Expectations for first-time homebuyers, and how The Police Credit Union can help
To those unfamiliar with the home buying process in today’s high-cost real estate markets, it may seem as though the logical first steps would involve attending open houses and scouring listings on house hunting apps. But if you begin your home search without having first made a fairly accurate assessment of your financial situation, it’s all too easy to become disillusioned as you’re forced to readjust your expectations. Unless you’re in a position to make an all-cash offer, you’ll make the entire home buying process more rewarding, and greatly increase the odds of getting the home you want at the right price, by taking the time to plan and budget ahead of your home search. To determine how much you can reasonably afford to pay for a home without becoming overextended, it’s critical to consider these factors:
How lenders assess your ability to pay
In determining whether to approve your home loan and at what interest rate, your monthly gross income and level of debt will be primary considerations. In addition, lenders will weigh your credit score and financial history, assets, obligations and work history. To protect their investment, they will also consider the value and condition of the home you want to buy.
As the Consumer Financial Protection Bureau explains, your debt-to-income ratio is an important way in which lenders measure your ability to manage payments on the money you plan to borrow. To calculate your debt-to-income ratio, add up all of your monthly debt obligations and divide them by your monthly gross income (typically the amount of money you earn before taxes and other deductions are subtracted). While lenders differ when it comes to underwriting guidelines, a fairly common standard is to allow you to pay approximately 40 percent of your gross income toward all of your recurring debt payments each month, including your prospective mortgage payment, credit cards, car payments, student loans, etc. With some exceptions, 43 percent is the highest debt-to-income ratio under which a lender may offer you a qualified mortgage.
What will be the impact of your mortgage on your overall budget?
It’s important to note that the maximum loan that a lender will approve for you should not necessarily be the benchmark by which you decide how large a mortgage you decide to take out. Not only will you have your down payment, closing costs and other expenses to consider, but you’ll want to be certain that your monthly mortgage payments won’t leave you so cash strapped that you’re forced to overhaul your lifestyle, and cut out purchases that you consider to be vital to your happiness and well-being. For this reason, it’s helpful compile your own list of your typical monthly expenses that are separate from anything related to what you will spend on your home. Examples of these would be food, utility bills, entertainment, fuel, day care costs, clothing and toiletries, savings and investment account contributions, child support and/or alimony, car payments, etc. Once you have added up these expenses, subtract them from your take-home pay. The resulting number is approximately the most you would want to pay in order to be comfortable making your mortgage payments.
Have you built up emergency savings and can you cover home repairs? Lenders will require that you have some savings when you apply for a mortgage, although the amount you’ll need to have acquired will depend on your individual financial situation. In general, financial experts recommend having at least three to six months of income set aside to cover your basic living expenses in the event of a job loss, sudden illness or injury or another emergency. According to Money magazine, it’s also advisable to have a separate emergency fund earmarked for home repairs. Plan to keep an amount equal to one to three percent of your home’s value available for this purpose.
How much cash will you have for a down payment?
It’s often been stated that the down payment is the biggest hurdle most people face when it comes to home ownership. While this assertion still rings true, the 20 percent down payment that was once considered standard for a conventional mortgage is no longer the norm for homebuyers. With the availability of mortgage programs that enable buyers to purchase a home with far less money down, most people aren’t waiting until they can set aside 20 percent of a home’s purchase price to enter the market. While a smaller down payment generally means you will pay more for your home over the life of the loan, the availability of mortgages with lower down payment requirements goes a long way toward making home ownership possible for those who live in high-cost areas.
Nowadays, you may eligible for a conventional mortgage with a down payment as low as 3.00 percent on your first home if you satisfy the lender’s requirements and underwriting guidelines. For those who meet the requirements for a VA loan or USDA loan (only applies to properties in specific rural areas and outlying suburban areas), you can actually get a zero-down payment loan.
For some perspective on how a smaller down payment requirement can lower the barrier to home ownership, consider the following scenario: A down payment of 3.00 percent on a home with a selling price of $850,000 would be $25,500. If you needed to come up with 20 percent for your down payment on the same home, that number would be $170,000.
Plan to budget for private mortgage insurance if you need to put less than 20 percent down
Unless you qualify for a loan from the U.S. Department of Veterans Affairs, you will typically need to purchase private mortgage insurance (PMI) if your down payment is less than 20 percent of your mortgage. PMI is intended to protect the lender from losses in case the borrower defaults on the loan. It can be paid in a lump sum or added to your monthly mortgage payments. Rates for PMI vary according to credit scores and other variables, but generally costs homebuyers anywhere from .30 percent to 1.00 percent of the loan amount on an annual basis. Freddie Mac reports that PMI averages $30 to $70 per month for each $100,000 borrowed. Practically speaking, this will likely add several hundred dollars to the average mortgage payment in certain affluent markets.
Can you consider making a larger down payment?
If it’s feasible for you, there are a number of advantages to making a down payment larger than the minimum required by your lender. First, you can reduce your monthly payments, and save money in interest by taking on a smaller mortgage. You may also secure a better interest rate on your loan because your lender will view a larger upfront payment as a sign of financial strength and dependability (i.e., you’re less likely to default since more of your own money is on the line). Perhaps most obviously, a 20 percent or higher down payment will help you to avoid paying PMI, which can easily tack on several hundred dollars to your mortgage payments. Finally, a larger down payment allows you to build equity in your home faster, which can provide a measure of protection in a market downturn. If your home drops in value, you’re less likely to find yourself in a situation in which you owe more on your mortgage than the property is worth.
Account for property taxes and homeowner’s insurance: Property taxes are one of the highest expenses you can expect to incur as a homeowner, and are assessed annually based on the value of your home. According to NerdWallet, buyers generally pay two months’ worth of city and county property taxes upon closing. In most cases, lenders will require that you purchase homeowner’s insurance before you are approved for a mortgage. Premiums vary widely depending on where you live, your home’s value and the policy you choose, so it’s a good idea to compare rates from different providers.
Don’t forget about closing costs: Finally, it’s crucial not to overlook closing costs when evaluating a mortgage. These are the various fees paid at the close of a real estate transaction, and they typically cost anywhere from 2 to 5 percent of the purchase price of a home. In some of the most competitive housing markets, this can add up to tens of thousands of dollars. You can pay these expenses out of pocket as an upfront expense, or wrap them into your loan. When comparison shopping for mortgages, pay close attention to what different lenders charge for these fees, and which, if any, can be negotiated. Essentially, you want to avoid sticker shock by gauging whether they are offering you what amounts to an artificially low interest rate, for which they compensate with higher closing fees.
Ready to take the first steps toward home ownership? The Police Credit Union can help make this possible with a wide variety of mortgage options to fit your budget and lifestyle goals as a first-time homebuyer. Our fixed-rate and adjustable first-time mortgage programs feature below market rates, low fees and down payments as low as 3.00 percent for qualified buyers. What’s more, as a member of The Police Credit Union, you are invited to use HomeAdvantage® — our network of local, highly qualified professionals from top brokerages who have been hand-picked for their expertise and outstanding service. Buy your home with one of our agents, and you can save $100’s to $1,000’s in Cash Rewards* at closing. Visit our Real Estate Resource Center for details.