House shopping can be a fun process: viewing houses with your realtor, determining just which items you want in a house, where you want to live, and then eventually imagining your things in your new home once you pick one can be very exciting. Unfortunately, trying to find a home can also be stressful. Applying for loans when necessary, searching for the right agent (and then the right home), placing an offer, waiting for the home inspections, potentially facing deals that fall through, and dealing with all the other issues that can come up when you purchase a house can be daunting.
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In addition to handling all these items, you also need to determine how much of a mortgage you can actually afford to pay each month. Some people have a hard time qualifying for a loan at all, while others get pre-approved for far more than their budget will actually allow, so you have to be careful.
The best way to start your home search is to sit down and do a careful budget. While a bank or loan company will look at your finances, they won’t know all the different costs that go into your monthly budget. You need to determine on your own — before you go to a bank — just how much you can afford to pay each month. You won’t necessarily get a loan for as much as you can afford monthly, or you might be offered a loan that is higher than you can afford.
The best way to set yourself up for a financially stable mortgage is to know what you believe you can afford yourself before anyone else tells you. Make sure you include any debt you have, utilities, but also money for groceries and all your other expenses. Don’t forget to factor in money for retirement, savings, and your emergency fund. You can use a affordability calculator to get you started, but notice that the calculator may only factor in debt and income (or lack other important factors.) Make sure to add in your income that goes towards savings as well.
You will also want to determine whether you should apply for a fixed rate mortgage, a variable rate mortgage, or any of several other types of mortgages. Depending on your income and financial situation, the different types of mortgages have advantages and disadvantages. If you are sure you can pay it off quickly, you might want to consider a variable rate mortgage; however, if you fail to pay off this type of loan quickly, you might put yourself at financial risk. You will also need to figure out whether you want a 30-year mortgage, a 15-year mortgage, or something else. Obviously, your mortgage payments will usually be higher if you have a shorter mortgage period, but you will save on interest.
How much of a down payment you can make will also affect your decision. Traditionally, most people try to put down at least twenty percent of their mortgage for a down payment (but the requirement is usually ten to twenty-five percent for a conventional mortgage.) However, not everyone will be able to do this. Especially if you are purchasing your first home, you may qualify for special first-time home buyer deals. If you can’t pay twenty percent down, you might have to pay insurance. On the other hand, if you can put down more than twenty percent, you might want to consider this (if you are relatively debt-free and in a good savings position otherwise) because doing so will reduce your mortgage payments.
Although most people cannot predict a large financial issue, you should also be prepared in case of unexpected costs due to a job loss or other crisis. In addition to building up your emergency fund, you should be careful to choose a mortgage that is truly affordable for your budget now, but also possible if something changes in your budget in the future. There is always the possibility that you might face unexpected medical expenses, the loss of a job (or the loss of one income if you are part of a two-income household.) It is always tempting to purchase a house at the top of your budget, but doing so can put a huge financial strain on you in the future.
Once you have taken all these issues into account, you can start shopping for a loan. Make sure you look at several different sources and find the best deal for you, and be sure to factor in all the different factors, including closing costs. Remember, you don’t have to purchase a house that will cost as much as you are approved for (and you often shouldn’t.) Also, remember that taxes will affect how much your monthly bill will be, so a $300,000 house with high taxes will cost a lot more each month than a house priced the same in a lower tax district.
All the issues mentioned above need to be factored in when you determine how much mortgage you can handle. Even if someone who has the same income as you — and qualifies for the same mortgage amount as you — chooses a big house at the top of the approved amount, that doesn’t mean you need to, or that you should. You might have completely different bills each month, so be sure to carefully determine how much you feel comfortable paying each month, before you get sucked into the idea of an extremely nice house at the top of your budget.