Buying or refinancing a home is a big decision, so it is important for the borrower to be fully aware of the financial responsibility they will be taking on. Therefore, before making the final decision, there are several things to consider, including:
- Buying vs. Renting
- How Much Can You Afford?
- How to Calculate the Mortgage Payment You Can Afford
- What to Expect When Refinancing
Throughout this portion of the guide, you will find helpful tools that will be instrumental in providing you with the figures you’re looking for.
Buy vs. Rent
Choosing between buying a new home and continuing to rent is something that just about every homeowner has to consider at some point in their life. It can be tempting for a renter to make the jump to homeownership, but before they do, they need to be in the right position, both personally and financially. Here, we provide borrowers with expert advice on how to know when to buy versus staying in a rental.
When Does It Make Sense to Buy?
Every individual has a different personal and financial profile, so there is no simple and direct answer to this question. Some buyers are persuaded by rising interest rates or low housing prices, while others may not even want to start looking for homes until they have enough money saved for a down payment.
Ultimately, knowing when it is the right time to buy a home should be driven by the buyer’s circumstances and life goals. For instance, if a renter is getting married and wants to have children, then their apartment may be too small to support a growing family. Or, a renter may have a goal of owning their own home by the time they reach 30 years old. Whatever the case may be, there are five key factors that a renter should meet before they buy a house. These include:
- The Savings Are There: Most lenders are going to want the borrower to have anywhere from 10% to 20% of the home’s selling price saved for the down payment. FHA loans require less (3.5%), but no matter what type of mortgage the borrower is applying for, they need to prove to the lender that they can save money.
- Stable Lifestyle: If a borrower is looking to start a new career or their partner loses their job, then now is not the time to start looking at homes. Owning a home requires the buyer to have a stable lifestyle and consistent income. If a couple is expecting one of them to be laid off in the coming months, then they need to ensure that whatever mortgage they are applying for, they can afford to pay with just one income if necessary.
- More Affordable to Buy Than Rent: Rent rates in a lot of areas are just as high as mortgage payments, if not higher. Therefore, if the renter is going to have to pay more money to rent than buy, then they might want to start considering buying a home. An added benefit is when a renter becomes a homeowner, their monthly payment will be going toward equity in the home.
- Good Credit Rating: The stronger the borrower’s credit history, the lower the interest rate will be on their mortgage loan. So, this is an important factor to meet when deciding between renting and buying. Conversely, if the borrower’s credit is poor, then they should wait to apply for a mortgage, and instead focus on improving their credit.
- External Factors: There are several factors that a borrower has absolutely no control over, but these can still affect their decision. Declining or increasing interest rates is one such factor, while the state of the current housing market (buyer’s or seller’s) is another.
Tips on Savings to Prepare for Buying
As stated earlier, having enough money saved to put down on a home is important for a few reasons. It proves to the lender that the home buyer is financially responsible and capable of saving money. It also helps the buyer save money on their monthly mortgage payment because the more money that is put down, the lower the mortgage will be.
But, saving money isn’t always the easiest thing to do. Here are ten tips that can help you save the money you need for your down payment.
- Save your tax returns
- Save any bonuses or raises from work
- Set up automatic transfers from your checking to your savings account
- Refinance your student loans
- Keep your car when it’s paid off and deposit the payment into a savings account or refinance your car payment if you still owe money on it and transfer the savings to your savings account
- Any time you receive $5 as change for a purchase, put it in your savings account
- Use cash rewards credit cards and transfer the cash back into your savings account
- When your checking account is a few bucks over a round number, transfer the excess to your savings account
- See if your bank has a program that rounds your credit card purchases up to the nearest dollar and deposits the extra into your savings account
- Any time you receive “windfall” money, such as lottery winnings, birthday gifts, and others, deposit that money into your savings account
Each of these tips on their own makes for a slow but steady means of saving. But, by staying committed to your goal, you will gradually see your savings account grow.
How Long Do You Plan to Stay Where You Are?
Another factor that needs to be considered when deciding between renting and buying is how long you are expecting to remain in the area where you currently live. If you are planning on making a life-change within five years or you don’t particularly like the area in which you live, then remaining a renter may be a better idea than being restricted by a monthly mortgage obligation. On the other hand, if you love where you live and you plan on staying in the area for several years, then buying a home and putting down roots is a solid option.
Should I Rent or Buy?
If you are still unsure about whether you should rent or buy or your credit score is keeping you from getting approved for a loan, then there is another option that can be considered – leasing a home with an agreement to buy. Here’s a brief review of how this works.
How Does a Lease Option to Buy a Home Work?
The lease-to-buy option typically has fewer requirements than getting approved by a lender, and a lot of the terms are negotiated between the landlord/seller and the tenant/buyer. The down payment is also lower, with it essentially being the same thing as a security deposit.
A lease-to-buy option happens when the tenant leasing the home from the landlord states their intent to buy the property. A lease agreement is created to dictate the terms, including the rental rate and length of the lease. The tenant is also given the legal right to purchase the home on or after a certain date and at a certain price.
How Does Buying a Home Affect Taxes?
Unlike with renting, buying a home can benefit the buyer at tax time. In fact, there are five ways that buying a home can put more money in the buyer’s wallet through their tax returns.
- Mortgage Interest Deduction: The mortgage interest deduction allows a new homeowner the benefit of writing off interest on (up to) a $500,000 loan if they’re a single tax filer, or on a $1 million loan if they’re a couple filing jointly. Additionally, if they’re a couple filing jointly, they can also deduct the interest paid in home equity debt up to $100,000.
- Points Deduction: It’s not uncommon for a buyer to pay “points” on their mortgage in order to get a lower interest rate. One point is equal to 1% of the loan value and that money is tax deductible, either immediately or over time, depending on how many points are paid up front.
- Property Tax Deduction: When a home is purchased, the amount of property tax that is paid is tax deductible. So, the higher the property tax, the larger the deduction. The only requirement is that the deduction must be claimed the year the payments were made.
- PMI Deduction: Private mortgage insurance, or PMI, is usually required on home loans in which the buyer was unable to put at least 20% down. The amount paid to PMI is typically between 0.5% and 1% of the loan’s value and that money can be tax deductible if the buyer’s income qualifies them for the benefit.
- Home Office Deduction: If the buyer is self-employed or works as a freelancer out of the home, then they could be eligible for a home office deduction. The IRS allows a portion of the expenses required to conduct a business from home, like the cost of Internet service, electricity, etc. When filing their taxes, the buyer will need to figure out what percentage of living space the home office takes up.
How Much Home Can I Afford?
A home is the largest investment most people ever make. And, depending on how much the buyer can afford versus how much home they buy, their new home can either be a blessing or a curse. For this reason, it is very important for a buyer to fully understand the realities of the purchase they are about to make – and it all begins with knowing how much home you can afford.
How Much Do You Currently Pay in Rent Every Month?
If you currently rent and are able to pay your monthly rent comfortably, then the amount you are currently paying is a good starting point for determining how much home you can afford. However, there are certain costs associated with owning a home that aren’t included with a rental.
As a result, collecting all of your sources of income and your monthly expenses and debt obligations, and working out the numbers is a process that needs to be done.
Know Your Numbers
Once you have found the home you want to buy, you need to estimate the monthly home payment to make sure you can afford it. You can use a mortgage calculator to help you determine this information. A mortgage calculator will provide you with a monetary figure, but in order for it to be used as a guideline, it needs to include the following:
- Principal and Interest
- Mortgage Insurance
- Property Taxes
- Homeowners’ Insurance
- HOA or Condo Fees (if applicable)
Next, take the number the mortgage calculator provided and estimate what percentage of your income will be dedicated to paying the mortgage. The standard rule for lenders is 28%. If the mortgage payment accounts for more than 28% of your income, you will either have to find a way to increase your income or purchase a less expensive home.
Lastly, you will have to determine how much money you will have left after paying your monthly mortgage. To determine this, you add together all of your monthly income sources and subtract from that the amount of your mortgage. What is left is what you have to work with. Once you have this number, you will need to subtract each of your other fixed and variable monthly debt obligations, including:
- Car Payment and Insurance Costs
- Student Loan Payments
- Credit Card Payments
- Living Expenses (food, utilities, entertainment, clothing, etc.)
Once you go through the math, is the amount that’s left over enough for you to still be able to save? You do not want to get into a situation where you are working solely to pay your mortgage. Make sure the mortgage you are applying for is something you can comfortably afford or else you may wind up regretting your decision.
What Is My Monthly Mortgage Payment Going To Be?
You can determine your monthly mortgage payment, including taxes and insurance, by using our home loan calculator. Simply enter the price of the home you want to buy, the amount of your down payment, and the other requested details about the home loan. You will then be provided with a mortgage payment breakdown, payment schedule, and more.
How to Calculate the Mortgage Payment You Can Afford
Our home loan calculator can give you a good idea of how much of a mortgage payment you can afford. The calculator is easy to use and will require the following information:
- The area in which you are buying a home
- Your annual household income before taxes
- The amount of your down payment
- Total minimum monthly debt obligations
- Approximate credit score
- Additional information and details
Find out how much you can afford – use our mortgage payment calculator today.
Considerations When Refinancing a Home
If you currently own your home and are thinking about refinancing, there are certain considerations that need to be kept in mind, in particular, knowing how much your home is actually worth in the current market and what to expect when you get a second mortgage.
What Is My House Worth?
The housing market fluctuates almost daily, so knowing how much your home is worth at the time you want to refinance is essential for determining whether or not now is the right time to do it. For instance, if home values are trending low, your home is going to be worth less and will therefore have less equity. This will make it less profitable for the property to be refinanced. But, if home values are on an upward trend, then it is likely a good time to refinance your home.
You can find out how much your home is worth simply by using our home value estimator tool. In just minutes, you can have the information you need to make the right decision for your home.
Getting a 2nd Mortgage
A second mortgage can be taken out on a home when it has a significant amount of equity. For instance, if your home is valued at $300,000 and you have $120,000 left on your current mortgage, then you have $180,000 of equity in your home. If you wanted to take a second mortgage out, the lender may allow you to borrow as much as 80% of your equity, which in this case would be $150,000.
Second mortgages can be a good way to build wealth or they can be used to pay for substantial purchases, like a child’s college education, a luxury vacation, an in-ground swimming pool, a new car, or a major home improvement. But, in order to get the most value out of your home, you need to determine whether or not it is valued where you need it to be.
When you get a second mortgage, you need to be careful because if the market should flip, you could wind up being upside-down in your mortgage, which means you owe much more on your home than it is actually worth.
The best way to determine if taking out a second mortgage on your home is a good idea in the current housing market is by using our home value estimator tool. You can find out how much equity you have in your home and whether or not it makes good financial sense to use your equity by taking out a second mortgage.
How to Understand Your Credit History and Credit Score
Credit history and score are two of the most important consideration factors that lenders use to approve or deny their loan applications. But, this is not to say that someone with imperfect credit can’t get approved for a mortgage. In some cases, a borrower with imperfect credit may be offered a loan, but one with a higher interest rate, or the lender may require more money down, or advise the borrower to purchase a less expensive home. In this section of the guide, we will go over:
- Can I Buy a Home with Bad or No Credit?
- What Kind of Credit Score Do I Need to Buy a Home?
- How to Fix Your Credit Score to Buy a Home?
Can I Buy a Home With Bad or No Credit?
In the world of mortgage loan approvals, the higher the credit score, the better. A high credit score helps ensure that the borrower gets the lowest interest rate on their home loan while a borrower with fair credit or worse may find it especially challenging to get approved.
Here is how your credit score can affect your interest rates and approval odds.
- Exceptional Credit (760+): Having a top-tier credit score will enable you to take advantage of the best rate available at the time.
- Excellent Credit (720-759): This type of credit will only impact your interest rate slightly, usually no more than 0.25% higher than the lowest rate.
- Good Credit (680-719): Good credit will affect your interest rate a little more. Typically, borrowers with good credit are offered loans with interest rates approximately 0.5% higher than the lowest rate.
- Fair Credit (620-679): This is where the divide widens in relation to interest rate. Borrowers with moderate credit can expect to pay 1.5% higher interest than the lowest rate available.
- Poor Credit (580-619): It’s not impossible to get approved for a mortgage with poor credit, but borrowers can expect their score to cause them to pay rates anywhere from 2% to 4% higher than the lowest rate.
- Bad Credit (350-579): It’s a steep uphill climb, but some borrowers are still able to get approved with very poor credit, however, the interest rate they are going to get will be extremely high.
The ideal credit score for applying for a mortgage is 700 or above. While it is still possible to get approved with a score less than 700, the interest rate for borrowers with lower scores will start impacting the overall cost of owning a home.
If the borrower doesn’t have any established credit, the lender will require them to provide another means of creditworthiness. In most cases, the lender will want to see the borrower’s history of paying their utility bills, cable bills, phone bills, and other monthly expenses. So, while it is possible for someone to get approved for a mortgage with no established credit, it is more challenging than it will be for a person with an established credit history.
What Kind of Credit Score Do I Need to Buy a Home?
Different types of home loans have different credit requirements. For instance, for a conventional loan, the minimum FICO score for approval is 620. FHA loans are a little more lenient, but they also have limitations. The lowest credit score a borrower can have and still get approved for an FHA loan is 580. VA and USDA loans don’t have set minimums, but rarely are mortgages approved for applicants with credit scores lower than 580 in either case.
The average credit score for buying a house is 600 or above, so this means even an applicant with bad credit can get financed.
If you have imperfect credit, but you want to buy a home, all is not lost. Get copies of your credit reports and review them for inaccuracies. Simply disputing an incorrect piece of information can help raise your number once the negative information is removed. Once you have your score as high as it can go, get prequalified by your lender. This will tell you how much home you can afford, and it will also show sellers that you’re serious about buying.
Keep in mind that when you get prequalified, it is not necessarily a loan guarantee. Your credit score and history must remain the same or improve between the prequalification and the loan approval. Do not apply for new lines of credit or allow any of your accounts to go delinquent, or the prequalification will mean nothing.
How to Fix Your Credit Score to Buy a Home
When a lender reviews your credit, they are looking for certain factors, but some factors are more important than others. Knowing what lenders are looking for will help you to concentrate on the most important parts of your credit profile. Here’s a breakdown of what lenders look to most when deciding on a loan approval.
- Payment History (35%)
- Credit Utilization (30%)
- Age of Credit (15%)
- Different Type of Credit (10%)
- Number of Credit Inquiries (10%)
Because payment history is so important to lenders, you need to ensure that you do not miss any payments on your debt obligations. One way you can do this is by setting payment reminders for yourself through your bank. Or, you can arrange for your bills to be paid automatically from your bank account. If you choose this direction, schedule your payments to be made a few days before the due date to ensure the payment gets made on time and without error.
Another way to improve your credit is to reduce the amount of debt you owe. To accomplish this, you should stop using your credit cards. Next, you should review the interest rates for all of your credit cards and create a budget that allows you to pay more on the card with the highest rate. Once that card is paid off, start applying the extra money to the next card with the highest interest rate. By tackling your debt this way, you’ll save money and improve your credit steadily over time.
If you have missed payments in the past, then concentrate on getting your accounts current and keeping them current. The impact of those missed payments will soften the older they get.
Additional credit improving tips include:
- Keep the balances on revolving credit accounts as low as possible
- Pay off debt instead of moving it from card to card
- Do not apply for new credit cards if you do not need them just to increase your available credit
- Do not close paid or unused credit card accounts, because the older the accounts are, the higher they will make your credit score
Ruining one’s credit can happen overnight, but fixing it takes time. If your credit score is keeping you from getting approved for a mortgage, then focus your energy on improving it. Eventually, you will get where you need to be.