unusually low-rate mortgage in return for a share (often 30%-50%) of the profit when the home is sold or transferred (often within a specified number of years).

Example: Suppose the current prevailing interest rate is 6%, and the property was purchased for $500,000. The borrower puts down $100,000 and takes out a mortgage of $400,000 amortized over 30 years. The lender and the borrower agree to a lower interest rate of 5%, and to a contingent interest of 20% of the appreciated value of the property. Because of the lower interest rate, the monthly payment is reduced from $2,398 to $2,147. However, this saving in monthly payments comes with a trade-off. Suppose the property is later sold for $700,000. Because of the agreement on the contingent interest, the borrower must pay the lender 20% of the profit, namely, $40,000.

By participating in the appreciation of the property, the lender takes an additional risk that is related to its value. Hence, whether this is a favorable trade-off depends on the conditions of the housing market. A shared appreciation mortgage differs from an equity-sharing agreement in that the principal of the loan is an unconditional obligation (to the extent collateralized by the property). Thus, if the property’s value decreases, the borrower would still owe whatever principal is outstanding, and if the borrower sells the property for a loss, the contingent interest is simply zero.

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Buy-Down Plans

Buy-down plans help you qualify for mortgages that you may have otherwise not qualified for.

 

This method is so called because someone–often a relative of the buyer but sometimes the home seller or the home builder–advances cash needed to pay part of the initial mortgage interest. In short, the interest rate is reduced, or “bought down,” so the buyer can qualify for a mortgage. Hence the term Buy-Down.

To understand how this works, you must understand that lenders consider a borrower qualified if he or she has the income to meet the first year’s mortgage payment.

Example: Buyer needs $60,000 to buy a new home. His income qualifies him for a mortgage at 10% but the lender is asking 13%. Solution: Builder sets up a three-year buy-down plan. He supplies enough cash to absorb 3% mortgage interest in the first year, 2% the second year, and 1% the third and last year.

The buyer can afford a 10% mortgage in the first year. The lender, who will receive the full 13% interest anyway, agrees to the deal. By the fourth year, the buyer is responsible for the full 13%, and by then he should be able to afford it.

The buy-down is a good way for a parent to help a child buy a home. If the buy-down is financed by the seller or the home builder, it won’t be a free lunch. The buy-down amount will be reflected in a higher purchase price.

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The Assumable Mortgage

I was always told not to assume, because you may make an ass of yourself. In this one instance it is ok to assume. The assumable mortgage is the only assumption you may ever need to make.

 

In simple terms, a mortgage is said to be assumable if a buyer can take over the responsibility of making payments (“assuming” the loan) form the home seller. If you can assume a home mortgage when you buy a house, you may be able to finance a good portion of the cost at a bargain rate.

Example: Brad bought his home for $70,000 five years ago with a $60,000 mortgage at 9% interest rate and $10,000 cash. Now Brad sells his home to you for $90,000. There is a $55,000 balance remaining on the mortgage. If you can assume that mortgage (and come up with the $35,000 balance of the purchase price yourself). You can finance the home at a one-third discount off today’s mortgage rates. Result! Lower monthly payments and lower interest costs.

Despite recent changes in home financing and in the law on mortgage assumptions, many mortgages are still assumable by credit-worthy buyers.

All loans insured by FHA remain assumable at their original rate. Any credit-worthy buyer can assume a VA-guaranteed mortgage at its original rate. Another possibility is that you may be able to obtain a reduced-rate mortgage through the Federal National Mortgage Agency (FNMA) or Fannie Mae. FNMA is one of the largest purchasers of mortgages originated by banks. It has a step-up program, “The Mortgage Solution,” that you may find as economical as an assumption. If FNMA owns the mortgage on the home you want to buy, it will in effect give you a new first mortgage at a below-market rate.

Always ask the sellers how they financed their home. Then ask the lender whether it sold their mortgage to Fannie Mae, before you resign yourself to borrowing the full amount you need at market rates.

As my mother used to say, don’t assume anything because you may make an ass of yourself. The assumable mortgage is the one time you can assume and not worry about making an ass of yourself.

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FmHA Home Loans

If you want to live in a rural area, away from the hustle and bustle of the city, consider the FmHA Home Loans.

The Farmers Home Administration (FmHA) makes home loans available to moderate and low-income people. Some loans are made by FmHA itself. Others are guaranteed by this agency. The loans are available in “rural” areas that are not part of or associated with a city or large urbanized area.

The Farmers Home Administration (FmHA) is a little-known federal agency that gave loans to farmers and other borrowers who had difficulty obtaining traditional financing. You can still get a mortgage through the FmHA in its new iteration through the U.S. Department of Agriculture (USDA).

When it comes to mortgages, the FmHA encourages you to buy property in rural areas as a way to spur economic growth. Understanding the application requirements and loan restrictions will give you the best chance of qualifying for financing through the FmHA. FmHA loans are only available if you plan to purchase property in an area that has fewer than 25,000 people. You may mistakenly assume that this type of loan is only available to farmers who want to buy agricultural properties, but this is not the case. You can use an FmHA loan to purchase a primary residence, but you must meet several basic requirements.

  • You must show you have a steady income
  • You must demonstrate a positive credit history
  • You must prove you have the ability to repay the loan, if granted
  • Your income must be no more than 115 percent of the moderate income level for your area as determined by the U.S. Department of Housing and Urban Development (HUD). HUD determines the moderate income level by reviewing income data for the area and setting caps based on the number of people in your household.

The FmHA only gives funding to those who want to buy homes that it determines to be modest in cost, size and design.

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VA-Backed Mortgage

The va-backed mortgage is for veterans. If you are a veteran looking for a home, don't forget this awesome benefit you are entitled to. Thank you for your service

A VA-backed mortgage is very similar to FHA-insured loans, except:

  1. The Government (through the Veterans Administration) insures the lender against loss on only part of the home loan.
  2. The loans are available, only to veterans with minimum periods of duty during specific periods of time
  3. It’s possible to get a zero downpayment home loan!

That’s right, a qualifying veteran can get a 100% mortgage to buy a home. See your local Veterans Administration office for more information on this benefit. And one more thing, THANK YOU FOR YOUR SERVICE!

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