The process of buying a home and securing a mortgage can be very confusing if you don’t know what you are doing. That’s why it’s always important to do your homework. Obviously researching the mortgage process and the terms is very helpful, but perhaps the most important research you can do is in your own personal finances.
Go to any mortgage or banking website and more than likely you will find a “home affordability calculator” Apparently by feeding this calculator information about your annual income your current debts, it can tell you how much house you can afford. But what does that mean? I can only imagine that it means that if you are the average person doing average things with your money and your income and financial situation remains exactly the same for years to come than you can buy this house. Or perhaps it means that house A or house B is in your “price range.” A mortgage broker or loan officer can tell you the same thing given the same information. But are you going to let an online calculator or a mortgage broker tell you what is best for your financial picture? Is your financial health really in their best interest? Most likely it isn’t, but it is in your own interest.
Unfortunately, house prices fluctuate greatly depending on the area you live. Hopefully your income keeps pace with the housing prices in your area. Since most people who buy homes need a mortgage to do so, the most important thing you will want to look at is whether or not the monthly payment fits in your budget. Online calculators and mortgage brokers will try to tell you which payments will and which won’t fit in your budget, but it’s mostly just speculation. (Just look at all the people who could “afford” the houses they are now in foreclosure on) Here are just a few of the reasons that an online calculator or mortgage loan officer can not take the place of your own knowledge of your true “affordability.”
They don’t take into account possible future changes in income or circumstances: An unexpected job loss might come as a surprise to you as much as to your bank, but you have a better understanding of where you are at financially and what the future may hold for you. Are you in a job that you don’t really like? Have you thought of the possibility of switching careers in the future? What if what you really want to do doesn’t pay as much as your current job? You don’t want a house that “chains” you to a job you don’t enjoy just so you can afford the mortgage payment. Are you planning to have any (or more) kids in the future? Even if you aren’t planning it, is there still a possibility that it could happen?
When my husband and I were looking for houses, our “affordable” amount was pretty high since we had no kids and no debt. However, we knew that in a few years our plan was to have kids and live on one income with me staying at home. Knowing that we would need to make a mortgage payment on only one income in a few years, we knew that what the bank said we could afford was actually a lot more than we wanted on our plate.
They don’t always take into account extra housing expenses: Taxes are a huge extra expense that is added to your monthly mortgage payment. Depending on where you live, taxes could add anywhere from a miniscule amount to thousands of dollars per month to your mortgage. Taxes tend to rise with the rising of home values, but that isn’t always the case. You may be able to “afford” a mortgage for a $400,000 house, but the taxes and monthly insurance could eat your budget alive. And a bigger house means more rooms to furnish, more space to heat, more repairs to make and generally, more money each month and each year for you to spend.
They tend not to take into account what would be the best down payment for you put down: If you already have a sizable down payment stashed away for your new house, then you are in a good place. However, if you have a minimal amount to put down or don’t want to put anything down, be prepared to stand your ground when negotiating a mortgage. We knew we didn’t feel comfortable putting a large down payment on our house because we had other things we wanted to do with that money. Putting an emergency fund in place was more important for us that putting that money in to the house mainly because we knew that with an emergency fund, we’d be able to keep making mortgage payments if something happened to our income or a very large expense came up. Perhaps you have other ideas for what you would want to do with your money that the bank might want you to put down on the house (just please don’t blow it) or maybe you just don’t have the money right now, but you will later due to an income increase or debt being paid off. You know what’s best for you to put as a down payment.
They don’t take into account what else you want to do with your money: A mortgage is most likely just one of the monthly payments you will have to attend to. You are going to have other things you want to do with your money monthly – like invest it or save for your childrens’ college fund. I’ve heard some investors say that 20-30% of your monthly income should go towards your housing costs. But what if you want to only pay 10% and you want to invest the rest? If you feel like that extra money each month will be worth more to you in an investment account than in an additional 1000 sq ft of a house, then you should follow that. Make sure your money is working towards what is important to you.
They don’t know if you’re willing to sacrifice other items in order to buy a more expensive house: The person above may think their extra money is better off in an investment account, but you may think your extra money is actually better off in a bigger house (particularly if you have many children). Perhaps you really don’t want the kind of houses that fall into your “typical” budget. What if renting movies from library and cooking at home instead of going out to dinner and a movie is worth a nicer house to you? What if you run a business out of your home and need more space to expand your business? These are questions and circumstances that you have to address personally.
They don’t know your reasons for buying a house right now: Sally may be buying a house that she plans to live in through her retirement years and her goal is to have the mortgage paid off in 15 or 20 years. She may have more than enough money to pay the monthly mortgage payment, but what she really needs to focus on is if she can successfully pay off the loan at the end. John may want to basically “rent” his house for a few years with an interest only loan and only gain the market value increase in the end. He could be building his dream home in the process of paying an interest only loan. Karen may want to buy a larger more expensive house so she can rent out multiple rooms to college students.
There are many things that can affect why you are buying a house and what budget works for you. You are the only one that knows all the ins and outs of these reasons and situations. Online calculators and mortgage brokers may be able to help steer you in the right direction, but you need to make sure you know what you want and need and why.
Image courtesy of Dean Terry