If you’re looking at buying a home, it’s very important for you to budget correctly so your mortgage payment doesn’t make you house broke. If you didn’t know, house broke is where your mortgage payments are so high, you can’t afford to pay for anything else. It’s a dire situation and here are some tips to avoid it.
Lower Your Debt-To-Income Ratio Before You Buy
Prior to the recession, many home buyers figured the home they were buying would appreciate in value exponentially, and they wouldn’t have to worry about using credit recklessly. People were taught that buying a home was an investment, and it was okay to think you could just sell in a couple years and make a profit.
Because of this mindset, people used credit freely to buy the extra toys thinking they were going to make more money from their jobs in a couple years and their house was going to be worth more in a few years.
Today, you don’t have the luxury of an exponentially appreciating home to borrow against. The third and fourth mortgages just won’t cut it anymore and that’s why, before you buy a home, it’s so important to reduce your debt-to-income ratio.
Plus, you can get a better rate on your loan, which will also save you money. Reduce your ratio to about 25-30%, which is about average, and you will feel a lot more comfortable in your home then with high debt.
Get A Loan Based On What You’re Making, Not What You Could Be Making
One of the major factors that brought the housing economy down were risky loans called Adjustable Rate Mortgages. These loans would start off at a low interest rate, say around 4%, but as the years go buy, the “adjustable rate” would adjust. Say, after just a couple years, your payment went from $1,400 a month to $2,200 a month, how would that effect you?
Many people got these loans because they figured they would be making more money in a couple of years, and they would be able to afford the payment without a problem. And, if they didn’t make more money when their payments went up, they assumed they could just sell the property for more then they paid for it and come out ahead.
We all know what happened instead. The bubble burst, people lost their jobs, homes lost value, and those adjustable rates still went up leaving many people underwater in their homes. It was, and still is for that matter, a huge disaster.
Instead of thinking about what you can afford in five years with a nice raise from your employer. Plan on making the exact same as you are now, and if you do get that raise, pay down your mortgage faster instead of using that money to catch up on an adjustable rate mortgage. Be smart with the loan you choose and you will be ahead of the game when the market returns.
Interest Rates Can Make Or Break You
The difference you pay over the life of your mortgage is dependent on your interest rate. That difference can be huge. For example, if you buy a $200,000 home at an interest rate at 5% compared to 6%, the difference you would pay is $2,000 a year or $60,000 over the 30 year term. That’s a huge number.
Right now, interest rates are at 50 year lows, but how long will they last? Who knows. When they go up, you can be sure, their are going to be a lot of people wishing they bought with the better rates.
But if rates do go up, can you still get a better rate? Yes, you can always buy discount points. Discount points are fees paid to the lender when you get the loan that can lower your interest rate. A discount point is usually 1% of the loan amount. So a discount point on a $200,000 loan would be $2,000.
The discount point on a 30 year loan usually reduces your interest rate by 0.125%. So, if you pay one discount point at $2,000, and lowered your interest rate from 5% to 4.875%, how much would you save?
Before you consider buying discount points, know the math, and know how long you plan to stay in the home. Let’s do the math:
- $200,000 loan at 5% interest = $10,000 a year interest,
- $200,000 loan at 4.875% interest = $9750 a year interest,
- Yearly savings = $250,
- $2,000 paid for discount point/$250 a year savings = 8 years to get your money back.
As you can see, buying discount points is wise only if you plan on staying in the home long enough to make your money back and time enough to make a little money. However, be cautious with buying discount points, you may be able to get a better rate anyways by refinancing later on.
Make A Larger Down Payment
Easier said then done. If you had a down payment of around $10,000 and qualified for a loan at $200,000, you could buy a home up to $210,000. If you waited a year and saved up some money to put down around $25,000, you could get more home for the money.
Also, putting down the larger down payment will give you instant equity which is always a good thing. That larger down payment will give you a better rate, more equity in your home, and will allow you to afford more home for your money.
Home buyers that put little to no money down during the bubble are largely the people under water on their mortgages today. You can’t blame all of them of course. For people that bought a home before 2005, no money down or very little money down was the norm. But we all know how a slip in home values can make that situation a nightmare.
Buying a home with no money down is a serious risk that you have to weigh yourself. If you can wait a little longer to put more money down, then do so. If you plan on buying with no money down, expect to stay in your home for a long time before you start to build some equity and gain appreciation.
All in all, if you want to buy a home without being housebroke, be smart with your decisions, put down a descent down payment, lower your debt for a better rate, and don’t buy a home that you plan on being able to afford when you get that raise.
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