What you can afford
If you've decided it's time to buy, you're ready to ask the crucial question: What can you afford?
First, you have to take a close look at your finances and ask yourself if you have enough saved for a down payment, which is usually 10% to 20% of the total cost of the home. For example, if the price is $150,000, you'll need to come up with between $15,000 and $30,000. If you have the cash, it's time to see if you can borrow the rest with a mortgage.
The mortgage test
Will you be eligible for a mortgage? You can think of that question as an open-book test. The two main topics on the exam are your income and your debt. You already have the answers — you just have to provide them to potential lenders.
Add up your income: Lenders who provide mortgage loans want to make sure they'll be repaid, so having a reliable source of income is critical when you're applying for a loan. The general rule is that you spend no more than 28% of your gross income on your mortgage principal and interest, taxes and insurance (sometimes shortened to PITI). So if your annual household income is $50,000, the amount lenders calculate you could pay for housing is about $14,000, or $1,167 a month.
Do you have debts? Lenders want to know about everything you owe, even if you pay all your bills on time. You can have a large enough income for a mortgage and still be denied a loan if your regular debt payments, including PITI, are more than 36% of your total income. Using this guideline, with an annual income of $50,000, your total credit payments typically couldn't total more than $18,000, or $1,500 a month. If your non-PITI debts averaged $500 a month, the amount you could qualify to pay for housing might be reduced to closer to $1,000 a month than $1,167.
A word to the wise
While the limits about how much debt you can carry might seem frustrating, they're in place to prevent you from taking on more debt than your income can handle. Not only would that be a problem for the lender, it would be very stressful — and possibly disastrous — for your own finances.
Down payments scaled down
What if you haven't saved 10% for a down payment? Don't give up. If you can come up with just 3%, or even less, it still may be possible to find a mortgage. The Community Reinvestment Act (CRA) requires some banks to offer mortgages to people with incomes below what is normally required. If you're a first-time buyer you may also be eligible for some breaks. To find out what you qualify for, including programs in your own state, check the US Department of Housing and Urban Development (HUD) website at www.hud.gov.
First-time homebuyers
Be sure to check with your local bank or lending institution, as many have programs designed to help first-time home buyers, including down payment and savings assistance, lower rates, longer terms, educational programs and other advantages.
