The Backwards (But Right!) Way to Finance Your Next Home

When it comes to getting a mortgage to buy your first home, 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 at all the way to start your home-buying experience. 

In fact, if you go about financing for your home this way, you’ll not only have a miserable experience, but it also could cause you to buy the wrong home!  

Follow these Four Steps — 

You’ll be all set and on the right path if you follow the 4 steps below.

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 way 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, 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 #3 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.  The difference in purchase price may be as much as $50,000 or more—that’s a huge difference in purchase price you need to account for!!

2. 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.

You should also be looking at your monthly budget so you can compare future home expenses to your current rent expenses. That will help you determine an affordable mortgage payment.  

Again, 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.  

3. 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 some first-time buyer programs.

Decide upfront how much cash you can put towards your home purchase. Will it include a gift from 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 won’t change your interest rate or really help anything from a loan standpoint. So you could 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 2.5% and 3% 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.  Many people think that 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. 

4. Now you’re ready with your 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. 

Hope this is helpful info for you! If you’d like to chat with a lender, we have a couple of amazing lender partners that we can refer you to. Just reach out!