If you’re in the market for a new home or investment property,
one of the first questions you’ll probably ask is, “What can we afford?” Many
buyers become so caught up in how much they can afford that they don’t realize
their total buying power—that is, the total amount of purchasing potential they actually
have.
Buying Power Defined
Your buying power is comprised of the total amount of money you
have available each month for a mortgage payment. This means the money you have
each month after fixed bills and expenses. Any money you’ve saved for a down
payment, the proceeds from the sale of your current home, if applicable, and
the amount of money you’re qualified to borrow all impact your buying power as
well. When you take all of this into account, you may find you are able to
purchase a larger home or a home in a more desirable neighborhood, or you might
realize you should be looking for homes in a lower price range.
What About Housing
Affordability?
Housing affordability is a metric used by real
estate experts to assess whether or not the average family earning an average
wage could qualify for a mortgage on the average home.1 Although
this figure is essential to creating a comprehensive overview of the real
estate market, it’s not a factor you should consider in your home search. What
may be considered affordable to you based on your income and other factors may
be different than what’s affordable to the average buyer.
Why Buying Power Matters
A common misunderstanding is that a home’s list price
determines whether or not you can purchase it. Although it’s important to look
at the price tag, it’s essential to consider what your monthly payment will be
if you own the home. After all, the purchase price doesn’t include the
housing-related expenses, such as annual property taxes, homeowner insurance,
associated monthly fees and any maintenance or repairs. Figuring out the payment
will prevent you from overestimating or underestimating your buying power.
After all, you’ll live with your monthly payment, not the sales price.
Once you have clarity on your buying power, you’ll be able to
buy the home you want, instead of settling for a home because you feel it’s the
only one you can afford. It will also prevent you from becoming “house poor,” a
common term for someone who’s put all their money toward the down payment,
leaving them nothing left over for fees outside of their monthly house payment.
Both scenarios can negatively impact the lifestyle you want to live.
Understanding your buying power can help you get the home you want without
sacrificing the lifestyle you desire.
If you haven’t sold your
current home yet, a Comparative Market Assessment (CMA) will give you a general
idea of how much you may get for your home based on what other homes have sold
for in your area. Contact me for a FREE CMA!
Calculating Your Buying
Power
You might be wondering, “How do I know what my buying power
is?” Buying power is calculated by adding the money you’ve saved for a down
payment and/or the money you made from selling your home (minus fees and
mortgage payoff) to all of your sources of income and investments that could be
used to make your monthly payment. Make sure to include your monthly pay,
commissions or tips, dividends from investments, payments from rental
properties or other monthly income you receive as well as the loan amount
you’re willing to finance and qualify for.
Most lenders advised buyers to spend no more than 35 to 45 percent of their pretax income on
housing, meaning all your income and sources of revenue prior to paying taxes.
Make sure you factor in not only your mortgage payment, but also property tax
and home insurance to the cost of housing.2 However, other financial
experts advise spending no more than a very conservative 25 percent of your
after-tax income on your housing expenses.2 Whether you plan to spend the average, play
it conservative or split the difference is up to you.
Traditionally, mortgage
lenders have targeted the ideal housing expense amount to be a ratio of 28
percent or less.3
However, these figures bring up an important point: you don’t
have to spend all of your savings and available monthly income on a mortgage
payment. It’s important to set money aside for regular home maintenance,
unexpected repairs and monthly fees, such as a condominium or homeowners
association fee. While the above ratios are commonly accepted, a lender will
look at your total financial picture when they decide how much they’re willing
to lend. It may be tempting to take out a large loan in order to purchase the
home of your dreams, but keep in mind the less money you have to borrow, the
stronger your buying power may be.
4 Things That Impact
Buying Power
1. Credit score. A
great score can help you lock into a lower interest rate.
2. Debt-to-income ratio. The
lower the ratio, the better risk you may be to lenders as long as you have an
established credit history.
3. Assets, including
the documentation of where the money for the purchase is coming from and the
mix of your investments.
4. Down payment. The
more you’re able to put down, the less you will have to borrow. With a down
payment of 20 percent or more, you won’t have to purchase private mortgage
insurance (PMI) and you may also be able to negotiate a lower interest rate.
How to Save for a Down Payment
If you’re thinking of buying a home one day, one of the first
steps to take is to start saving for a down payment. Here are some tips to make
saving easier.
First-time buyers:
1. Set a savings goal.
One way to figure out how much to save is to use the average sales price for
homes that are similar to what you want and figure out your target down payment
percentage. For example, if homes are selling for $200,000 in your area and you
want to put 20 percent down, you’ll have to save $40,000. Set a goal to save
that amount within a specific time frame; just keep in mind the longer you
save, the more the average selling price will change. Although the majority of
buyers saved for six months or less, 29 percent of all buyers (and 31 percent
of first-time buyers) saved for more than two years for a down payment.4
2. Cut back on expenses. Review your monthly expenses and look
for ways to save. Twenty-nine percent of buyers cut spending on non-essentials
items and 22 percent cut spending on entertainment while they were saving for a
home.4 Think about items you can live without or cut back on
temporarily while you’re saving.
3. Look for ways to boost
your income. Get a side job or sell items online or at a garage
sale to increase your income in a short amount of time. Be sure to save any
windfalls you get, including your annual income tax refund or work bonuses.
4. Check out home-buying programs. Your state, county or local government
may offer special programs, such as grants, for first-time buyers to use.
5. Ask your family. Thirteen percent of all buyers, and 24
percent of first-time buyers, were given money from family or friends to use
toward the down payment of their home.4
Repeat buyers:
More than 52 percent of repeat buyers used the proceeds from
the sale of their primary residence toward the down payment on their next home.4
Similarly, 76 percent tapped into their savings accounts.4 If you’re
thinking of buying another home, here are more ways to save more money, in
addition to the tips listed above:
1. Rent a room. If you have an income flat (or
mother-in-law unit) attached to your home, rent it out and channel the income
into a high-interest savings account.
2. Make your money work
for you. If you don’t plan to
buy for at least five years, invest it and let the compound interest work for
you. Discuss this option with your financial planner or broker to see if this
is ideal for you and your goals.
3. Tap into your 401(k). If you have a 401(k) plan, you may be
allowed to borrow a portion of it, the lessor of up to $50,000 or half of its
value, for your down payment. Remember, it’s a loan so you’ll have to pay it
back. If you leave or lose your job before you’ve repaid the loan, you’ll have
between 60 to 90 days to repay the balance or face stiff taxes and penalties.
If you want to buy an
investment property
Whether you’re buying a second home or a rental property, here
are a couple tips to save for a down payment.
1. Tap into your equity. If you’ve paid off or paid down your
mortgage on your primary home, you may be able to tap into your equity to
purchase another property. Contact your lender to learn more about a HELOC or
home equity loan.
2. Get a partner. Find a friend or relative who’s
willing to purchase property with you. Typically, you’ll split the costs and
profits equally. Just make sure to work with an attorney to create a
partnership agreement to fit your situation.
Work Out Your Buying Potential
What’s your buying potential? Fill out this worksheet to get an
estimate.
Housing Expense Ratio:
|
|
1. Monthly income before taxes
|
$
|
2. Multiply line 1 by 0.28
|
X 0.28
|
3. Monthly mortgage
payment (PITI) should not exceed this amount
|
= $
|
4. Monthly income before taxes
|
$
|
5. Multiply line 4 by 0.36
|
X 0.36
|
6. Total monthly
payments on all debts (including mortgage) should not exceed this amount
|
= $
|
7. Subtract the total
monthly payments on all outstanding debts (e.g., car loans, credit cards,
student loans, etc.)
|
- $
|
8. The monthly
mortgage payment should not exceed this amount
|
$
|
9. Look at line 3 and line 8. The lower figure is an estimate
of the maximum mortgage payment in consideration of your income and debts.
|
$
|
10. Multiply line 9 by 0.80
|
X 0.80
|
11. This equals portion of your mortgage payment that is the
principal and interest only
|
$
|
12. Use the table below to see the size of the loan you may
be able to obtain with this monthly mortgage payment.
|
Source: Iowa State University Extension, What is your house-buying power?
Monthly Payment on
30-Year Fixed Rate Mortgage
Loan amount
|
3%
|
3.5%
|
4%
|
4.5%
|
5%
|
5.5%
|
6%
|
$50,000
|
211
|
225
|
239
|
253
|
268
|
284
|
300
|
$75,000
|
316
|
337
|
358
|
380
|
402
|
426
|
450
|
$100,000
|
421
|
449
|
477
|
506
|
536
|
568
|
600
|
$150,000
|
632
|
674
|
716
|
759
|
804
|
852
|
900
|
$200,000
|
842
|
898
|
954
|
1012
|
1072
|
1136
|
1200
|
$250,000
|
1052
|
1123
|
1193
|
1265
|
1340
|
1420
|
1500
|
$300,000
|
1263
|
1347
|
1431
|
1518
|
1608
|
1704
|
1800
|
Didn’t see your desired
loan amount? Use the table below to estimate your monthly payment
(principal and interest) per $1,000 of your loan. To figure out an estimated
loan payment, multiply the factor by the number of thousands in the amount of
your mortgage.
For example, if you intend to borrow $400,000, with a loan term
of 30 years at 4% interest, multiply 4.77x 400 = $1908 per month.
Interest Rate
|
15-Year Term
|
30-Year Term
|
Monthly Payment
|
Monthly Payment
|
|
3%
|
6.90
|
4.21
|
3.5%
|
7.14
|
4.49
|
4%
|
7.39
|
4.77
|
4.5%
|
7.64
|
5.06
|
5%
|
7.90
|
5.36
|
5.5%
|
8.18
|
5.68
|
6%
|
8.44
|
6.00
|
Don’t forget to factor
in property taxes and insurance. These are often added to your principal
and interest of your mortgage payment—the money used to pay down the balance of
your loan and the charge for borrowing the money. Since these numbers
vary, contact your county assessor’s office for the current property tax rate
and your insurer for a home insurance quote. Once you have these figures,
divide each by 12 to estimate how much they’ll add to the above payment
amounts.
Do you want a clearer
picture of your buying power? Would you like to see what kind of homes you can
get with your buying power? Give me a call or email me at lindawilliams.suncoast@gmail.com!
Sources: 1.
National Association of REALTORS https://www.nar.realtor/topics/housing-affordability-index/methodology
3.
Credit.com https://www.credit.com/loans/mortgage-questions/how-to-determine-your-monthly-housing-budget/
4.
National Association of REALTORS, 2016 Profile of Home Buyers and Sellers
5. Iowa State University Extension, What is your house-buying power? https://store.extension.iastate.edu/product/pm1460-pdf
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