Buying your first home is an adventure that can be as scary as it is exciting. In the end, it’s a destination well worth the journey. Buying a house, especially compared to renting, isn’t just a permanent home for your family. It’s a long-term investment in one of the most stable economic markets in the world.
Congratulations on starting this adventure.
Here are a few things you can do to get ready for mortgage approval:
Estimate How Much House You Can Afford
There are multiple online calculators available to help you pinpoint exactly how much you can afford to pay per month in mortgage, but as a general rule, aim for no more than 2.5 times your gross annual income. If you make $58,000 a year (the average household income in America), a $145,000 home should feel very comfortable, financially speaking. How much that comes out to per month in mortgage payments, however, depends on a few different factors.
Know Your Credit Score
In general terms, the higher your credit score, the better the interest rate you’ll get, but not always. The housing market, the Fed, and the overall strength (or weakness) of the economy also contribute to interest rates. Just know that it’s not entirely personal, and unless you can make a bigger down payment, your interest rate isn’t going to be easily malleable.
For a $145,000 home with a 20% down payment, your monthly payment will be about $550 per month in principle and interest at a 4% interest rate. As a reference point, your payment increases to $620 a month at 5% interest. Note that this doesn’t include tax.
Maximize Your Down Payment
A higher down payment results in a lower mortgage payment. Period. For a $145,000 home, a 3% down payment will cost you about $755 a month in principle and interest, including PMI (see below). A $30,000 down payment cuts your total loan so much that you can expect to pay $150 less, about $620 per month. When you get into the $200,00 or $300,000 house range, the difference between a 5% down payment and a 20% down payment is the difference between a Ford Focus and a Cadillac CT6.
Knowing your comfort level is important. It’s easy to forget that a mortgage is just a loan. You’re borrowing money. Being realistic about your employment status, future earnings, and borrowing limits is key to smart home ownership.
Saving for as large a down payment as possible is not just a matter of lowering your monthly payment. It can also be the difference between buying a house with 3% equity compared to 30% equity. Just because you can afford a $190,000 home with $10,000 down doesn’t mean that’s the right financial decision, especially when a $150,000 house with a $30,000 down payment may be the safer choice.
Weigh the Pros & Cons of PMI
If you don’t put down at least 20% of the home value, expect to pay PMI, or “Private Mortgage Insurance.” This is literally an insurance policy for lenders loaning money to someone with limited savings. Those who cannot put down at least 20% are seen as higher risk, so PMI is used to protect lenders against the threat of loan default.
PMI ranges from 0.3% to 1.2% of the total amount of the loan. Assuming a minimum 3% down payment, expect to pay an extra $420 per year ($35 per month) to $1,600 ($140) in PMI on a $145,000 house.
The downside of PMI is that it’s non-refundable. If you can avoid paying it–if you can afford a 20% down payment–do. The extra hundred dollars a month can be invested in far better ways, offering far better rates of return.
The benefit of PMI is that many people wouldn’t be able to get into a house without it. If a 1% tax makes the difference between renting–literally paying for your landlord’s mortgage–and paying down your own mortgage, there’s no reason to hesitate. In the two to five years it takes to pay down your mortgage to an 80% loan-to-value ratio (the equivalent of 20% in equity), the 4% average return on the housing market has no comparison to paying rent for five years with no assets and no equity.
Don’t Forget Taxes
Taxes and fees vary by state, city, and ZIP code. Ask your realtor for a realistic analysis of projected taxes for the area you’re looking to buy.
How much you can afford to pay in mortgage per month depends on your annual income, down payment, credit score, and the cost of the house you want to buy. Use Zillow’s mortgage calculator for a general idea of what size house you can comfortably afford, or contact us today to see how we can help get you into a house that’s right for your family, your future, and your budget.