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What You Need vs. What You Want
The first step to buy a home is to identify what you are interested
in purchasing. You should make two lists: a "Wish list"
or what you would like, and a "necessity list" of
what you need. The house you purchase should be some combination
of those lists, controlled by what you can afford.
Here are items to consider in developing a wish list or a
necessity list:
• Type of house
• Proximity to work/places of worship/school/social services.
• Neighborhood safety
• Condition of House
• Number of bedrooms and baths
• Age of home
• Parking
You should consider your current lifestyle. What changes
do you want or need to make? What do you have in your current
home you could not do without? If first-time buyers do not
look carefully at what you want and need, you may spend too
much time looking at houses that are inappropriate for you.
Affordability and You
Lenders obviously take risks when they lend
money. For this reason, they want to be sure
that your house payment is within your means
-- in other words, you can afford to make
your payments. Therefore, lending institutions
set limits on borrowers' monthly debt payments.
These limits are called the housing ratio
(often referred to as the front ratio), and
the debt-to-income ratio (often referred to
as the back ratio). Let's look at these ratios
in more detail.
Housing Ratio
The housing ratio is the maximum percentage of a borrower's
income that can be used to make the monthly mortgage payment.
These percentages are pre-set, according to the loan type
selected. The maximum monthly payment, as determined by the
housing ratio, includes principal, interest, taxes, and insurance.
Depending on which loan you choose, the housing ratio percentage
could be 25 percent, 28 percent, 29 percent, or even 33.
Debt-to-Income Ratio
The debt-to-income ratio is the maximum monthly amount that
the borrower can spend for the house payment and all creditor
debts. This percentage is also pre-set depending upon the
loan type selected. The debt-to-income ratio could be from
35 percent to 45 percent.
For example, let's say that the loan program you have selected
has a 41 percent maximum limit on the amount you can spend
monthly for the house payment plus creditor payments. Let's
also assume your gross monthly income is $1500. This means
that the most you could have going out for the house payment
plus all creditor debts is $615. ($1500 x 41% = $615).
Remember that high debt will reduce affordability. The more
monthly debt payments you have, the smaller the amount you
can spend for your home purchase. You may need to work on
reducing debt before you apply for a mortgage loan. The ratios
are flexible. A lender might use a higher ratio if:
• You have a history of saving and have a lot of money
in the bank.
• You make a larger down payment.
• A major debt, like a car loan, is going to be paid
in full within the next few months.
• You can prove your income is going to increase in the
near future.
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