How To Afford The House You Want, How To Afford A Mortgage

AFFORDING THE HOUSE YOU WANT

Have you ever wondered how you could afford the house you really want, or how to get a mortgage for the house you really want? Most articles on getting mortgages tell you how much of a mortage you can afford based upon your current situation. In this article we'll look at what you need to change in your financial situation to be able to afford the home you want.

Changing your financial position most likely won't happen overnight, so let's assume that you want to buy a home in a certain area or at a certain price rather than a specific home that you have in mind now. Let's use $250,000 as the price of our hypothetical home.

Let's first open up our Mortgage Affordability calculator in a new window so you can plug in some numbers. Enter your annual income, the amount of credit card, loan, and other monthly debt payments you're currently paying (use the minimum payments), the amount you have available for a down payment, the interest rate you expect to get on the mortgage, the monthly amount of your house insurance, and the monthly amount of your property taxes. Enter the length (term) of the mortgage you want, and hit Calculate.

If the home price in the results box is close to the price of the home you want, you're all set. If not, then there are some things you need to change.

The most important factors you must change in order to afford the home you want are your income, your debts, and your down payment. Whether you get a second job, work overtime, or manage to get a promotion, you'll likely need to increase your income. With that increased income you'll be able to pay down any debts you might have, and/or save for a larger down payment.

A few months of increased income won't be enough to change the minds of the underwriters. You'll need at least one full year's tax returns showing your increased income. Ideally, you should be able to show three years of higher income. If you're self-employed, tax returns can be a problem, as you may be making money, but there's no W2 form to show. A solution would be to incorporate so that you're an employee, and receive W2's just like "real" people.

If you're fortunate enough to have parents, friends or relatives who are willing to help you buy a house, getting money from them for a down payment is an option. However, they cannot lend you money. Your parents or relatives could gift you money. They could also pay off some or all of your debts.

Now let's start working backwards to find out how much you'll need to earn and how large a down payment you'll need.

Underwriters typically want your mortgage payment to be no more than 25% to 28% of your monthly income. Let's assume for the moment that you have no debt, no taxes and no insurance so that we can temporarily leave those fields in the calculator at zero, and let's use 6% as your rate and a down payment of $18,000.

Using our monthly mortgage calculator, we find that on a loan for $232,000 ($250,000 less your $18,000 down payment), your monthly mortgage payment would be $1390.95 at 6%. That means your monthly income would need to be $1391 x 4 = $5564, or an annual pre-tax income of $66,768.

Of course, you will need home insurance and you'll be paying property taxes, so we need to add those to get more accurate figures. Both can vary in price, so let's use somewhat average figures of $900 a year for insurance and $6000 a year for taxes. If the underwriter includes insurance and property taxes, and uses the 28% of your monthly income multiplier, you'll need an income of $84,252 to qualify for that $250,000 home. As you can see, the addition of the $6000 in property taxes makes a good case for living in a low-tax state if possible.

If there's no chance of you (or you and your spouse) making that kind of money, what can you do? The obvious answer is to make a larger down payment. In our $250,000 example, increasing the down payment by $10,000 would lower the annual income requirement to around $70,000. Not only will the additional $10,000 down payment get you into your house, but it will also save you about $11,000 in interest over the term of a 30 year mortgage.

What about your other debt?

Underwriters typically want to see a debt to income ratio of 33% or better, although some may go as high as 38%. This means that you can carry an additional 5% to 13% of your monthly income after your mortgage payment in the form of loans or credit card payments. Using our example of $70,000 a year, you could have $400 to $450 in additional monthly debt payments and still qualify.

If your debt is above that range, it will preclude you from getting your mortgage. Consider your options. Is there a way to pay off that debt quickly? If it's a second or third car, a motorcycle, boat or other "toy," ask yourself if it's something you really need. Carrying high debt isn't just a problem in getting a mortgage. It also makes you vulnerable to changes in the job market and restricts your financial freedom.

The above numbers are on the conservative side, and you may find mortgage lenders who will allow lower income levels or higher amounts of additional debt when qualifying you for your mortgage. As we've seen with the mortgage crisis of 2007-2009, though, being conserative with getting a mortgage is not a bad idea.

Yet another factor in being able to afford the home you want is the interest rate. You see very attractive rates advertised all the time, but those are for borrowers who have the best credit scores, best incomes, and best debt to income ratios. You can help yourself get a better rate by focusing on improving your credit score as detailed in our Mortgage Credit Grade article.

If your credit score is 620 or lower, you have real problems that will make it difficult or impossible to get a mortgage. Scores below 620 are "subprime," a term that should now be familiar. Scores in the 620 to 700 area are considered good. 700 to 800 is considered very good to excellent.

Your credit score can mean a difference of one-half to a full percentage point in interest, so it's important to clean up your records. If you find errors, have the credit reporting firms correct them. If there are problems in your past, try to deal with the problem creditor to get your record wiped clean.

Your credit report won't just make a difference in your interest rate; it may determine whether or not you get the mortgage you want. Problems on your credit report are one issue to pay attention to. Another, but less often encountered problem is a lack of credit. If you have no credit history, there's nothing for the underwriters to use to judge your credit worthiness. Consider getting a credit card or a small loan and making your payments promptly to show that you're reliable.

It's not uncommon for applicants for a mortgage to give false information about their incomes. Some even print phoney tax returns in order to get a mortgage. These people are assuming that the mortgage company won't take the time to verify the tax returns with the IRS. Considering that falsifying tax returns is a federal crime, that's a risk nobody should take.

Take some time to experiment with different numbers on our Affordability Calculator to see where you need to make changes to get the house you want. Just remember these two rules of thumb: your mortgage payment should be no more than 25% or so of your monthly pre-tax income, and your total debt payments, including your mortgage payments, should be no more than 33% of your monthly pre-tax income.

As you calculate ways to afford the home you want, don't forget things like entertainment, hobbies and other expenses that enrich your life. There's more to life than paying bills.