How Much House Can You Afford?
It is very important to know how much money you can safely spend on your new home before you waste your time looking at homes that you cannot buy even if you wanted to. You should get pre-qualified with a mortgage company before you start looking to avoid disappointment or potentially losing the home of your dreams because another Buyer is more prepared than you. As ominous as this may sound it is a relatively simple process that can be done over the phone or even online in a matter of minutes. We deal with a number of Mortgage Pros that have an excellent reputation and track record for successfully acquiring loan approval for our clients.
As you think about applying for a home loan, you need to consider your personal finances. How much you earn versus how much you owe will likely determine how much a lender will allow you to borrow.
1) Determine your gross monthly income
This will include any regular and recurring income that you can document. Unfortunately, if you can’t document the income or it doesn’t show up on your tax return, then you can’t use it to qualify for a loan. However, you can use unearned sources of income such as alimony or lottery payoffs. And if you own income-producing assets such as real estate or stocks, the income from those can be estimated and used in this calculation. If you have questions about your specific situation, any good loan officer can review the rules.
2) Calculate your monthly debt load
This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other ongoing monthly obligation like alimony or child support. If it is revolving debt like a credit card, use the minimum monthly payment for this calculation. If it is installment debt, use the current monthly payment to calculate your debt load. And you don’t have to consider a debt at all if it is scheduled to be paid off in less than six months. Add all this up and it is a figure we’ll call your monthly debt service.
In a nutshell, most lenders don’t want you to take out a loan that will overload your ability to repay everybody you owe. Although every lender has slightly different formulas, here is a rough idea of how they look at the numbers.
Typically, your monthly housing expense, including monthly payments for taxes and insurance, should not exceed about 50% of your gross monthly income. If you don’t know what your tax and insurance expense will be, you can estimate that about 15 percent of your payment will go toward this expense. The remainder can be used for principal and interest repayment.
In addition, your proposed monthly housing expense and your total monthly debt service combined cannot exceed about 40% percent of your gross monthly income. If it does, your application may exceed the lender’s underwriting guidelines and your loan may not be approved.
Depending on your individual situation, there may be more or less flexibility in the guidelines. For example, if you are able to buy the home while borrowing less than 80 percent of the home’s value by making a large cash down payment, the qualifying ratios become less critical. Likewise, if Bill Gates or a rich uncle is willing to cosign on the loan with you, lenders will be much less focused on the guidelines discussed here.
Remember that there are hundreds of loan programs available in today’s lending market and every one of them has different guidelines. So don’t be discouraged. It is just as important to find the right Mortgage Broker as it is to find the right Real Estate Agent!
In addition, there are a number of factors within your control which affect your monthly payment. For example, you might choose to apply for an adjustable rate loan which has a lower initial payment than a fixed rate program. Likewise, a larger down payment has the effect of lowering your projected monthly payment. Find more information about mortgages here!
Bi-weekly and weekly payments
Most mortgages have the option to allow payments to be made on a weekly or bi-weekly basis. This option may be desirable for two reasons. The first is it can save you money as you can expect to pay off your mortgage about 4 years sooner. This can save you dramatically over the life of your mortgage. The other reason why these options are so popular is that if your employer pays you on a weekly or bi-weekly basis, you can simplify your budgeting by making the payment line up with the way you paid.
Making Extra payments
Paying extra amounts on your mortgage can make a big interest saving over time. When we select a mortgage company, privilege payments options are something that we look for. A 20% privilege payment will allow you to pay off up to $20,000 per year on a $100 000 mortgage. It is important that the privilege payment also be flexible to allow you to pay smaller payments on the mortgage and as often as you wish. An extra $1000 periodically paid on a mortgage can help you become mortgage free faster.
Reducing the CMHC Fees on your Purchase
When you require a mortgage for more than 75% of the purchase price of a property, that mortgage must be insured by Canada Mortgage and Housing (CMHC) or GE Mortgage insurance. The premium charged by these companies, decreases as the down payment increases. When you finance your property at 90-95%, a premium of 4 % is added to the mortgage. By increasing the down payment to over 10% of the purchase price the premium can be reduced to 3.1%. If you can put down 25%, you can avoid any additional insurance fee. Depending on your situation there are ways that you can structure this financing to avoid the CMHC or GE insurance premium.
Advantages of Bigger Down Payments
As mentioned above, when you put a 25% down payment on your purchase you can avoid the CMHC premium. More importantly the larger the down payment, the lower the amount of interest you will pay over the life of your mortgage. It is important to note that it may not be wise to stretch yourself to increase your down payment and end up borrowing on credit cards or a line of credit at a higher rate.
Short Term Rates vs. Long Term Rates
The options for mortgages available can be very confusing for most mortgage shoppers. Terms for mortgages vary between variable and fixed rate, 6-month terms to new 40 year terms. Taking a variable or floating rate mortgage can have savings. Typically the shorter the term or guarantee of the rate, the lower the rate will be. This does not always happen, depending on the market place and the economy, but history has shown that short-term rates tend to be lower than long-term rates. The up side of variable rate is the strong potential for interest rate savings. The down side is the fact that you are accepting the interest rate risk without a guarantee. If you are considering a variable rate mortgage you need to look at your own risk tolerance, and your cash flow available to deal with potential increased payment. Considering projections of rates and where we see interest rates heading can also be important in this decision. Make sure you talk to an expert when you are making this decision.