How Much House Can I Actually Afford Before I Start Shopping?

The 30 Percent Rule for Mortgage Payments#

As a general rule, we recommend that a mortgage payment never exceed 30 percent of your gross monthly income before taxes. This gives you a simple starting point for figuring out a comfortable price range before you look at homes.

Be realistic: don’t find the number you’re comfortable spending, find the number you can comfortably spend. Go into the buying process with a firm budget, stick to it, and be upfront with your real estate agent about it. For example, if a home your agent shows you will cost $1500 a month and the maximum payment you can afford is $1200, don’t let your love for the house blind you. An extra $300 is a huge undertaking when you haven’t factored in bills and home repairs yet.

Looking at Your Total Debt Load#

We also point to a broader guideline: as a general rule of thumb, your total debt obligation, including your future mortgage payment, should be no more than 36 percent of your gross monthly income. When you calculate this debt-to-income ratio, you should include current minimum payments on all credit cards and loans other than the mortgage, such as car payments, installment loans, bank or credit union loans, student loans, and credit lines. A high debt-to-income ratio can hurt your chances of making a major purchase like a home, while a low ratio combined with good credit history can help you qualify for better terms.

Check Your Credit Before You Apply for a Mortgage#

Before you apply for a mortgage, get copies of your credit reports from all three of the credit reporting agencies, Trans Union, Equifax and Experian, and take a look at your credit score. Your credit score is a major component in determining the interest rate for your loan. In general, the higher your credit score, the lower your interest rate. If your score is low, there are other programs you may be able to qualify for, but the interest rate may be higher. Keep in mind that a mortgage is typically a 30-year loan, so a 2% difference in your interest rate could result in tens of thousands of dollars in interest payments throughout the life of the loan. If your credit score is on the low end, you may want to consider cleaning up some items on your report and working on increasing your score prior to applying.

Credit scores are not the only factor lenders use. They generally also ask for personal data, such as income and monthly payments, to determine your ability to pay. When qualifying for a refinance or mortgage, most mortgage companies will run a three credit bureau merge. If you are married, your report is combined with your spouse’s to form a single report, so be sure to check your report from all three bureaus, especially if you are married. You can visit AnnualCreditReport.com to obtain your free copy of your credit report and review it for accuracy.

Dispute Incorrect Information

Under the Fair Credit Reporting Act, you have the right to dispute items on your report that you believe to be incorrect. Remember, only incorrect information can be removed from the report. Your reports will come with instructions on how to dispute information. When the agency receives a dispute, it must reinvestigate and record the current status of the disputed items within a reasonable period of time. If the agency cannot verify a disputed item, it must delete it. If your report contains incorrect information, the agency must correct it.

Improve Your Credit

While you are reviewing your report, look at your repayment history. If you don’t have the best credit history, start strengthening it now. A lender is usually looking for a minimum of 12 months of on-time payments. Because numerous credit inquiries, such as new applications for credit cards, can hurt your credit score, it is best to avoid applying for new credit in the months preceding your application. Suggestions to rebuild your credit:

• Pay your bills on time.
• Keep balances low on credit cards.
• Limit your credit accounts to what you really need.
• Check that your credit report information is accurate.
• Be conservative in applying for credit and make sure that your credit is only checked when necessary.

VA and FHA Loans Can Widen Your Options#

Depending on your situation, certain loan programs may make homeownership more reachable. A VA loan guarantees a home loan for veterans, active duty personnel, and surviving spouses, offering competitive rates and low or no down payments. An FHA loan is a government-backed mortgage designed for buyers with lower credit scores or limited savings, allowing you to buy a home with a down payment as low as 3.5%. It also allows for higher debt-to-income (DTI) ratios, helping buyers with significant existing debt like student loans or credit cards to still successfully qualify.

Shop Around for the Best Mortgage#

Choosing the type of mortgage is as important as choosing your home. Besides FHA and VA loans, the most common mortgages, as outlined by usa.gov, are:

• Fixed-rate mortgage: the interest rate stays the same no matter what the length of the loan is. On the downside, if rates fall, yours will not.
• Adjustable-rate (ARM): a lower initial rate, but the rate is subject to changes over the length of your loan, both positive and negative.
• Interest-only: you pay only the interest on the loan monthly for a fixed term. After the initial period ends, the balance of the loan is due, meaning higher payments, having to pay a lump sum, or even refinancing.
• Balloon mortgage: usually a fixed-rate loan with low payments. At the end of the initial period, the entire balance is due immediately, which makes the balloon mortgage risky for most borrowers.

Pre-Qualifying vs. Pre-Approval#

Pre-qualifying is a process whereby a loan officer takes information about you, either over the telephone or face-to-face, and indicates the mortgage amount and type you will qualify for. The lender would then give you a pre-qualification letter, which is of considerable value in dealing with a realtor or potential seller, because realtors and sellers are interested in dealing with people they know can get the loan necessary to close the deal.

Pre-approval is a step beyond pre-qualifying, in that you are actually approved for an amount and for a certain type of loan. The pre-approval is contingent on your finding or making an offer on a property. With a pre-approval in hand, you can close the loan faster, and you may find your offer more acceptable to the seller.

What Do You Want in a Home?#

Before you go and find a realtor, consider what you want in a house by asking yourself some very important questions: How much can I afford? How big of a house do I need? How many bedrooms should it have? How much is it going to cost to heat this house in the winter? Is the yard big enough?

Searching for the Perfect Home#

Since this process may be overwhelming to first-timers, it’s usually best to use a real estate agent. While they will get a commission from the sale, they can be a huge help when it comes to figuring out how to get the best deal on your home and understanding the paperwork involved. A real estate agent will consider your budget and your wants and needs and come up with a selection of homes that fit your criteria. Shopping on your own, you could be prone to stepping into houses far beyond your budget, and falling in love with a home you cannot afford makes the entire process more difficult. Be sure to make a list of your wants and needs before going house shopping. For example, if you’re a parent, or thinking about becoming a parent, you’ll want to be sure you’re in a good school district.

Put in an Offer#

Don’t offer the sellers the full asking price right out of the gate. There’s always a chance they’re willing to take less than what they asked for. Talk everything out with your real estate agent, decide your absolute highest price, and figure out the best approach for your first offer. A home may be priced at $200,000 but the reason for that price may just be that the seller doesn’t know how much their home is really worth.

Getting Help With a Down Payment#

Cambridge Credit Counseling is a HUD-approved housing counseling agency, and we recommend that homebuyers who cannot afford a 20 percent down payment speak with one of our housing counselors. A counselor can assess your situation and help determine whether you qualify for special programs that support homeownership.

First-Time Home Buyers#

It’s important that you know your rights and responsibilities as a homeowner. If you’re a first-time homebuyer, Cambridge Credit Counseling recommends speaking to a housing counselor who specializes in the home buying process. The counselor will walk you through the process, make sure you understand exactly what you’ll be responsible for, and help you prepare for all of the intricacies of homeownership. Additionally, you may be eligible for certain benefits as a first-time homebuyer, such as down-payment assistance.

Cambridge Credit Counseling offers a First-Time Home Buyer Course. You can also see a list of housing counseling agencies in your area.

Choosing Homeowner’s Insurance Coverage#

Homeowner’s insurance is absolutely necessary when owning a home, and it’s certainly not something to be cheap about. Homeowner’s insurance usually covers damage to your home from natural disasters, theft, vandalism, and upgrades to your home in case building codes change in your area. The liability portion of the insurance covers your attorney’s fees, should you need one, and damages in lawsuits involving bodily injury or property damage caused by you, a family member, or a pet.

According to bankrate.com, there are four terms that homeowner’s policies use to describe the coverage they offer you:

• Actual cash value: the replacement cost minus the depreciation.
• Replacement coverage: the cost of rebuilding is covered up until you reach the amount of the policy. For example, a $100,000 policy will cover only that amount of your rebuild, even if your home costs $150,000 to rebuild entirely. If you suffer less damage that is not a total loss, you will be covered for the cost of the damage, minus your deductible.
• Extended replacement coverage: the cost of rebuilding your home, up to a certain percentage over the insured amount, typically 20% or 30%.
• Guaranteed replacement coverage: your damages would be covered in full, regardless of the cost. This type of coverage has been removed from most insurers’ policies, and it is quite expensive where it is still available.

Signing the Closing Documents#

Read, read, read. The closing consists of two sets of documents: mortgage documents to officially borrow the money, and real estate documents to sign the house over to you. A real estate agent and attorney can explain the documents you are signing instead of you trying to understand the legal language on your own. Don’t leave the reading of the documents up to someone else, though. This is a huge purchase, and it’s important to pay close attention to everything that’s put in front of you to sign.

What To Do Next#

If you want personalized guidance before you start house shopping, we offer a free appointment with a housing counselor, and residents of Massachusetts, Connecticut, New York, Missouri and Kansas can also get help related to mortgage modification. You can call us at (800) 757-1788 to schedule a session and talk through your specific numbers.