There are many things to consider when buying a home, and chief among them is undoubtedly the budget.
As bankers, we feel it’s the decision that should come first in the home buying process and should guide all your subsequent choices. Establishing a budget helps you determine what neighborhood you can live in, how large your house can be and most importantly, what monthly payments you can afford to maintain your current lifestyle. After all – you don’t want to end up “house poor.”
So how do you set a budget? Here are some things to think about.
Your debt-to-income ratio
One of the things mortgage lenders will look at is the amount of debt you have compared to your overall income. That’s what’s called the “debt-to-income” (DTI) ratio. A low DTI shows you have a good balance between debt and income. As you might guess, lenders like this number to be low, and the lower it is, the greater the chance you will be able to get the loans or credit you seek.
If your DTI is high, consider paying down high interest credit cards or other debts before you buy your new home in order to get below the required limits.
Your down payment
It’s a good idea to come to the table with a down payment of at least three percent in hand. The more you can put down at closing, the more ownership you’ll have in the home and the less you’ll pay in financing over the course of the loan.
The thing to keep watch out for is your “loan-to-value” (LTV) ratio. The LTV ratio is calculated as the amount of the mortgage lien divided by the appraised value of the property.
For example, if you’re taking out a $92,500 mortgage to purchase a home appraised at $100,000, you would have a LTV ratio of 92.50% (92,500/100,000).
Lenders like to see a LTV ratio of 80 percent, which means you’ll want your down payment to be 20 percent of the purchase price. Lower LTVs are better and can help you qualify for a better interest rate. If you’re not able to save up enough of a down payment to keep your LTV below 80 percent, you could be required to purchase private mortgage insurance, which means you’ll be paying more in your monthly payment.
How to set your budget
To set your budget, you’ll want to look at your income, your debt and the amount of down payment you have available. By using a home mortgage calculator, you’ll be able to adjust those numbers to see how small tweaks can impact your overall monthly payment.
MidWestOne has a few calculators available that can help.
- Mortgage qualification – this calculator lets you enter your total monthly gross income and your monthly expenses to determine how much mortgage you can qualify for. Essentially it’s looking at your DTI radio. This is a great way to set your budget range.
- Rent or buy – if you’re a first-time homebuyer, this calculator is a great tool. It compares the cost of renting versus the real cost of buying a home in an easy-to-understand table.
- Mortgage – the Mortgage calculator shows how much interest you will pay, your principal balances and the impact of any principal prepayments. This is a good calculator to use once you have a home picked out and are getting down to the nitty gritty details of offers, counter offers etc.
If you’re in the market to buy your next home, we encourage you to take the time at the beginning of the process to fully understand your financial situation and set a healthy budget. This will set you up for future success and ensure you’re comfortable and happy in your new house.
If you’ve got questions, we’re happy to help. Reach out to your local MidWestOne banker.