Deciding How Much Home You Can Afford

Understanding how much you can afford is one of the most important rules of home buying. Depending on your individual situation, your budget can affect everything from the neighborhoods where you look, to the size of the house, and even what type of financing you choose.

Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.

Loan prequalification vs. preapproval

One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.

What factors are important to lenders?

Banks and lending institutions will use several criteria to determine how much money they'll agree to lend. These include:

• Your gross monthly income
  
• Your credit history
  
• The amount of your outstanding debts
  
• Your savings--or the amount of money you have available for a down payment and closing costs
  
• Your choice of mortgage (i.e. 30-year, FHA, etc.)
  
• Current interest rates
  

Two important ratios

Lenders also use your financial information to figure out two, very important ratios: the debt-to-income ratio and the housing expense ratio.

• Debt-to-income ratio
  
  Many lenders use a rule of thumb that the amount of debt you are paying on each month (car payment, student loan, credit card, etc,) shouldn't exceed more than 36 percent of your gross monthly income. FHA loans are slightly more lenient.
  
  
• Housing expense ratio
  
  It is generally difficult to obtain a loan if the mortgage payment will be more than 28 to 33 percent of your gross monthly income.

Down payments make a difference

If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20 percent down payment may be qualified with the 33 percent housing expense ratio, while someone with a 5 percent down payment is held to the stricter 28 percent ratio.

Other ways to improve your purchasing power

• Gifts
  
  If you're having trouble saving money, many lenders will allow you to use gift funds for the down payment and closing costs. However, most lenders require a "gift letter" stating the gift doesn't have to be repaid, and will also require you to pay at least a portion of the down payment with your own cash.
  
  
• Negotiating Closing Costs
  
  Through negotiation, some sellers may agree to pay all or most of your closing costs (for example, if you agree to meet their full asking price). If you choose to try this, make sure to ask your real estate agent for advice.
  
  
• Loan Programs
  
  Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at reduced interest rates, or with little or no down payments. Check with your local housing authority for more information.
  
  
• Loan Types
  
  Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low initial interest rates. Others opt for 30-year loans because they have lower monthly payments than 15-year loans. There are significant differences between different loans, so make sure to discuss the pros and cons of different loans with your agent or lender before making a decision.
  
  
  

Home seller credit could save real estate deal

No one likes to give money away, but a monetary credit from the seller to the buyer can solve a problem that might otherwise derail a home-sale transaction. Here's a typical scenario where a seller credit could save the deal.

The buyers are stretching to buy their dream home. Tapped out financially, they panic when they discover during their home inspection that the roof needs replacing. The inspector impresses upon the buyers that the roof must be replaced immediately; it can't wait. But the buyers don't have enough extra cash to cover the cost of a new roof.

One option for the buyers is to back out of the deal, and find another less expensive house, or a house with a roof that's in better condition. But this puts the buyers back in the market searching for a new house. And the sellers have no recourse but to put their house back on the market, and search for another buyer.

Another option is for the buyers to ask the sellers to credit them enough money to take care of replacing the roof. If the sellers are willing, the transaction stays together. The sellers will net less from the sale, but the sale will close. If more time on the market means less money for the seller, this could be an acceptable solution for both parties.

There are other benefits to be derived from this approach to repairing property defects. One is that it relieves the sellers of the burden of having to oversee work while they're in the midst of moving out of the house. Another is that buyers often prefer to oversee the work themselves to make sure that it's done properly. Also, there's often not enough time to have repairs done before closing.

HOUSE HUNTING TIP: Before you ask the seller to credit you money at closing, check with your mortgage broker or loan agent to find out what restrictions your lender might have regarding seller credits. Usually, lenders will only allow a credit for up to 3 percent of the purchase price. Also, most lenders limit the amount of money they'll allow a seller to credit to not more than the amount of the buyer's nonrecurring closing costs.

Nonrecurring closing costs are one-time-only costs that a buyer pays at closing, such as loan origination fees or transfer taxes. Recurring closing costs are those costs paid at closing that are part of ongoing expenses a buyer will pay, such as homeowner's insurance or mortgage interest.

Lenders don't like money to pass from the seller to the buyer if it in some way lowers the amount of the buyer's cash down payment. But they will usually allow a seller credit that offsets the buyer's nonrecurring closing costs. This means that you won't walk away from the closing with a check for the amount of the credit in your pocket. Instead, the seller credit will lower the amount of money you need to bring to the closing. The money you save can be applied toward repairing the property defect.

Seller credits can be useful when buyers are short of the cash required to make an offer. Let's say you have enough saved for a 10 percent down payment. But you are shy the money needed for closing costs. Your purchase offer could include a provision for the seller to credit you an amount at closing to be applied toward your nonrecurring closing costs.

A credit lowers the seller's net proceeds. So, you may need to increase your asking price to cover the amount of the credit if you're in competition, or if the property is attractively priced.

THE CLOSING: Just make sure, before you do this, that the property is likely to appraise at the higher price.

Author: Dian Hymer for Inman News