Analyze Your Buying Decision
can you afford a home purchase
This is a very important first step before you start looking for a home. There are loan options that can help, but understand your financial limits to avoid cash-flow problems and foreclosure.
Calculating the Home Buying Numbers
Your First Step: calculate how much house you can afford using the simple calculators below.
This will help determine the price range of the homes to search.
Please note that these calculations do not consider the true cost of a mortgage, which includes additional monthly costs for escrow and other related fees: see our notes below
Estimate the Numbers:
- Monthly Payment Calculator
estimates the monthly payment on the amount borrowed
- Monthly Affordability Calculator
estimates how much you can borrow on a budgeted monthly payment plan.
The Total Cost of a Mortgage
The total cost of a mortgage has four elements:
represents the amount you borrow, which has to be repaid over time
is the cost that lenders charge for the use of their money during the loan period
is an assessment that local governments collect on property to pay for local services. Property tax rates will vary by location and can affect your total cost and affordability
- Homeowners Insurance and Other Fees
will be required to replace the value of the loan in the event of a disaster such as fire, earthquake, flood, etc.
Other fees that may be included are PMI (required if your down payment is less than 20%), neighborhood fees, and tax liens.
four cost components
equals the total monthly mortgage payment that you will pay each month:
Principal + Interest + Taxes + Insurance (PITI)
= Total Cost of Your Mortgage Loan
Many times buyers ignore these additional costs when figuring how much of a home they can afford.
PITI is part of the formula that lenders use when calculating your affordability ratios.
Property taxes and insurance costs must be collected and paid when they are due.
In most cases, lenders will make the collection by allocating each month to your mortgage payment the amount you need to pay for taxes and insurance. They will maintain an escrow account that will hold these funds.
These collections are placed in escrow, a depository account that the bank manages.
Your total monthly payment will include payments for real estate taxes, insurance, and Private Mortgage Insurance (PMI) and other items that are placed in escrow and used to pay taxes, insurance, PMI and other items on your behalf when they come due.
Note that the escrow portion of your monthly payment may increase or decrease,
depending on the change of your taxes and insurance assessments. Generally, funds are assessed 6-12 months in advance of payment so that enough funds are in escrow to meet the assessment charges.
If your mortgage does not have an escrow account, you will be required to pay your taxes and insurance separately and show proof of payment to your lender.
What Goes Into the Numbers
1: You Will Need a Down Payment
Mortgage lenders expect home buyers to use a portion of their own money to purchase a home. The standard down payment percentage is 20% of the home's purchase price.
Many lenders may allow for lesser percentages as little as 3-5%, provided that private mortgage insurance (PMI) is obtained. Many of these zero-down mortgage loans come with restrictions.
(we have detailed information about zero-down mortgage loans at our affiliated site: www.PickmyMortgage.com - opens new window)
Existing homeowners can use the resale equity of their home as down payment. New home buyers will need to use their savings or cash gifts from family members.
Note: IRS rules allow for an one-time distribution from qualified IRA accounts without the 10% penalty for acquisition of a home for first-time home buyers.
See IRS publication 590 for information:
We quote from the IRS web site:
Can I withdraw funds penalty free from my 401(k) plan to purchase my first home?
If you are less than 59 1/2 years of age, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on early distributions from qualified retirement plans.
However, depending on the rules for your 401(k), you may be able to borrow money from your 401(k) to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) as well as other plan rules.
Topic 424, 401(k) plans
If I can't withdraw funds penalty free from my 401(k) plan to purchase my first home, can I roll it over into an IRA and then withdraw that money to use as my down payment?
Yes, if you are receiving a distribution from a 401(k) that is eligible to roll over into a IRA and you meet all of the qualifications for an IRA distribution for a first-time home buyer. Your plan administrator is required to notify you before making a distribution from your 401(k) plan whether that distribution is eligible to be rolled over into an IRA.
To see if you qualify for a distribution to be used as a first-time home buyer, refer to Publication 590, Individual Retirement Arrangements (IRAs) (Including Roth IRAs and Education IRAs).
2: You May Need to Pay Discount Points
Discount points are up front fees that lenders charge in order to offer you a lower interest rate on your mortgage.
A point equals 1 percent of the mortgage loan amount. For example, if the lender charges 2 points on an agreed loan amount of $100,000, your point fees will be $2,000.
Many lenders offer mortgage loans with zero points. These products generally carry higher interest rates.
Typically, each point that you pay on a 30-year loan lowers your interest rate by 0.125 of a percentage point. This reduction may vary by lender.
Compare rates vs. points calculation — from Dinkytown.net: www.dinkytown.net
3: Don't Forget About Closing costs:
Closing costs are incurred costs associated with the closing and transferring home ownership from the seller to the buyer.
These costs include lender fees, prepaid fees, title search, recording fees, surveyor's fees, attorney fees, and other closing-related fees. You will find a more detailed discussion.
Closing costs can average about 2-5% of the total sales cost. That does not include points.
Now Estimate how much you will have for a down payment:*
Tax Benefits of Home Ownership
Interest rate charges and other related costs to service your mortgage loan are generally tax deductible.
This will include points paid and other up front lending fees, if any. You will need to itemize your deductions on Schedule A (Form 1040).See your tax advisor for further information.
See your tax advisor regarding mortgage interest deductions.
The following calculation shows the estimated "Effective Interest Rates" for each income tax bracket.
The "Effective Interest Rate" is the calculated annual interest rate that you will pay for the year after you deduct qualified home equity interest from your taxes.
IRS-related publications and forms for homeowners:
- Publication 936: Home Mortgage Interest
- Download IRS1040, Schedule A: Itemized
Download Publication 936:
Getting Yourself Pre-Approved
You may want to pre-approve your mortgage loan before house hunting.
You will be able to make an offer knowing exactly how much you can afford. Also, if the seller knows that you have been pre-approved for a mortgage loan, your offer will be more attractive if the seller wants to sell fast.
There is no obligation when you pre-approve for a mortgage loan from a lender.
Nor does it obligate the lender to provide you a mortgage loan.
The pre-approval simply reviews your credit and income qualifications based upon the information supplied. The final approval will require verification of your financial status and home purchase.
With a pre-approved mortgage, you can get most of the paper work completed
so that you can close on your home as soon as possible.
We can help get your pre-approval application started.
Search and compare lenders through our financial network
Qualifying for Credit
Lenders typically use two key criteria in qualifying you for credit:
1: Your Capacity to Repay
the Mortgage Loan
your capacity to repay your loan is analyzed by two lending ratios:
i: The "housing ratio": calculated by dividing monthly housing expenses by your gross monthly income. As a basic rule, the housing ratio should not exceed 28%.
ii: The "debt-to-income ratio": calculated by dividing your fixed monthly expenses by your gross monthly income. As a basic rule, the debt ratio should not exceed 36%.
2: Your Credit History
your outstanding credit report lists any payment delinquencies that you may have had over the past three years.
The report can be a factor in a lending institution's decision to approve or decline your mortgage application. You should review your credit report for any errors before applying for a mortgage.
Allow yourself about 2-3 months prior to the loan application for correcting of any errors that may be on your report.
You have the right under Federal Law to know what is in your credit report.
We invite you to visit our Credit/Debt Management Center for complete information about:
(links jump to our center at: www.SayGoodCredit.com)
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