There was a multitude of issues that led to the housing/lending crisis, but one thing was the lack of regulation when it came to obtaining a loan to buy a home. Immediately following, there were some pretty strict standards set in place to be sure that buyers could actually afford the homes they were buying. This strictness made it more difficult to secure lending and therefore, purchase a home. Since that happened, things have loosened up a bit, but in my experience there are a lot of people under the wrong impression about their ability to buy. Let’s talk about…
- Tax, HOA, Purchase Price Game
- Money Down
- Other Factors
You may have had a real estate agent ask you to get a pre-approval before looking at homes. This is an important believe it or not. If you want the honest truth, here it is: Agents don’t want to spend our time looking at houses with someone who cannot buy one. However, there are safety reasons as well. A pre-approval means you’ve given your information to a lender, which vets you a little bit. As an agent, i'll at least have record of who you are if you try to kill me. It seems extreme, but there have been many instances of missing agents that have been found dead recently. So agents may have concerns about their safety, and knowing your name and address may give an agent some reassurance. If an agent asks you to get a pre-approval first, try not to get offended, it’s just part of the process. You’ll also need a pre-approval in order to put in an offer, so what are you waiting for?
The pre-approval should pretty much tell you whether or not you can get a mortgage. If you speak to a good lender, they should be able to give you a monthly allotment for your payment. This payment is your max payment based on your numbers (income, debt, credit, etc) and it needs to include your mortgage, taxes, HOA fees, and home owners insurance. You and your agent can then play with the numbers for different properties depending on how expensive the different variables are.
Tax, HOA, and Purchase Price Game
Just as a general rule of thumb, with rates around 4%, you can calculate the mortgage piece to be about $50/mo for every 10k in loan amount. So for a 100k home loan your mortgage payment is about $500/mo. (This doesn’t include taxes or any other expense) The taxes need to be divided by 12 to get your monthly payment amount. What many people need to realize when searching for homes is that every $600 in taxes is equal to $10,000 in purchase price, which both result in $50/mo. Example… $200K home with taxes at $5000/year is the same as $180k home with taxes at $6000/year. If you can afford one, you can afford the other. Sometimes people count out the home at 200k because a lender approved them for a lower purchase price, but didn't give them the full details of how this was calculated. The effects of this can be exponential as you get into a higher price range. If you find a $500k home with taxes at $15,000/year, and that’s the top of your budget, work with your agent to search by tax range. If you search for homes with taxes under $12,600/year ($2400 less), you just bought yourself another $40,000 in purchase price, so you can now buy that house at $540k. Those numbers and that scenario is very realistic in some areas and for many people; furthermore, if they don't realize this, they may be missing out on their perfect home due to poor guidance.
“Just as a general rule of thumb […] it’s about $50/mo for every 10k in loan…”
The HOA fees for townhomes can really hurt you. Typically townhomes and condos sell for a little bit less than single family homes, but an HOA fee is typically around $200/mo or higher.
***Sidenote- if you don’t get a pool, clubhouse, workout room, or some type of amenity other than snow and lawn care, you should seriously consider a single family home. You can pay a lawn care service and a plow company less than $200/mo.
Add the HOA fee into your calculation of monthly payment. You might be hitting a ceiling on purchase price and/or property taxes because you have to factor in $200/mo for HOA fees. Without that $200/mo in HOA fees you can go up $2400/year in taxes or—get this—$40,000 in purchase price! Same as the example above! That is a big swing in either direction and you may be able to get into a better neighborhood or get more house for your money.
There are 2 types of mainstream loans, Conventional and FHA. A Conventional loan is a private backed mortgage and an FHA is a government backed mortgage. FHA loans are considered easier to get, and most of the time have the best interest rates. One of the things that makes it easier is the minimum amount you have to put down. You only need 3.5% of the purchase price as a down payment. AND! Even for a conventional loan, it’s still only 5% minimum. We’ll get to the downside of putting so little down, but if you are going to be saving money because you own rather than rent, sometimes it’s worth it. Through many conversations with friends and clients alike, I’ve found that there is a common misconception that you need to put 20% down. Again, this is NOT the case. It's currently either 5% or 3% but putting down 20% has it’s benefits, which is where the assumption comes from.
“You only need 3.5% as a down payment. AND! Even for a conventional loan, it’s still only 5%…”
These acronyms stand for Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP). They are the same thing with different names for private (conventional) and government (FHA). I’m going to use “PMI” since that seems to be what the general public is most familiar with. PMI is a % rate of the loan that you’ll need to pay per year. The rate varies, but is usually around 1-2%. That’s a lot of money to pay each year, and it's factored into your monthly payment. In addition to some of the things aforementioned, this can really mess up all of our calculations for monthly payment and what is/isn't affordable. This PMI is what you have to pay if you are not putting down 20%. This is why there is a common misconception that you “NEED” 20% down to buy a home.
***Disclosure: talk to your lender. FHA and Conventional PMI situations are different. You may be able to get rid of your PMI payment when you reach an 80/20 loan to value mark, but you may not—sometimes there is a minimum amount of time you need to pay it regardless of your loan to value. Also, there may be ways to pay your PMI up front, and it may be cheaper in the long run to do it that way.
Besides having some money saved for down payment, there are other things to consider. When you speak with a lender, they’ll be quizzing you on all of this so that there aren’t any surprises down the road, and therefore you'll avoid watching the home you fell in love with slip away.
***Sidenote: Be honest with your lender about everything. Thank you.
Since regulations change frequently, I’m not going to be very specific in this section so that the content can remain true for as long as possible. Just understand that your lender is there to help you get a loan, but they cannot break the law or the rules to do so. They can, however, help you remedy some situations and give you options for the future. It would be very wise for you to get in touch with a lender sooner than later if you are planning to buy within the next year or two.
They will be looking at your credit score, monthly/yearly income-bank statements and tax returns, your credit history, debt, debt/income ratios, and monthly expenses. All of these factors will have an effect on your ability to buy. In order to ring true to the title of my article, I wanted to point out a few things that may be misconceptions. The first is regarding your credit score the other is a tip for your budget.
Your credit score doesn’t need to be perfect. Even now the rates don’t change much from a credit score higher than 620. It’s possible to get a mortgage even with credit scores in the 500’s!! Of course a low credit score usually comes with other credit-type ailments i.e. foreclosure, short sales, high debt, etc. BUT! It’s possible.
If you have to go a little over budget to get a home you want, you may be able to make some of it back as a homeowner. Currently (2016) you can write off your property taxes, and mortgage interest. You are primarily paying interest every month towards the beginning of your 30 year mortgage, so the tax benefits can make up for a lot of tightening of your budget necessary to get the home you want.
Considering all of these things, you can probably buy a home! But the important thing to do is find out whether you can or can’t. It doesn' hurt to do some due diligence except your pride if you can’t :( But don’t fret! Talk to your lender and agent to find out what you can do NOW so that you can buy in the future. If you take care of things now, then, when you are ready to buy, you’ll be able to buy. Get a pre-approval, and ask the right questions so you and your agent can plan accordingly and find the most home in the best neighborhood without going over budget nor wasting time. Hopefully this empowers you!
Thanks for reading! Leave your comments/questions below!