Conventional wisdom suggests that buying a home is a long-term investment and that you should buy as much home as you can possibly afford. It’s possible to build equity over time, but that depends largely on what you pay for a home, how robust your market is, and how long you occupy the home.
To choose the right home, you have to try to see as far into the future as possible:
How long will you likely live in the home?
How large is your family likely to grow?
What activities will you have and what space requirements?
Where do you want to live – near work, near family, in a certain school district?
You should have a fairly good idea of the number of bedrooms, baths and living areas you want as well as other features you want your home to have.
Now it’s time to look at affordability. How much can you buy, and how much home can you get for your money?
The trick with buying a home is getting as much as you can on your wish list without becoming “house poor.” House poor means you can afford your house payments but you can’t afford to do anything else.
That’s why lenders have a conforming loan standard that they use as a benchmark for prequalifying you as a borrower. This is true whether you’re a first-time home buyer or a millionaire move-up buyer.
To qualify you, lenders use two ratios – income to mortgage debt, and income to total debt.
To qualify for a 30-year fixed rate conforming loan that is federally insured, your income to mortgage debt can be no higher than 29% of your gross annual income, and your debts plus mortgage payment can be no higher than 41% of your gross monthly income, according to FHA.com.
That means that if you make $3000 gross income per month, under a conforming loan standard, your house payment (principal, interest, insurance and taxes) should be no larger than $870.00.
If you’re carrying credit card debt, student loans, or pay child support, the monthly debt service must be accounted for. To get the income to total debt ratio, multiply your monthly income by 41%. If you make $3000, your total debt including your house payment can be no larger than $1,230.00. That means to qualify for a $870.00 house payment, your debt service can be no higher than $360 per month.
This formula is time-tested, and it’s designed to help you minimize the risk of home buying by making sure you can afford your payments over time.
Qualifying to buy a home is only the first step. You will want to be able to handle whatever comes you way - repairs, rising utilities, remodeling or other updates, and ongoing maintenance.
Under some circumstances, you can borrow more money with an adjustable rate loan, or other loan products, but keep in mind that any loan outside conforming standards are likely to be higher risk and carry higher costs to defray risks for the lender.
Sometimes, a conforming loan can actually be too expensive for your needs. If you’re relocating, and believe you’ll only be living in your home three to four years, a fixed-rate loan may cost more than you need. You may be better off with a hybrid loan that gives you a lower fixed rate for the first five years, and then adjusts after that.
Talk to your lender and see what you can qualify for before you go shopping for a home. Lock in your rate, so you can calculate your payments and obligations accurately.
If mortgage interest rates go up, that could impact the amount your lender will loan you. You may qualify for a smaller amount, which means buying a smaller home or a home in a less expensive neighborhood.
It’s really about affordability. The more comfortable your payments are, the more likely you are to enjoy your new home.