How Do I Know How Much Home I Can Afford Versus Qualify

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How Do I Know How Much Home I Can Afford Versus Qualify

This BLOG On How Do I Know How Much Home I Can Afford Versus Qualify Was UPDATED On November 14th, 2018

How Do I Know How Much Home I Can Afford Versus How Much Of A Home Loan Do I Qualify?

  • How Do I Know How Much Home I Can Afford is the key and not How Much Mortgage Do I Qualify
  • Lenders use a formula to qualify borrowers for a mortgage
  • The only person that has the answer to How Do I Know How Much Home I Can Afford is the home buyer
  • How Do I Know How Much Home I Can Afford is often asked by first time home buyers
  • There are expenses that homeowners are responsible for that renters are not
  • We have covered many articles on buying versus renting and on paper
  • It may seem like a no brainer to be buying versus renting
  • However, if something is too good to be true, then it normally is
  • Overall, buying is definitely better than renting
  • First time home buyers need to know this
  • This is because they are able to qualify for a home loan does not mean that they can afford a new home depending on their lifestyle and their income versus expenses

How Do I Know How Much Home I Can Afford?

One of the most common first home buyer questions is How Do I Know How Much Home I Can Afford?

  • Another most frequently asked first time home buyer questions is how do I know if I can afford to purchase a home?
  • Many people think that they need a lot of money to purchase a home and therefore they never consider it
  • However, it is not as difficult as most think it is
  • Sometimes, buying a home may be much cheaper than renting

Benefits Of Buying A Home Versus Renting

One of the greatest benefits of buying a home and paying monthly mortgage payments versus renting a home is that paying monthly mortgage payments will pay down the principal on mortgage loan balance.

Here is the main key points of buying versus renting a home:

  • When renting a home, renters are payment monthly rental payments
  • That is just an expense and renters will never see that payment again
  • Paying monthly rental payments, none of that is an investment and renters will never see that again
  • That rent payment paying to landlord is helping landlord pay their mortgage payments
  • Renters are building equity on the property they are renting from their landlord
  • Renters do not recoup any of monthly rent payments—ever
  • Most folks who rent a home or an apartment are under the assumption that it takes a lot of money to become a homeowner
  • Believe it or not, many still assume they need 20% down payment PLUS closing costs to become a homeowner which is not the case
  • Most folks do not even think about becoming a homeowner
  • This is because they just assume that a home purchase requires a lot of money
  • Renters assume monthly mortgage payments will be much higher than their current monthly rent payments which is normally not the case

Case Scenario On Home Purchase

We will take a case scenario where a renter is about to purchase their new first home as a first time home buyer:

  • Renting an apartment or home, renters will need to come up with a security deposit and first month’s rent
  • Depending on rental, the landlord may require one month’s rent or two months’ rent for security deposit plus first month’s rent in order to turn over keys
  • Let’s use a real case scenario:
    • Try to be as exact as possible with the numbers on a $100,000 home purchase
    • Will take a renter who would be considering purchasing the $100,000 home versus renting a home that has a market value of $100,000
    • Most homes in the Chicago and its six surrounding county of Cook, Lake, Kane, McHenry, DuPage, and Will Counties have average monthly rents of $1,500 per month for a two bedroom apartment and/or home
    • For a $1,500 per-month rental, renters would need at least the first month’s rent plus a one-month rent equivalent for the security deposit for a total of $3,000 for you to get your keys
    • On a home purchase, you will need to put down at least $1,000 earnest money
    • Will need 3.5% of the purchase price of $100,000 (or $3,500) for a FHA Loan to show the lender that down payment is covered
    • Remember that the down payment and closing costs on a home loans can be gifted
  • Since you already gave the $1,000 earnest money, need to cover $2,500
  • All real estate transactions have closing costs
  • Lets figure closing costs on this home purchase will be $5,000
  • The closing costs of $5,000 can be covered with sellers concessions and/or lender credit.
  • HUD Allows up to 6% for a seller to contribute to the home buyer for sellers concessions
  • Most of the time, buyers do not have to worry about closing costs
  • This is because closing costs can be covered by sellers concessions and/or lender credit or the combination of both
  • Lender credit can be given by a lender in lieu of the higher mortgage rate
  • Lets say that if the borrower needs all closing costs covered with a lender credit
  • Borrowers may need to pay a mortgage rate of 4.0% versus the par rate of 3.75% with no lender credit
  • If on this case scenario we assume that the property taxes are $5,000, in Illinois, property taxes are paid in arrears
  • So the home buyer will get a $5,000 credit towards property tax proration credits at closing where the buyer can apply the property tax proration towards their closing costs

Summary Of Of Down Payment And Closing Costs Needed On This Case Scenario

Let’s look on a monthly basis now:

Here is what your housing payments will be on a $100,000 home purchase with $5,000 annual property taxes and $600 annual homeowners insurance:

  • Purchase price of single family home: $100,000
  • 3.5% down payment on the $100,000 purchase price: $3,500
  • FHA requires 3.5% down payment so the FHA loan amount: $96,500
  • Upfront mortgage insurance premium:
    • $1,688.75 (added to the FHA loan balance)
    • New loan balance: $98,188.75
  • Annual FHA mortgage insurance premium is 0.85% of FHA loan balance or $834.60 annually, $69.55 per month
  • Annual property taxes are $5,000, or $416.67 per month
  • Annual homeowners insurance is $600, or $50 per month

Now we can do the monthly housing payment calculations:

  • Monthly principal & interest on mortgage balance of $98,188.75 @4.0% FHA 30-year fixed:
    • $468.77
  • FHA monthly mortgage insurance premium:
    • $69.55
  • Lenders require on all FHA Loans for property taxes:
    • Escrow of property taxes:
    • $416.67
  • Lenders require escrow for insurance on all FHA Loans:
    • Escrow of homeowners insurance: 
    • $50

TOTAL MONTHLY HOUSING PAYMENT: $1,004.99

In this scenario, the new homeowner would get the home with cash back at closing. Owning their home requires a monthly payment of $1,004.99. Renting the same home would cost them $1,500 per month.

How Do I Know How Much Home I Can Afford? Is It More Than Renting?

Yes, home ownership does come with more expenses than renting.

The homeowner is responsible for expenses as the following:

  • Expenses for maintenance such as lawn, snow plowing, landscaping, general repairs
  • Expenses for scavenger services
  • If things break down, homeowners cannot call their landlord and are responsible for themselves
  • On the rewards end, your property will appreciate
  • Homeowners get to write off mortgage interest expenses
  • Upside in appreciation
  • Homeowners get to enjoy their investment
  • Homeowners are secure
  • Do not have to worry about landlord not renewing lease

Upgrading To A Larger Home Or Downsizing To A Smaller Home

I need to upgrade or downsize, but I can’t sell. How does this work?

  • This question is not a first time home buyer question and many homeowners do upgrade to a large home or downsize to a smaller home

There are often cases, though, where families need more space or less space. They can make that shift and qualify for a second mortgage on a second property.

  • First, to qualify for a second owner-occupant property without selling the original property you own, if you intend to keep both properties, then the second property needs to qualify as an owner-occupant residence
  • If it doesn’t, it needs to get financing as an investment property
  • Home buyers can keep an existing owner-occupant property
  • They can purchase a second owner-occupant property if the new owner-occupant property they are purchasing is much larger and/or much smaller
  • A mortgage underwriter needs to understand why the home buyer is vacating an existing owner-occupant property and purchasing a second owner occupant property
  • Good reasons include marriage, or a growing family.:
    • a home buyer can purchase the second owner-occupant property if they are moving into a larger property that is at least 30% larger due to a growing family
  • An underwriter will also understand if the home buyer is going from a larger home to a smaller home
  • This is due to downsizing
  • Many folks who have larger single family homes and become empty nesters and decide to downsize to a town home or condominium
  • Once the second property purchase can qualify for a primary home loan, the next step is to qualify for the second home purchase with having two mortgage loans
  • If the existing property has at least 25% equity, then lenders will let you use 75% of the potential rental income of the first property as qualified income in debt-to-income ratio calculations
  • An appraisal will be required on the existing home to determine value as well as market rental value
  • Exiting homeowners without 25% equity in the first property, then the home buyer can pay down the current loan balance to have at least a loan to value of 75% LTV
  • If that is done, then 75% of the potential rental income of the exiting property can be used as qualified income in the calculation of the borrowers debt-to-income ratios

First time home buyers who have questions or want to go over the benefits of buying versus renting, please contact us at Gustan Cho Associates at 262-716-8151 or text for faster response. Or email us at The Gustan Cho Team at Loan Cabin at gcho@gustancho.com.

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