There’s no time like the first time: Information for First Time Buyers.
Part One: Are You Financially Ready?
Once you’ve made the decision that you’re tired of paying your landlord’s mortgage and want to start investing for yourself (see previous post), it’s time to figure out the money. Before you march into the bank and demand cash, there are a few things you can do to prepare.
1) Figure out how much you are spending now.
If you don’t already keep track of your expenses, take out a piece of paper or open up a fresh excel spreadsheet and write down your average monthly cost for everything you buy. Include the big stuff like Rent, Utilities, Transportation but also smaller items like concert tickets, that two a day Starbucks habit, and your monthly manicure. As a side note, there are some great Apps out there that can help you keep track of your monthly spending.
Then you want to figure out your monthly debt payments. Car loans, credit cards, student loans and any other loans you may have.
Ultimately the lender will determine a maximum borrowing amount they’re willing to lend. But it’s also important to know what payment you are comfortable with.
2) How much can you afford?
If the question is, can I even be considering this right now. The below formulas are an easy way to figure out what you can afford.
Affordability Rule 1
Your monthly housing costs shouldn’t be more than 32% of your gross monthly income (income before taxes). Housing costs include monthly mortgage payments (principal & interest), property taxes, and heating. This is known as the PITH (Principal, Interest, Taxes and Heating.) For a condo the PITH would also include half of the monthly condo fees.
A lender will add up your housing costs and figure out what percentage they are of your gross monthly income. To be considered for a mortgage, your GDS (Gross Debt Service) must be 32% or less of your gross monthly income.
Affordability Rule 2
The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income. This includes your housing costs (PITH) plus all your other debt payments (car loan/lease, credit card payments, lines of credit etc.)
Total monthly income x 0.40 = TDS (Total Debt Service)
Subtract Total other debt payments from TDS to find out the monthly housing costs you can afford.
3) How much do I have to put down?
One of the biggest challenges in making that first foray into the market is saving the down payment. The amount you put down can vary from 5% upwards to 25% or more. Mortgage loan insurance can enable purchasers to put down the minimum 5%. The insurance is there to protect the lenders against default. However, with this option you do have to consider the extra cost of the insurance itself.
Being diligent on putting money away can be challenging, but perhaps setting up an automatic deposit into a savings account will ensure that you’re putting that money away every month. It doesn’t have to be a large amount; even a small amount will keep growing. And the best part is, you don’t have to think about it.
With these three questions answered you’ll have a much better idea whether you’re ready or not to pursue a home purchase.
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