Can You Afford Being a Homeowner?
The prime reason behind any housing crisis is the fact that people end up buying homes which they cannot really afford. Eventually they fail in paying their mortgage payments and lose their homes in foreclosures and short sales. You wouldn’t want this, right? Well, you can prevent this if you determine your affordability before you invest in real estate. Evaluate the monthly payments which you will be able to make in future and figure out your financial requirements.
There is a rule of thumb, which you can use to determine your affordability. Generally, you can afford any home if it costs twice or thrice more than your annual household income. If you can pay a huge down payment and have no debts other than the home mortgage which you will take, you can afford a home that is four times your annual household income. A greater amount of down payment reduces your monthly payments, which you will then be able to make easily.
Now let us look at the affordability in a little more detail.
The Rules of the Lenders
Lenders determine your affordability before they approve your mortgage application. You can use the same techniques to evaluate your affordability.
Generally, a mortgage lender uses two main factors to determine your affordability: one is the front end ratio and the other is the back end ratio. The front end ratio or the housing expense ratio, is the portion of your monthly income that will go towards your mortgage payments. This is usually expressed as a percentage.
Generally, most lenders accept 28% as the greatest value, but some may relax this to 30%. As an ample, if your monthly income is $5,000, then you should be comfortable with a mortgage payment of $1,400, which is 28% of 5,000.
The back end ration, also referred to as the debt to income ratio is the portion of your monthly income which you allot for all your other debts such as credit cards, auto loans and so on. Any value that is below 40% means you can afford the home. Once again, assuming your monthly income is $5,000 and you pay debts of around $300, your debt to income ratio will be 34%. Since this is less than 36%, you mortgage application will probably be approved, and you will be able to afford the home, in future as well.
Additional Expenses
Your down payment and the monthly payments are not the only costs that are associated with becoming a homeowner. You should calculate other expanses as well such as property taxes, insurance premiums, closing costs, title transfer fee and so on. These are those costs that you will definitely have to bear, but you should be ready for other unpredictable expenses as well. For instance, you may need to deal with repairs or get yourself new furniture.
So did you calculate your affordability? As long as you can manage the monthly payments without straining your budget, you will have to face no financial problems.