The First Time Home Buyer Series is an ongoing series that details the events leading up to our first home purchase. This is the first post:
My wife and I have a couple of financial goals that we are hoping to achieve in 2009.
- Debt Free, hopefully by the end of the summer
- Save for our first home, hopefully a 2010 purchase
This will be our first home, and we are not exactly sure where to begin. We do plan to lose the debt first. But what should we be researching or learning about the home buying process in the mean time?
According to my Personal Financial Planning class text, "Personal Finance, Skills For Life" by Vickie Bajtelsmit, we should begin with the following steps:
- Estimate the monthly amount you can allocate to total housing costs consistent with your budget and financial goals.
- Estimate the nonfinancing costs of home ownership and subract them from your total budgeted amount.
- Estimate the amount you can borrow with that level of payment.
- Add other sources of funds and subtract closing costs to calculate the house price you can afford.
Step #1 - Estimating the monthly amount we can allocate to total housing costs.
Based on our current budget, we have $1,000 to $1,500 left over each month to apply to our debts. This is after rent, utilities, food, entertainment, 15% of gross income for retirement, insurance, car replacement savings, 2009 Christmas savings, and all other fixed and discretionary spending. The only aspect of our budget that I'm not quite content with is how much we are saving for our future outside of retirement. My thought would be to sock away another 10% each month into what David Chilton, author of "The Wealthy Barber" calls the "we made it big fund." If after buying a home, we were to take the $610 that we spend on rent and place it in the "we made it big fund," then this problem would be taken care of. So how much of a monthly payment can we afford, assuming we begin saving $610 additional dollars after we purchase? Based on our current numbers, my first guess would be $1,000 per month, max.
Step #2 – Estimate the nonfinancing costs of home ownership and subtract them from your total budgeted amount.
So if my maximum monthly payment is $1,000, how much of this amount can be applied directly to the mortgage? For example, the $1,000 will need to include property taxes, homeowner's insurance, and repairs and maintenance. The exact numbers will of course depend on a few unknown variables such as what neighborhood we move into and how old the home we purchase will be. But, I'll take a wild stab and make some assumptions:
Based on my assumptions, I will have $775 available to pay the principal and interest on a mortgage.
Step #3 – Estimate the amount you can borrow with the $775 payment.
According to bankrate.com, a 30 yr. fixed mortgage rate is 5.7% and a 15 yr. fixed mortgage rate is 5.4%. With this information, you can either use a financial calculator, spread sheet, or formula to calculate your loan amount. I've chosen to enter the following into my financial calculator, a BA II Plus:
Based on my calculations, I can finance a $133,528.50 mortgage on a 30 year fixed loan, or a $95,468.44 mortgage on a 15 year fixed loan. There are other "creative" ways to finance homes these days such as adjustable rate interest loans and I will eventually do some research regarding these other types. But for now, I'm just sticking to the traditional type of mortgages.
Now that I've estimated the mortgage I can afford, I'll actually have to secure the loan from a lender. Traditionaly, lenders used two types of ratios to determine how much they will lend to an individual:
- Mortgage Debt Service Ratio – this is the monthly payment for mortgage principal, interest, property taxes, and homeowner's insurance divided by gross monthly income. Usually, lenders will require this ratio to be no more than 31%.
- $775 + $150 + $25/$5,833.00 = 16.2%
It looks like we are well underneath this 31% benchmark. So good so far.
2. Debt Payment Ratio – Total Monthly Debt Payments/After-tax monthly income. Usually lenders will require that this be no higher than 41%, but can range from 33% to much more depending on the loan and lender.
- No Consumer Debts at Time of Purchase + $775 + $150 + $25/$5000 (estimated) = 19%
This also looks like we are well beneath the 41% mark. It looks like lenders would be willing to lend much more than my textbook would recommend! Of course, irrersponsible lending and people taking out loans for more than they could really afford is one of the problems with today's economy.
Step #4 – Add other sources of funds and subtract closing costs to calculate the house price you can afford.
We are expecting to have $10,000 – $25,000 (depending on whether or not we purchase at the beginning or end of 2010) available for a down payment and closing costs. Once again, I'll have to make some assumptions here. Let's say we decide to purchase our home at the end of 2010 and have $25,000 saved for closing costs and downpayment. I'll assume $3,000 worth of closing costs which leaves $22,000 for the down payment. If purchasing a $117,000 home with a $22,000 down payment, I will be left with a $95,000 mortgage. My monthly payments would be right around the $775 mark on a 15 year fixed mortgage.
I may be stuck with Private Mortgage Insurance for a few months, but this should disappear quickly.
If we decide to go this route, I feel that this is a very conservative approach. We could definitely purchase more house, resulting in a larger mortgage. And we may decide to do so. For example, with a $22,000 down payment on a $155,000 home, our 30 year fixed rate mortgage would equal $132,000 resulting in the same $775 monthly payment. However, this isn't entirely true as I would have to pay the monthly private mortgage insurance which would increase my interest rate from .25 to .5 percent.
Ultimately, time will tell what we decide. But, I now have an adequate price range in the back of my mind when browsing the real estate listings!
