How Much Home Can You Afford Today?

So… you want to buy a house huh? Well before you dump a ton of cash on a house you can’t afford you’ll want to read farther. When finding a home, one area that is often overlooked is the simple question “How Much Can I Afford”. We will look at a few different factors to consider and go into detail of each factor.

One of the first factors that will determine how much house you can afford will be decided by the lender. You will only be able to buy a house for what they are willing to loan you. Some of these deciding factors are Income, Credit and Collateral.

Income (lender)
They will first look at your current income as well as an estimation of how much you will make over the next 30 years. They will want to know what type of assets you have such as stocks and bonds, or personal property such as cars and boats. In addition, they will look at your debts such as credit cards, college loans, outstanding car loans and bank loans.

Lenders will often use the front-end ratio and back-end ratio to determine the loan amount.

A Front-end ratio indicates what portion of an individual's income is used to make mortgage payments. It is calculated as an individual's monthly housing expenses, divided by his or her monthly gross income, and then expressed as a percentage. Monthly housing expenses include the mortgage principal, interest, taxes and insurance payments - collectively known as PITI. Monthly gross income is simply annual income divided by 12 (months). Lenders use the front-end ratio in conjunction with the back-end ratio to approve mortgages.

A Back-End Ratio indicates what portion of a person's monthly income goes toward paying debts. It is calculated as an individual's total monthly debt, divided by gross monthly income and expressed as a percentage. Total monthly debt includes such expenses as mortgage payments (made up of PITI), credit-card payments, child support and other loan payments. Lenders use this ratio in conjunction with the front-end ratio to approve mortgages. The back-end ratio is also known as "debt-to-income ratio".

Credit Worthiness (lender)
The lender will pull your credit rating from three major credit reporting agencies. These agencies are Experian, Equifax and Trans Union. This credit report will reveal your personal financial track record of paying your bills on time.

Collateral (lender)
The lender will look for any asset that can be used to repay the loan in instances where you would not be able to repay the loan. Generally, the house you buy will be considered collateral for your mortgage. Therefore, if you do not repay your loan, the bank can foreclose on the mortgage and reposes your house.

The next couple factors are more personal decisions to be though of when deciding how much to pay for a house.

How Long (personal)
One determining factor in deciding how much to pay for a house, will be based on the length of time you will be in the house. Basically you are only planning on buying a house for 3 years, you might consider not buying a house for appraised value simply for the reason that you will pay closing fees when you purchase the home as well as upon selling your home 3 years down the road. With this being said, make sure you make the purchase financially worthwhile and purchase the house below appraised value.

Comfort Level (personal)
Next, figure out what you can afford based on your lifestyle/goals both personally and financially. This is the most important in my eyes and should be weighted highest in importance. As Dave Ramsey teaches in The Total Money Makeover, a good rule of thumb is to never take more than a fifteen-year loan and never have a payment over 25% of your take home pay.

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Colaboration:

Types Of Mortgage

Buying a home is one of the biggest commitments you will ever undertake. So choosing your mortgage does take thought. Take some time to consider what mortgage is right for you? After all it's your money you will be spending so, I would recommend utilizing it in the best way possible.

The kinds of mortgage available to you

There are thousands of different mortgages on the market at the moment, all offering something different, something similar but essentially offering one of two types:

Repayment and Interest, with a repayment and interest mortgage you (the lender) you will have to payback the specified mortgage amount plus the interest in a specified time. For example if you borrowed £100,000 over 25 years, the total plus interest is £190,000 over 25 years, this is what you will repay. You will see the balance becoming increasingly smaller over the term of the loan.
Interest only, with an interest only mortgage you only pay the interest on you mortgage, however when the term of your mortgage is over you are still left with the initial buying fee of your house. Using the above example this would be £100,000 still left to pay. When you take an interest only mortgage you will need to take out an alternate savings plan, in the form of a pension, I.S.A, or an endowment. These alternate plans run alongside your mortgage to accumulate the final sum to zero your balance after the term is over.

Advantages of a repayment and interest mortgage

It is possible for you to pay off lump sums of your mortgage to minimize the balance and make term shorter. However do be careful as some lenders do charge for a early settlement. If you do decide to repay early it is better to do upon the changing period of your mortgage i.e. when you are eligible to start another discounted term with another lender.
You do not always have to take out life insurance with a repayment mortgage. Some pension plans that are in place do cover for unfortunate events such as death.
You know the full balance of your mortgage and also the term of the repayment, so you always know when your mortgage will be paid in full.

Disadvantages of a repayment and interest mortgage

In the early years of a repaying your mortgage the majority of the monthly repayment is interest rather than capital. For lenders who move house regularly, this can mean that little of the capital is paid off.
If no life insurance, pensions or assets are in place to cover the repayment of the house. In the unfortunate event of a death the house will still have to be repaid. If payments are not kept up to date then the house will be sold.
There may be financial penalties for making additional payment into your mortgage account.

Interest only mortgage

With this type of mortgage, only the interest is paid off with each mortgage payment. After the term of the mortgage elapses e.g. 25 year period, the lender is left with the full balance for the initial purchase of the house. To combat this problem (if you do not have the money to repay after the term is over) you the lender can take out another policy to run along side the mortgage payment? These policies are an ISA, pension plan or endowment policy. When you find a policy to suit you? The policy will grow along with your mortgage to accumulate the balance of you initial payment over the same term as your current mortgage. So at the end of the specified lending term you have the correct amount of funds to pay your balance.

Pension Plan

Using a pension plan to accumulate the balance of your mortgage is a tax free saving scheme. The balance of your house will be saved over a period of time until you can pay your final balance. If you do intend to use a pension fund to save for the balance of your house, consideration should be taken into account to open another pension fund for retirement purposes too.

ISA Plan

With an ISA plan you invest in stocks and shares via an Individual Savings Account (ISA) - which is a tax-free method of saving. This method of saving may not be suitable for most borrowers. Before considering this option you should consult with an independent financial adviser.

Endowment

An endowment is still the most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The endowment policy along with the interest only mortgage should in effect end at the same time, leaving you with the ownership of your home and nothing to pay. Endowments have undergone much criticism; this is due to investors being promised high returns from their investments. However lately this has not been the case, borrowers have found their investments have been as good as expected and a shortfall in the end amount of invested cash will not match the amount owed on the current property.

Taking into account the recent problems that have arisen regarding endowment policies it is worth remembering that returns on endowment policies have been pretty good, however you do need to see the term out in full. Also endowments do provide life assurance as part of the actual policy, so in the unfortunate event of a death the mortgage balance is paid in full.

Advantages of an interest only mortgage

Your investments and savings could accumulate more than the required amount to cover the final payment; this could leave you more cash for your own personal use.
Some plans have good tax benefits and help reach the required amount it a quicker and cheaper rate.

Disadvantages of an interest only mortgage

In the unfortunate event of your investments not acquiring the designated amount of cash to cover the loan repayment, the investor could face a shortfall which they will then need to pay. If you are worried about a shortfall on your investment, you should keep in touch with your investor and request regular updates on the situation of your endowment. If the worst comes to the worst, you can increase payments to compensate for the loss of investment.
Cashing in your endowment, ISA or pension could have adverse effects on the amount of money you have saved over the past however many years. If you do decide to cash in any existing policies you may be subjected to a penalty, this could be a cash amount specified by the investment company/lender. Please seek professional advice if you are worried about the end results of your finances, don't be too hasty as most policies accumulate more of the cash in the final year.