Buying Guide

How Much House?

Finding that dream house is only one step in the process of buying a house. Often, the most difficult step in buying a home is determining what price range to look for a house in. It is important to understand what it takes to qualify for a certain price of house and how that affects the buying process. To help you understand that process, and make the most of every day and dollar you spend, Monster Real Estate.com has prepared this Home Buyers Guide to provide an overview of the financial matters affecting a home purchase.

With the various financing programs available in today's mortgage industry, "affordability" is not so much determined by sales price as it is by the financing which translates that price into a monthly payment. Accordingly, a house hunter can determine the price of a home that is affordable by determining a mortgage loan amount that is affordable under current conditions, and working backwards. And remember, that even though there are many ways to qualify for a home, you should make sure that the monthly payment makes sense for you. A good rule of thumb is that the monthly payment should not be more than 25 - 33% of your monthly income.

The key items are the size of the down payment, interest rate, loan term, and the amount of the mortgage. There also exists different mortgage programs which allow for lower payments through interest-only programs or different payment options. Monster Real Estate.com and their affiliates can be very helpful in sorting through these variables.

The down payment might be zero in the case of VA-backed mortgages. Or a buyer may invest 20 to 25 percent, or more, of the purchase with a conventional loan and not be required to buy mortgage insurance. The obvious source of money for your down payment is either your savings or the proceeds from the sale of a home you already own. But there are some other not so obvious sources. In recent years, for example, "parent power" has taken some new twists for first-time buyers, as well as retirement funds and life insurance.

Mortgage Insurance Can Reduce Down Payment. If you need a conventional loan, there is a way to put down only 5 or 10 percent. Through the lender, you will be required to buy private mortgage insurance (PMI). This insurance provides protection for the lender in case of default, and allows the lender to approve a larger mortgage amount.

The larger the down payment, the less money you need to borrow, which means a lower monthly payment. However, remember that in addition to your down payment and monthly payments, you will need money to pay for closing costs, moving, appliances, household setup, a reserve for family emergencies and other miscellaneous items. So don't plan to put your last penny down on the closing table.

The balance due at the closing of a real estate purchase, which is the purchase price of the home, plus settlement costs and prepaids (escrows), minus the down payment(s), is the amount that must be financed. This is the mortgage amount that must be qualified for, and is subject to the variables of interest rate, and loan term.

In simplistic terms, the lower the interest rate at which you borrow, the lower your monthly payment will be. Also, the longer the loan term (years over which the loan is repaid), the lower your monthly payment will be. However, when you pay over a longer term, you ultimately pay more interest and thusly, more money than at the same rate on a shorter term.

By finding the best combination of interest rate and loan term, you can derive a monthly payment that fits your budget. The repayment of the loan is broken down into two parts: P&I (Principal and Interest), and Escrows (Taxes and Insurance paid to the mortgage company in installments, which is then paid by the mortgage company to the various taxing authorities and insurance companies). The total payment is often referred to as P.I.T.I. (Principal, Interest, taxes, Insurance). In some cases, a borrower may pay a premium to have escrow payments waived, meaning the borrower would pay taxes and insurance on their own. However, in such a case, P.I.T.I. would still be considered as the Principal and Interest, plus the taxes and insurance pro-rated over the course of 12 months.

Generally, lenders figure that the home buyer shouldn't pay more than 28-36 percent of monthly income for P.I.T.I. payments, or 36-38 percent for both P.I.T.I. and monthly debts combined. This might be a little more or a little less depending on other outstanding long term debts (more than 10 months), alimony/child support payments, number of children and their ages, and other household budget items.

The easiest way to make a quick estimate of the mortgage amount you may qualify for requires applying the two basic formulas for loan application that lenders use. Keep in mind the loan balance will vary over the term of the loan, although the monthly payment remains the same.

Two Lender Formulas Most lenders will require that loan applicants meet both guidelines before approving a mortgage loan. The first formula compares income to housing costs without including long term debts, the second includes all debts.

28% Formula

Total Monthly Housing Costs/Monthly Income = 28% or less

36% Formula

(Total Monthly Housing Costs + All Monthly Debts)/Monthly Income = 36% or less

A variety of other formulas exist. VA and some lenders use a single ratio based on mortgage payment and all debts, which allows easier qualifying for a more expensive home for a borrower with little debt.

To figure your housing budget, simply multiply your monthly income (before taxes) by 28% and 36%.

As stated before, there are a myriad number of mortgage programs and features, each with its own set of advantages and disadvantages. Some offer lower payments, some offer faster repayment of the balance of the loan, some offer less money paid over the life of the loan, some offer bigger tax advantages. Ultimately, each loan is a give and take of benefits in respect to each other. Monster Real Estate.com and its affiliates can help you make sense of these options, and can help you decide on the program that is best for you. You can be pre-qualified for a program, and start your home search right away!

For tax advice, please consult your accountant or tax professional. For legal advice, please consult your attorney.