Editors Note – this article is the second article in our series “Buying a home.” In this series we’ll share tips and tricks that will help make the home buying process less confusing and more enjoyable.
Once you’ve made the decision to purchase a home, the next big step is figuring out exactly how much you can afford. This is extremely important, because the dream of home ownership can quickly turn into a nightmare if you buy a home you cannot truly afford.
Establishing a budget for your mortgage helps protect your financial interests down the road. Take the time to consider the following steps:
Evaluate your financial situation.
Take stock of your finances and determine how much money you’d like to provide as a down payment on your home. Make sure you are not completely depleting your savings. In addition to money for every day expenses, it is recommend you have at least 2 months’ worth of living expenses remaining to cover emergencies that may arise.
Consider the future.
Taking your current financial situation into consideration is important – but there’s more to it. Your future goals and potential life changes also play a large role in budgeting for a mortgage. Do you plan to start a family soon? Do you have children leaving for college? Do you plan on replacing a car in the years to come? Do you anticipate any changes in your employment situation?
Also, consider potential future maintenance costs when evaluating a home. Will you need to fix the roof in a few years? Will you need to replace the windows, the heating and air conditioning system, kitchen appliances? Those are some major cost factors in owning a home, and if you need to do any of the major projects within a few years of buying the house, this could impact your monthly budget.
Give yourself a safe buffer by choosing to take out a mortgage that will accommodate potential changes in your future.
Review your monthly budget.
Calculate your gross monthly income, which is your income before taxes and deductions. For example, if your salary is $40,000, your gross monthly income is roughly $3,333. Bankers will use this amount as part of qualifying you for a mortgage.
Next, figure out what your income is after taxes and deductions. Then, add your debt commitments, including loans and credit card debt, and subtract it from your net income. Also, subtract your down payment and the amount of money you will retain in your savings for living expenses and an emergency fund. Divide this number by 12 to determine the amount that is available for your mortgage payment.
Factor in additional costs.
Once you actually begin looking at properties, keep in mind that your monthly mortgage payment consists of more than just the principal and interest charges. In addition, you must factor the following into your monthly mortgage payments:
- Real estate taxes – If you have your eye on a certain home, divide the home’s annual property tax amount by 12 to estimate the amount you need to pay or set aside each month. For example, if the property taxes are $4,200 per year, the monthly amount is $350.
- Homeowners insurance – talk to your real estate agent or call an insurance agent to receive an estimate on this cost.
- Private mortgage insurance, often referred to as PMI. PMI kicks in when you put down less than 20 percent of the home’s value towards your home purchase and is designed to protect the lender.
It’s important to keep all these factors in mind when you are determining your monthly mortgage budget. To help you with these calculations, take a look at the “monthly payment” calculator on the MidWestOne website.
Compare your estimated monthly cost with your income.
Once you have determined a monthly cost for home ownership, divide that amount by your monthly gross income. This will result in the percentage of your income. Many lenders will require that percentage to be no more than 28 percent.