Of course, modern day life in America doesn’t always flow like that. Young people struggle to afford high-priced homes and older folks have no interest in selling what they’ve invested a lifetime into building. Interest rates are low right now, but home values are going up.
Affordability is an issue, but not an insurmountable obstacle. The first step in buying a house is determining exactly how expensive of a house you can afford. There are different factors to consider, not just the interest rate, so read this carefully before applying for a new mortgage.
Eliminate all outstanding debt before house hunting
Before we get into the numbers of buying a house, take out a debt consolidation loan and pay off all your outstanding credit cards. Then, pay of the loan. Lenders like to see minimal debt when reviewing mortgage applications. They want to make sure they get paid first.
It’s not impossible to get approved for a mortgage if you have other debt, but the amount of money you can afford to pay on a mortgage each month will be reduced by the cumulative total of all your other monthly payments. Less debt equals more house that you can afford.
Interest rates, property values, and terms of the mortgage
Interest rates are historically low right now, but property values are high. This is something to consider carefully. Paying less in interest doesn’t prevent you from overpaying for the house. Do the math. How much will you end up paying in total to pay the house off?
As for terms, low interest rates are a good opportunity to extend the length of the mortgage. Stretching it out over thirty years and locking in that low rate will mean lower monthly payments. It’s unlikely that you’ll refinance when rates are this low.
Another factor to consider is your down payment. If you put down less than 20%, you may have to pay private mortgage insurance (PMI), which is an additional 0.5% to 1% of the mortgage coming out of your pocket each year. Ask your lender for more details on that.
Also, if you don’t have a large down payment, all is not lost because you look into getting a high ratio mortgage for your potential new home. In a nutshell, high ratio mortgages enable homebuyers to only put a down payment as low as 5% of the property’s purchase price.
Putting it all together to determine affordability
You can use a mortgage loan calculator to figure out a monthly payment amount on a mortgage once you have the interest rate and terms, but that’s putting the cart before the horse. Before submitting an offer, you should already have a number in mind.
How much can you realistically afford to pay every month? Eliminating other debt will make that number higher, but can you then go debt-free, no longer using your credit cards? It’s unlikely. Factor those monthly payments in—along with other necessities like groceries, utilities, and car payments (if you have them)—and leave yourself some cushion.
As a final note, ask yourself “How big of a house do I actually need?” Planning for the future is good. Buying small and upsizing later could be better. Don’t let ego get in the way. Just because you can afford it doesn’t mean you should necessarily buy it. It’s 2021—no need to keep up with the Joneses or Kardashians.
By Kevin Flynn
Kevin D. Flynn is a former fintech coach and financial services professional. When not on the golf course, he can be found traveling with his wife or spending time with their eight wonderful grandchildren and two cats.