Living the American Dream - Financial Resource Management

How Much Income Should be Devoted to a House Payment?

Calculate How Much of a House You can Afford.

Are You Ready to Purchase a Home?

Owning a home is the American dream. However, that dream can be shattered if you are not prepared for the expense of being a homeowner. The following list will help you determine if you are financially ready for homeownership.

Do you have a steady form of income and stable employment?
Do you plan to stay in the same area for at least three to five years? This length of time may be required to recuperate the costs of getting into a home.
Have you created a budget so you know how much money you can realistically spend for housing?
Do you save regularly?
Is your current debt low enough to afford a mortgage payment?
Have you established a credit record? If not, can you build a non-traditional credit record? Non-traditional credit is documentation of consistent payments to your landlord, utility company, or even savings account.
Do you have favorable credit? Do you pay your bills on time?
Do you have sufficient money saved for a down payment and closing costs?
Have you been pre qualified for a loan? This entails visiting with a lender to see if your income and debt would qualify you for a loan.
Are you willing to make the necessary sacrifices it will take to be a homeowner? These sacrifices may include going without some luxuries to build up your savings for a down payment, future repairs, and even adequate savings to cover house payments in the event you loose your job.

How Much Income Should be Devoted to a House Payment?

Determining how much of a house you can afford is very important. Loan officers may not always act in your best interest. It will be to your advantage to already know how much of a house payment you can realistically afford when you visit with a loan officer. There are two main things that determine your ability to afford a home, income and debt.

Ratios are used to determine how much of a house payment you can afford. These ratios are known as front end and back end ratios. Concerning the front end ratio, experts recommend that no more than 30 percent of your monthly income be devoted to your monthly house payment. Concerning the back end ratio, experts recommend that no more than 40 percent of your monthly income be devoted to your monthly house payment and your monthly debt payments. There are many different loans available and each loan has slightly different ratios. You may not qualify for a loan with the recommended front and back end ratios (30/40). If you only qualify for a loan with high front and back end ratios take the time to see if you will still be able to afford the necessities and some luxuries in life before making the decision to accept the loan. This will take sitting down and calculating a budget for once you are in your home. Remember to include items such as utilities and possible repairs if you are looking into an older home. This will be a 15 or 30 year commitment and there are serious consequences for not paying your house payment; you could loose your home.

How to Calculate How Much of a House You can Afford

To calculate how much of a house you can afford, start by adding up your monthly debt payments. Then calculate the front end ratio. This will be done by taking your gross monthly income and multiplying it by .30. This is how much of a house payment you could comfortably afford with your income!

To figure the back end ratio, take your gross monthly income and multiply it by .40, then subtract your monthly debt payments. This is how much of a house payment you could comfortably afford considering your income and debt! Plan to use the lesser of the two figures.

The Elements of a House Payment

There are four main elements that make up a monthly house payment; they are Principle, Interest, Taxes, and Insurance. Principle is the amount you will borrow and interest is what you will be charged for borrowing the money. The taxes are for the property, and the insurance includes two different types. The first is homeowners or hazard insurance, it is up to you to choose a homeowners insurance agent. This is a yearly payment that can be divided into 12 and figured into your monthly house payment. The amount will depend on the insurance policy that you choose. The second insurance is mortgage insurance. Mortgage insurance is a special insurance charged for households that make less than a 20 percent down payment. This insurance protects the lender in the event that you default on the loan (or in other words, miss a monthly payment). This insurance is not to protect you. If you miss a house payment you are still responsible for making up the payment. It only takes three consecutive missed house payments to start the foreclosure process. Foreclosure is the legal means of repossessing your home should you fail to make the payments.

Steps Involved in Purchasing a Home

Begin by seeking homebuyer education. You can contact The U.S. Department of Housing and Urban Development (HUD) to find an approved homebuyer education course in your area. Visit www.hud.gov or call 1-800-569-4287.
Prepare your credit record. Is your credit in good standing? Do you need to improve your rating or establish a non-traditional credit report? (For more information, see Credit found in the Resource section of this site.)
Determine how much of a house payment will be affordable to you and your household.
Shop for a lender. Compare fees, interest rates, closing costs, and personality. Chose someone you will enjoy!
Obtain pre qualification. This is an estimate of how much money you could potentially borrow.
Establish your needs and wants in homeownership. Make a list of your needs and your wants prior to looking for a home.
If you choose, contact a realtor. Realtors are familiar with the housing market and can assist you in finding the house that meets your criteria. The seller generally pays the realtor’s commission.
Make an offer. A realtor can assist you in making an appropriate offer. Offers are usually dependent on the inspection, appraisal, having a clear title, and actually receiving the loan.
Contact your lender for the loan. (Some experts recommend receiving loan approval before making an offer.) This can give you some additional help if there are others making offers on the same property because you will actually have been approved for the loan and not just pre qualified.
Order a home inspection for the home you want to purchase. Your realtor and lender will have suggestions on who to use. The charge for using a home inspector will be added into your closing costs.
Shop for and choose a homeowners insurance policy. Remember to consider flood and earthquake insurance if appropriate.
Under the Real Estate Settlement Procedures Act (RESPA) you are to receive paperwork that outlines the costs you will incur in receiving the loan. These documents include:
- Good Faith Estimate – obtained at pre qualification, it lists the charges you will likely pay at closing and give you an estimate of the monthly mortgage payments associated with the loan.
- HUD-1 Settlement Statement – indicates the actual charges you will have in purchasing the property.
- Truth-in-Lending Statement – this informs you of, among other things, the annual percentage rate, who will be servicing your loan, the monthly payment, payment due date, number of payments expected with the loan, and any penalties for any prepayments or late payments.
Attend closing. At closing you will sign papers making the sale final. You will be required to bring a cashier’s check to cover the closing costs.
After the transaction is recorded with the county you can move into the house!

Preparing for homeownership can be a lengthy process; especially if you need to reduce some of your debt. Finding a home can even be a difficult task. Remember to communicate well with your family your needs and your wants, and seek further education. HUD approves housing and financial counseling agencies to teach homebuyer education. They request 8-12 hours of education to be eligible for financial assistance programs. There are many different assistance programs (financial and educational) available to help families achieve the dream of homeownership. Contact HUD to find a housing counseling agency in your area that can give you more information on available programs, www.hud.gov or call 1-800- 569-4287.

Information Adapted from: Utah State Family Life Center’s Opening the Door to Homeownership Booklet; Leona K. Hawks Ph.D., Professor, Utah State Extension & Lucy Delgadillo Ph.D., Assistant Professor, Utah State University Family Consumer and Human Development Department; U.S. Department of Housing and Urban Development, www.hud.gov