Real Estate 101: What can you Afford?
03 Aug 2015
Whether you’re in the market for your first home, an upgrade from your current home, an investment property, or a vacation home, the process can be daunting. Purchasing real estate is the single largest debt you’ll accrue in your lifetime, so you want to make sure you do it right. Navigating the maze that is real estate, mortgages, escrow, and loan documents can be confusing and frustrating. There are so many steps that must be taken during the process, and if you’re not an expert then you could take a misstep that costs you your dream home or retirement income.
One of the most common questions we get is this: why should I purchase a property that I can afford and not a property for which I qualify?
This is a great question, and the answer is simple: just because you qualify for a million dollar loan doesn’t mean you should sign on the dotted line. Your actual mortgage payment isn’t the only cost to consider when purchasing a property.
- First and foremost, what can you afford for monthly payments? Most financial experts say that your housing should eat up no more than 25-35% of your monthly income. However, housing costs don’t include just your mortgage payment: property taxes, PMI, homeowner’s insurance, and HOA fees must also be considered. Therefore, your mortgage payment should take up no more than 25% of your monthly income.
- How much will you apply to the down payment? The recommended amount is 20%, but more is usually better. The more you put down, the lower your monthly payments. If you can’t put 20% down, you will need to pay for private mortgage insurance (PMI) each month.
- How much are the property taxes? Depending on the county in which you’re buying, property taxes range from 1-2% of the property’s appraised value. They can be paid bi-annually (typically in December and April) or you can pay monthly (usually the cost is rolled into your monthly mortgage payments). For example, a $600,000 home in Orange County will accrue property taxes around $6,000 a year, or $500 a month.
- How much are the closing costs? Typically closing costs can add 3-5% to the home price, and they are not included in the financed amount (in other words, you can’t roll them into your monthly mortgage payments, so you will have to come up with them on your own.
Oftentimes prospective property buyers qualify for a loan that, in reality, is out of their budget. Just because you qualify for a million dollar property doesn’t mean you should buy a million dollar property. You should consider all of the other factors that go into owning a property before signing on the dotted line.