It’s exciting to imagine leaving the rental life behind and owning your own home. A place where you can paint the walls whatever color you want, and you don’t have to worry about the rent increasing every year.  But the first thing you have to think about is, how much house can you afford? 

To begin with, sit down and think about your monthly income and expenses.  If you track all this with software (like Quicken or an online service like Mint.com) it will make it easier to look at all this information and make sure you aren’t missing anything. You want to ensure that you add up every source of income that comes into your bank account each month. This is your total monthly income. 

Next, add up all your monthly expenses. Leave out your housing expenses, like rent, for just a moment, and just consider your non-housing expenses.  Remember to include any debt you have to pay each month, like student or car loans. 

Now, subtract your monthly expenses from your monthly income.  The difference is how much you can cover in housing expenses.  So that is what your monthly mortgage can be, right? 

Not so fast! There are some other expenses that go into owning a home, and you want to take those into consideration too. 

Mortgage Costs

First-time buyers often believe that only the amount they borrow and the interest rate will determine their monthly mortgage payments. In reality, monthly mortgage payments also include taxes and insurance, which can add several hundred dollars to those monthly payments.

But, there are other costs associated with mortgages. Some of them are unique and don’t come up often, and they all depend on your specific situation. Let’s look at some of these possible other costs associated with mortgages. 

• Different housing types – Yes, the kind of house you buy will affect your mortgage. For example, if you want to buy a condominium (or condo), you will have a Homeowners Association (HOA) fee that you will be required to pay monthly. This goes toward maintenance and other condo costs, which may increase over time.

• Your actual loan qualification is based on the actual monthly payment, not just the sales price. Monthly payments will vary depending on your specific loan. For example, PMI or HOA fees, taxes for the property, and insurance on the home all affect your actual monthly payment. You have probably heard this payment called PITI, which means the principal, interest, taxes, and insurance on your home. The PITI is specific to each borrower, and this is what the lender considers when deciding if you qualify for the loan. Your mortgage advisor can help you with examples based on your financial situation. 

• How does a condo affect what types of mortgage you can get? Most FHA, VA, USDA, conventional, and jumbo loans can be used for condo financing, but they all have their own rules. Underwriting has to sort through these rules and get answers depending on the loan for which you qualify. 

• These rules are based on:
  • How many units in the building are owner-occupied?
  • How many already have the same type of loan?
  • Amount of non-residential space
  • How much the condo association budgets for maintenance?
  • The structural integrity of the building
  • If it is in a flood plain
  • Percentage of late HOA payments

• Why does the condo have to be approved for a mortgage and not just you? Condo mortgages are a higher risk for lenders because, if you default on your mortgage and the bank takes possession of your condo, they want to be sure they can sell it for a profit, or at least not too much of a loss. Underwriting looks at the finances of the homeowner’s homeowner’s association, condo documents and contracts, and how many units are owner-occupied and other factors to try to determine the financial health of the whole condo building. 

• How can you tell if the condo you are interested in qualifies for a mortgage? You won’t be able to tell on your own. You need to talk to your mortgage advisor in this situation as there are almost always ways to make the purchase work. 

• What are the condo fees? What are HOA fees? Homeowner Association fees (HOA) are not explicitly limited to condominiums. Neighborhoods made up of single family homes also sometimes form Homeowner Associations, and charge HOA fees as well. The costs are paid monthly by the homeowners into the association to be used for maintaining and improving the properties. But often, those fees are higher for condos than for single-family homes. Condo HOAs also sometimes require their owners to pay special assessments, which are one time fees for expensive building maintenance projects. If you are considering a property that has an HOA, be sure to include those monthly payments when you evaluate your home loan options. 

You need to take into consideration all these factors when planning your home budget.

If you apply for your home loan, and you are approved for a $400,000 home, that doesn’t mean you should set that as your home buying budget! On paper, it may look like you can afford that particular payment, but it doesn’t necessarily mean you can or should go that high. You have to factor in your other living expenses that are not included. If you have kids or spend a lot on hobbies or entertainment, you want to think about what you can afford before you get into a situation that becomes overwhelming.

Down payments

At this stage, it is also important to consider how much money you can put toward the purchase of your house as a down payment. What exactly is a down payment?

A down payment is the amount you put down toward the purchase of your house. Down payments are based on your current financial situation and the loan type you choose. You may have heard that you must put down 20% of the home price as a down payment, but the truth is, there is no standard down payment. There are different minimums for different loan types. For example, the minimum down payment for an FHA loan is 3.5% of the purchase price, but that could change depending on your financial situation. Since there are many factors that go into it, this is one of the areas where you should consult a mortgage advisor. 

You may be wondering if you can pay your down payment with cash? The short answer is “No”. You can not bring in a duffle bag full of cash to the closing. However, you can pay with cash if it is “seasoned.” This is a banking term meaning the funds been deposited into a savings or checking account for a minimum of 60 days.

You may also be wondering if you can use a gift from a relative for your down payment. We discuss gift funds in step 4. You need to follow the gift funds rules listed there. The same seasoning time frame applies to gift funds. They typically need to be deposited into a banking account for a minimum of 60 days before using them. 

At this point, you should be ready to move on to the next step … preapproval!