Buying a home is a major life milestone that many people hope to achieve at some point in their life. Despite it being a life dream for many, financing a house is not easy and is often the biggest hurdle for potential homeowners to overcome.
When it comes to financing a house, there is a lot to think about. From where you want to live and the type of house you’re looking for, to what kind of mortgage you want, finances are a major aspect that needs to be carefully considered before you move forward in the home buying process.
In hopes that your home financing plans go smoothly, here are a few things you should consider and keep in mind when planning, researching, and committing to a finance plan.
#1. Your Debt-to-Income Ratio
One of the biggest factors that’s taken into account when you apply for a home loan is your debt to income ratio (DTI). As the name indicates, it compares how much debt you have with what your income is. Most lenders want borrowers to have a DTI of 43% or less, though some lenders may prefer borrowers to have a DTI of less than 36%.
You can calculate your DTI using a free online calculator like this one by Wells Fargo. If you want to calculate it on your own, just take your monthly income, multiply it by 0.43 (or whatever percent you need your DTI to be), and that will tell you the maximum you should be spending on debt monthly.
Here’s a quick example:
Say your monthly income is $3,500 and your DTI needs to be 43% for the mortgage you want. If you multiply $3,500 by 0.43, you’ll get $1,505. If you spend less than that per month on paying back debts, then your DTI is less than 43%. If you spend more than that, though, then your DTI is above 43%.
#2. Application Fees and Closing Costs
There are a lot of fees that come in addition to buying a home and financing a mortgage. You should expect to pay mortgage application fees, home inspection fees, and closing costs on your home. You may even need to pay other fees in addition to these depending on your lender, real estate agent, and seller.
When you’re budgeting for your home and mortgage, it’s important to account for additional fees that may come up. While every lender will have their own policies, here’s a guide on some of the most common mortgage fees and the average costs that tend to go with them.
#3. Down Payment Requirements
Almost every type of home financing option will have some form of down payment requirement for when you first purchase your new home. This may be as high as 20% or as low as 3%.
Some loans may even have low or no down payment requirements such as USDA loans and VA loans. If you qualify for these, they’re almost always the best option. Even if you don’t currently qualify for a VA loan, if you know you will in the future, you may want to look into VA cash out refinancing options to help make your current loan more affordable in the future.
If you do choose a finance option that has a low down payment requirement, you’ll often be required to pay some form of mortgage insurance, whether this is PMI or MIP. Once you reach 20% equity, you can usually get these extra payments removed, but it is a cost you’ll have to factor in.
For those who can afford the traditionally 20% down payment, you’ll likely be able to get a better interest rate and avoid paying for mortgage insurance. Just make sure you don’t put yourself at risk of defaulting if you do choose to go with a higher down payment.
#4. Insurance and Taxes
As mentioned above, you may be required to pay additional mortgage tax on certain mortgages. Some banks may also require insurance for any type of mortgage. As these costs will be added to your monthly payments, it’s important to account for this. On average, you’ll be expected to pay anywhere from 0.5% to 1% of the loan amount in insurance every year.
You may also need to pay property taxes, though these may be paid at the same time as your mortgage.
#5. The Housing Market
Depending on the housing market where you’re searching, it may not be a good idea to buy right now. If you choose to buy a house for $400,000 and a market crash places your home value at only $250,000 a year or two later, refinancing your loan may be next to impossible.
On the other hand, if you buy your home for $250,000 and market prices jump in the next two years, you may find your home is now worth $400,000 and refinancing is made easier.
Unfortunately, there’s no real way to predict what the market will do. You can try to guess what the market will do based on the past few years, but there’s no way to control it. This can be frustrating for some people as it makes financing a house very difficult, so it’s important that you carefully consider the market trends before making your decision.
#6. How Long You Plan to Stay
Some families move often, whether it’s for work needs or just a personal preference. If you know you’re likely to move in the next few years, buying a home is probably not the best idea. Financing a new house is expensive and even if you decide to refinance and move, you do need to stay in your home for a certain amount of time before it’s worth it.
Financing a home is not like financing for groceries or your kid’s school tuition. There’s a lot of planning and researching that must go into it or you’ll end up with a poor mortgage and pay more than you need to. Before you commit to a lender, be sure to carefully consider the pros and cons as well and the points above. You may just save yourself stress, time, and money.