Prep to Finance Your New Home

In this series, How to Find a Home for You and Your Budget, you’ll learn how to find a home that is the right fit for your lifestyle, needs and, most importantly, your budget. It takes you through every single step and shows you how to avoid buyer’s remorse. Your first home is most likely the stepping stone for your next home so you want to do it right and set yourself up financially to move up to your next home.

When it comes to getting a mortgage, many buyers decide on the price point of the house they want to buy before talking to a lender. They’ll say something like -- “We are going to buy a home for $500,000” -- and then they head out to open houses in that price range. Even though that’s how it seems like it should be done and how many people do it, that’s not the way to start your home-buying experience. In fact, if you go about financing your first home this way, you’ll not only have a miserable experience, but it also could cause you to buy a home that is not a good fit! (I did this in 2005 as an uneducated buyer, reach out to me if you want the story)

Follow these steps and you’ll be on a better path.

  1. FIRST, decide what you want to pay PER MONTH before you talk to the lender.

This is the most important decision you’ll make when it comes to buying your first home. Everything else will fall into place once you make this decision. Decide this before you talk with any lenders, before you start searching for homes online, and before you start going to open houses. Why?

The reason is twofold.

  • Most lenders will approve you for more than you want to spend. Whatever you are approved to spend on a home is irrelevant. Most people are approved to buy way more house than they actually want to spend.

This often comes as a surprise, since most people feel like they won't be approved for enough. But that’s typically not the case; it’s actually the opposite! Most people are approved to spend more than they want to shell out every month for a home.

That’s why you should start the conversation with your lender not by asking them what you are approved to buy, but rather telling them what you feel comfortable paying per month for your new home (inclusive of condo fees or HOA if any, taxes and insurance). The lender can then work backward to determine the correlating sales price and tell you if you would be approved for that amount. They will need one other piece of information from you in order to provide a price point, which we will discuss when talking about cash for your transaction (see below).

  • If you plan to buy a condo or anything else with a monthly HOA fee, your correlating purchase price will differ since you need to include this amount. For example, the monthly payment for a $500,000 condo with a condo fee of $300 per month is going to be a completely different monthly payment than a house with no HOA fee.

Not sure how to determine an affordable monthly payment?

Conservative advice is to spend about 30 percent of your income on housing. Ask yourself if what you want to spend per month is in that range. If it is, you are A-okay. With the recent inflation and rise of interest rates, this may seem crazy, but you should still aim not to go above 40% of your income. Look at your current monthly budget so you can compare future home expenses to your current rent expenses. That will help you determine an affordable mortgage payment. If you focus on your monthly mortgage payment rather than fixating on one big sales number or price range. It’s easier to comprehend since most of us budget for monthly expenses already, and will help you take into account any HOA fees, etc.

  1. Decide how much cash you want to spend on the transaction.

In addition to what you want to spend per month, you need to know how much cash you want to spend on your purchase. As we mentioned above, this is the second piece of information your lender needs in order to determine your price point.

You most likely will need cash for down payment and closing costs, unless you have been approved for a special homebuyer program.Decide upfront how much cash you can put towards your home purchase. Will it include a gift from the family? A loan from your 401k?

Some things to keep in mind when you are thinking about how much cash you want to allocate to your home purchase:

  • Start with a dollar figure, not a percentage. You can work in percentages later when you have a sense of your purchase price.

You may be able to spend a little less cash to hit one of the points that lenders like to see. For example, if you have around 10% to put down, then putting 12% down probably wont change your interest rate or help anything from a loan standpoint. So you might decide to save that extra 2% for moving expenses since it will do you more good as cash in hand than cash in your home.

  • Closing costs are going to run you between 2% and 5% of your home price. Be sure to set aside some of your cash for closing costs, not just for down payment. Your lender can help you with this.

  • Don’t worry so much about putting 20% down. There is a very traditional mindset that says you must put 20% down in order to avoid mortgage insurance. Although that is accurate, these days there are many great loan programs, especially for first-time home buyers, that ease up on the private mortgage insurance (PMI) payments.

Now you’re ready with two important figures. You are all set to meet with a lender! You should now understand the two things that will help them determine your price range:

  1. What you want to pay per month.

  2. How much cash you want to spend on your purchase.

You can always make adjustments later on and see how that will change the price point, but start with some figures you are comfortable with in terms of monthly payment and cash for your purchase. A great lender will be able to explain how the lending process works and support you to find the best option for you. NEW CONSTRUCTION TIPS- Most builders will have a preferred lender and they will offer you incentives to utilize their lender. You should still talk to more than one lender to make sure you are getting the best loan product for your needs.

Stay tuned as next week we will continue the conversation with Financing Your Home Part 2. If you are looking for some local lenders, let me know and I can connect you!