Can I Afford To Buy a Home?
A home purchase will take many questions into consideration, and the answers to these questions can determine whether or not now is the right time for you to take this step.
Step one is to ask yourself:
- What size of home do I need?
- What are the heating and cooling bills for that size of home?
- What is my monthly budget?
- What kind of monthly mortgage payment can I afford?
- What kind of savings do I have set aside for a down payment?
Remember, as well, that home ownership does come with its challenges, financial and otherwise. There are the costs and energy of maintenance, repairs, home insurance, and taxes. You may want to consider a townhome or condominium where a monthly association fee can cover basic items like lawn care, snow removal, and exterior maintenance and repairs. Often, the home insurance required for such a home is the same as renter’s insurance and considerably less expensive. There are also home warranties you can purchase for peace of mind. Home warranties will often cover big ticket items like furnaces, A/C units, plumbing, and appliances.
Meeting with a loan officer is a valuable first step. They can help you:
- Determine if you’re pre-approved for a home loan based on basic information. Sometimes, they can even pre-approve you over the phone in as little as twenty minutes.
- Help you create a budget that includes taxes, home insurance, and association fees (if purchasing a townhome or condo) to help you determine a comfortable monthly payment
- Create a plan for being pre-approved in the future if you currently don’t qualify for pre-approval. This may include simple steps like checking your credit, paying down credit cards, setting up a savings account for a down payment, or looking into down payment assistance programs for first time buyers.
But, what if I don’t have the 20% down payment available?
20% down seems to be the magic number in every buyer’s head for a down payment amount. If you can put 20% down, that’s wonderful, but it’s not necessary.
Why is 20% down the recommendation? It’s the amount you will need in order to avoid paying Private Mortgage Insurance (PMI). When you have less than 20% down on the home loan, you are considered a higher risk borrower because you have less money invested. PMI is an insurance payment added on to your monthly mortgage payment that protects the bank in case you can’t make your payment and you default on the loan. If you can avoid PMI by putting 20% down, you’re in a good place, but most home buyers don’t have this option. Less than 20% down is very common and PMI makes home loans more accessible for many buyers.
Here are the drawbacks:
- You have to pay for it, which drives up your payments by 0.5% to 1%
- You have to pay on the PMI until the equity of the home reaches 20%. For some people, this could take years.
- Some PMI contracts even require that you pay for a fixed amount of time, or for the entirety of the loan, not just until you reach that 20% equity mark.
- They can be difficult to cancel after you’ve reached that magic 20% equity number. Some lenders require a formal appraisal be performed and/or a formal request be filed before they’ll consider cancellation–a process that could take months.
What’s the good news?
- There are programs that can give you a loan on your down payment. For example, if you can come up with 10% down, you may be able to take a loan out on the second 10% down to get you to the 20% down mark. Each month, you would make two payments–one on the mortgage, and another on your 10% loan–but you avoid PMI and aren’t throwing away money.
- Many programs will allow you to accept gift funds for your down payment. You may consider asking family members if they would be willing to loan you money (with or without interest) to help you reach that 20% down mark
Why wouldn’t I just wait until I have 20% down and keep it simple?
Sometimes waiting will cost a lot more than Private Mortgage Insurance. Many of our clients will state that they are waiting to buy a home until they can put 20% down. In the time they are saving toward that 20%, interest rates may rise and they could spend thousands of dollars more on the same home they could have bought six months ago at a much lower interest rate. Interest rates are rising and predicted to rise further in the coming two years, which will reduce your buying power greatly. For example, if interest rates were to rise even half of a percent (from 4.5% to 5%) a $150,000 home would cost you $22,500 more over 30 years. Your payment would be $62.50 more per month with just that 1/2 percent rise in interest rate.
Every situation is different and without a thorough analysis of your own finances, no one can say for sure what kind of down payment you’ll need for your new home. In reality, you may only need as little as 3.5% down to buy a home.
Is this a good time to buy a home in Rochester?
Rochester is slated to be the fastest growing community in Minnesota due to Mayo Clinic and the Destination Medical Center.
Overall, Rochester is one of the most confident housing markets. Just look at the numbers:
- Home sales in southeastern Minnesota increased by 6.4% in 2013 (Southeast Minnesota Association of Realtors Market Report)
- Median sales price has increased by 4.5% to $140,000 since 2012 (Southeast Minnesota Association of Realtors Market Report)
- Rochester’s Affordability Index is 241, which means “the median household income is 241% of what is necessary to qualify for the median-priced home under prevailing interest rates,” according to the Southeast Minnesota Association of Realtors Market Report
- Rochester is expected to gain 32,000 residents in the next 20 years. (MPR.org)
- Rochester has added 9,500 acres and has made 179 annexations since 2000, which means a lot of new builds and housing developments have sprung up in Rochester. (MPR.org)
Interest Rates and Buying Power
According to the Fiscal Times, interest rates are predicted to rise in the coming two years, which can reduce your buying power greatly. According to Dan Green of Mortgage Reports, “Not since 2009 have mortgage rates moved by this amount, this quickly.”
Consumers often focus on the home’s price, rather than its carrying cost, but it’s the carrying cost that really effects affordability. Your carrying cost really comes down to your monthly mortgage payment.
For example, let’s say that bank approves you for a home loan that will make your monthly mortgage payments $1,000 a month, which is perfect for you. If all things remain the same (the sticker price of the home, your down payment and your budget), but the interest rate jumps by one percent, you’d have to pay more back over time to buy the same home. This means that the amount the bank is willing to loan you decreases. Your purchasing power decreases, and by more than you might think.
|What you’d qualify for at a 4.5% fixed rate loan (4.665% APR)||What you’d qualify for at a 5.5% fixed rate loan (5.679% APR)||What you’d qualify for at a 6.5% fixed rate loan (6.694% APR)|
You can see that an increase an interest rates by just 1%, decreases your purchasing power by at least $20K. Put simply, higher interest rates mean less house.
Have more questions? Don’t be afraid to drop us a line.