Can I Afford a Home? Add Up All the Costs
Can I afford a home? Add up all the costs before you answer that question. The first step in determining if you can afford a home means figuring out how much mortgage a lender will qualify you for. To calculate this number, lenders use many different variables including:
Your income
Your credit score
The size of the down payment (less than 20% vs. 20% or more)
The length of the loan (15 years vs. 30 years)
The amount of debts you owe
The interest rate for your mortgage
The likelihood that you will default on your loan
Using one of the many Home Affordability Tools available on the Internet, you can estimate what size mortgage you will qualify for, and depending on the size of your down payment, what the monthly payments will be. These estimates will help you confidently enter realistic figures when you go to get pre-qualified or pre-approved for a home loan. You will also get a better understanding of how your income, debts, and expenses affect what you can afford.
Pre-qualification vs. Pre-approval
Pre-qualification from a lender is based on a cursory review of your finances using only the information that you provide, while pre-approval is a firmer commitment on behalf of the mortgage company and is a more formal process which includes a credit check and even an employment verification. A lender often uses pre-qualification to estimate how large a mortgage you will likely qualify for. Keep in mind that pre-qualification is not a lender's commitment to offer you a mortgage nor is it an application for a loan. Pre-qualification through a lender also does not have to commit you to finance your home through that same lender. Indeed, if anything it's simply a chance for the lending company to market its services.
Although pre-qualification gives you an idea of what you can borrow so you don't waste time and experience anxiety looking at homes you can't afford, going one step further and getting pre-approved for a home loan will put you in a better position to make a serious offer on a home when you finally find the house you want since you won't still be dependent upon getting mortgage approval. Be sure not to confuse pre-qualification with pre-approval.
The Total Costs of Buying and Owning a Home
The reason many people get in over their heads financially when purchasing a home is that they fail to estimate the total costs of buying and owning a home. You have to look beyond just the purchase price of the home when estimating how much home you can afford. You must take into consideration other costs such as:
Down payment: 1% to 20% of the purchase price of the home
Closing costs including appraisal, pest-control inspector, home inspector, escrow holder, and title insurer: typically 5% of the purchase price of the home
Realtor or real estate agent (if you use one): 2% to 3% of the purchase price of the home
Fees for financing to loan representative: 1% of the purchase price of the home
The costs don't end there. Once you own the home, don't forget the expenses of ownership. Along with your mortgage payment your total monthly payment will include property taxes and homeowner's insurance, and for some people home owners association (HOA) fees and private mortgage insurance (PMI). It also costs money to maintain, repair, remodel, and keep up a home, so make sure you leave yourself room to pay for home improvement projects and regular maintenance. When you move into a new home you also have to consider whether you will need to buy more furniture or purchase appliances. Since most people find that they spend a lot more money moving into their new home than they anticipated, you should be sure to leave yourself enough room in your budget so you can make your new house your home.
After figuring out how much mortgage a lender will qualify you for and taking into consideration all the other costs and expenses of buying and owning a home ask yourself, "Can I afford a home?" Add up all the costs.
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