If you’re done being a renter, and are ready to commit to owning a home and all the responsibilities that come with that (30 years of monthly payments, taxes, insurance, and maintenance time/expense), then there are a few steps you need to take to become “buyer-ready”.
First, how much can you reliably afford to pay every month for a mortgage? You should pay no more than 30% of your monthly income towards housing (rent or mortgage). Banks call this your “front-end-ratio”. So if you earn $24,000/year (before taxes), or $2,000/month, you can afford $600/month in housing payments (30% of $2,000).
Second, how much debt do you have? How much do you pay out each month? If you divide your monthly debt payments by your monthly income, you get your debt-to-income ratio. If have a total of $500 in monthly payments on your auto loan, credit card, and student loans, then your ratio is 25% ($500 / $2000=0.25 or 25%). If you add in your housing payments ($600 + $500 = $1,100) and divide that sum by your monthly income, you get your “back-end-ratio” ($1,100 / $2,000 = 55%). When banks consider your loan application, they will expect ratios of no more than 30% on the front-end, and 40-45% on the back-end. So in this scenario, you would need to reduce your debt (pay off the credit card) down to $200-300/month.
Another factor banks consider is your credit score. It reflects how reliably you’ve paid back money you’ve borrowed in the past. If you were late on payments, or missed them altogether, your credit history records this for up to 7 years, and your credit score reflects your behavior. The lower your score, the harder it is to get a loan. It also can cost you more in fees, and/or require more in down payment. For most banks, a score of 660 or higher is required. If you’ve never borrowed money (had a credit card or loan), then you may not have a score at all.
Most banks require 20% down payment, which on a $200,000 home is $40,000. This is to motivate you to pay your monthly mortgage because if you were to walk away from it, you would lose that money. But there are alternative programs for low-income households that require as little as 5% down. They also have down-payment assistance programs which are basically a second mortgage for the down payment only. These are usually for a shorter time period and may have a higher interest rate. In any case, a minimum of $1,000 for down payment is expected, plus there are “closing costs” associated with the actual purchase transaction which can run $2,500 – $5,000 or more.
The USDA has a program for rural areas like ours which targets low-income households, for example a family of four that earns less than $45,100/year. Their loan will include down-payment and closing costs, as well as a lower interest rate (currently 4%) and longer term (33 years). If the family cannot afford to pay the full monthly mortgage payment, then the USDA will only require them to pay 24% of their monthly income. The rest of that payment becomes a second loan which the family doesn’t have to pay until they sell the home. This makes ownership affordable to people despite their low-income, as long as they have very little debt, a good credit score, and reliable income.
To learn more about becoming “buyer-ready”, contact the Chaffee Housing Trust at 207-4348. We have financial counseling and homebuyer education available for FREE, as well as affordable homes for sale.