How’s your job? Love your work and see yourself staying put for the next 10 years? Or do you dread the commute, hate what you do and frequently scan job boards? Oh, and how’s your love life?
If a far-away job beckons or you decide you’re ready for marriage after all, you don’t want to end up yoked to a home you really shouldn’t have purchased. Before buying, you’ve got to take a serious self-inventory, including asking yourself some not-so-obvious questions.
Before you buy, think of selling
The career and relationship questions might seem obvious, but when you consider moving into your own home, you’ve got to probe even deeper. Does your career path mean you need to maintain a bit of mobility? Could a promotion or career advancement in the next five years mean you’ll have to relocate? If so, maybe you’d better keep on renting. Or if you’re planning to start a family, you might outgrow that starter home before you know it. Better look for something bigger — and check out the school district before buying.
It’s all about determining your first home’s shelf life. Before you buy, think about selling the home you’re considering:
- How is the neighborhood? Will potential buyers love the area as much as you do a few years down the road?
- Is the local real estate market on the upswing?
- What kind of development is going on nearby? Commercial, retail, residential — or is that a multi-stack highway interchange they’re building over there?
- Does the home have a quirky location or features you don’t mind but that might turn off future buyers?
Also worth thinking about: Your starter home may serve as a passive income provider in the future. Consider how the property might work as a rental unit.
It’s how much you can afford, not how much you can borrow
A lender will tell you how big a loan you’ll be eligible for when you prequalify, but that’s not necessarily what you can afford. You’ll want to leave room in your budget for the one-time and recurring expenses of homeownership.
Everyone’s financial situation is different, but many conventional lenders use the following formula to determine how much home a buyer can afford: Your house-related payments (mortgages, taxes, insurance) shouldn’t exceed 28% of your pretax income, and your total monthly debt obligation shouldn’t exceed 36% of your monthly pretax income. (Government-backed loans tend to be a bit more flexible.)
|Annual gross income||Monthly gross income||28% of monthly gross income|
But before you rush to a mortgage calculator to see how much house that will buy, remember to consider that your monthly note will likely include more than just principal and interest — there are also taxes, insurance and other expenses that will have to be accounted for.
What lenders consider
In the process of determining whether to grant you a loan, lenders will look at how much debt you have compared to how much money you make. It’s called the debt-to-income ratio, or DTI. The formula looks like this:
Total Debt / Gross Income = Debt to Income Ratio
Say you pay $7,200 toward all your debt each year; that’s $600 a month. If you make $60,000 per year, or $5,000 per month, your debt-to-income ratio is 12%. As we mentioned above, conventional lenders generally want to see an all-in DTI of 36% of your gross income or below — including your house note — but some lenders will allow for wiggle room on this, and if they determine you have the ability to repay, they may go above this watermark.
In the above scenario, that leaves 24% of your annual salary available for your housing expenses (36% minus 12%), or $14,400. Your mortgage note would need to be around $1,200 per month. You’ll notice in the chart above that the $60,000 income allows for a monthly payment of $1,400, so we’re close. Remember, you’ll still need to allow for insurance and taxes.
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