Buying a Home

How Much Can You Afford?
Understanding how much you can afford is one of the most important rules when home buying. Based on your individual situation, your budget can affect everything from the neighborhoods where you look for homes, to the size of the house, and even what type of financing you choose.

Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.

Loan prequalification vs. preapproval:
One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.

What factors are important to lenders?
Banks and lending institutions will use several criteria to determine how much money they'll agree to lend. These include:

• Your gross monthly income
• Your credit history
• The total amount of your outstanding debts
• Your savings (what you have available for a down payment and closing costs)
• Your choice of mortgage (i.e. 30-year, FHA, etc.)
• Current interest rates

Two important ratios
Lenders also use your financial information to figure out two very important ratios: the debt-to-income ratio and the housing expense ratio.

Debt-to-income ratio:
Many lenders use a rule of thumb that the amount of debt you are paying each month (car payment, student loans, credit cards, etc,) should not exceed more than 36% of your gross monthly income. FHA loans are slightly more lenient.

Housing expense ratio:
It is generally difficult to obtain a loan if the mortgage payment (principal and interest) will be more than 28 to 33% of your gross monthly income.

Down payments make a difference:
If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20% down payment may be qualified with a 33% housing expense ratio, while someone with a 5% down payment is held to the stricter 28% ratio.

Other ways to improve your purchasing power:

Gifts:
If you are having trouble saving money, many lenders will allow you to use gift funds for the down payment and closing costs. However, most lenders require a "gift letter" stating the gift doesn't have to be repaid. They will also require you to pay at least a portion of the down payment with your own funds.

Negotiating Closing Costs:
Through negotiation, some sellers may agree to pay all or most of your closing costs (for example: if you agree to meet their full asking price). If you choose to try this, make sure to ask your real estate agent for advice and check with your lender concerning limits on closing cost contributions by the seller.

Loan Programs:
Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at reduced interest rates, or with little or no down payment. Check with your local housing authority for more information.

Loan Types:
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low initial interest rates. Others opt for 30-year fixed-rate loans because they have lower monthly payments than 15-year loans. There are significant differences between different types of loans, so be sure to discuss the pros and cons of different loans with your agent or lender before making a decision.