The first step when contemplating buying a home is to figure out how much you can afford to spend. Knowing your price range will put your house hunt in perspective and help you narrow down your search. It is important here not to convince yourself you can “make ends meet” on a house that is really out of your price range. For this reason, you should always lower your price range a bit from the highest amount you can afford to pay in order to add in a little cushion. Doing this will go a long way to reduce your financial stress down the road.
Lenders will typically tell you that you can afford a mortgage worth about three times your gross annual income. However, this is just a very general rule of thumb and should be viewed as a starting point when figuring out what you can afford. Remember that lenders don’t always have your best interests in mind. After all, once you sign on that dotted line, they will get their money back one way or another. You need to be sure you can afford the mortgage. Do not just go off of what the lender tells you.
Everyone’s financial situation is different, so in order to truly know what you can afford you will have to take a good long look at your budget to see how much money you have left over each month to pay your mortgage. Don’t forget about the other expenses that go along with owning a house such as:
If you don’t already have a budget, it is very easy to make one. Just create a spreadsheet with your total monthly income at the top, and then subtract all your expenses. Be as thorough and realistic as possible. If you find yourself having to try to cut out a lot of expenses in your budget in order to be able to afford a potential mortgage payment, it is a big sign that you should find a house with a lower mortgage payment.
Odds are that at some point over the life of your mortgage you will suffer an emergency expense or drop in income that reduces what you can spend on your mortgage. So go ahead and add in some extra monthly savings into your budget for times when money is tight.
Once you have figured out how much you can afford to spend on a mortgage and have found a home in your price range, you will need to get prequalified for a loan from a lender. Getting prequalified means that a lender will estimate how much it will let you borrow and how much you will need for a down payment and closing costs. The lender typically won’t look at your credit score in order to do this, so these estimates may change once it investigates your financial situation more before approving your loan.
At the same time, you should also ask for loan preapproval from the lender. Preapproval is not a full guarantee that you will get the loan, but it is the closest you can get to knowing that you will be approved, and the seller (and you) will want to know ahead of time that the deal will work out. To preapprove you, the lender will look at your credit and finances to get a better idea of your ability to repay the loan. For this reason, you should look at your credit score before approaching the lender for prequalification and preapproval.
If your score is 740 or above you shouldn’t have much of a problem getting approved, but if your score is closer to 620 the lender might not approve you or may ask you to agree to pay a larger down payment or higher interest rate on the loan.
Once you are prequalified and preapproved you can finalize negotiations with the seller and close the deal. If you are having trouble getting approved, try talking with the lender about things you can do to improve your odds. It may only take something as simple as saving up for a larger down payment or changing your payment structure at work.