How Much Do You Need to Buy a House?
This question is especially important for those of us living in the San Francisco Bay Area and Silicon Valley, where home prices have appreciated dramatically in the past several years. In addition, an era of rising and "normalization" of interest rates from historic lows will impact a buyer's ability to afford a monthly mortgage payment. The market dynamics are changing quickly. It is important you know how much home you can afford so you can balance the rest of your financial goals- saving for retirement, saving for college, paying off student debt, starting an emergency fund, etc.
The answer to this complex question involves not only the initial costs of buying a home, but also your ability to keep up with the long-term financial responsibility of owning it. The process starts with making a list of the features you want in the home. Next, look at the neighborhoods and the surrounding amenities. Then, research the location’s listings and the final selling prices. The information provides a good view of the market’s activity and the cost of the homes in the area.
Ryan Nickell from EQ1 Real Estate, located in San Jose, CA, provided the following insight regarding the local Silicon Valley market dynamics:
"Currently, there are currently 18.2% price reductions County wide, out of 1,425 homes currently for sale in Santa Clara County. Back in the winter, there were only half as many homes on the market. This is increased inventory, plus a slight softening of the seller market, which is better for buyers because there are deals and diamonds in the rough now, with some $1.5M properties only seeing one offer. There are also around 20% of all homes are sold off-market, so who you work with matters."
How Much House Can You Afford?
The typical industry formula is to calculate your potential mortgage against your annual income and current debt. This is called the 28/36 rule, and it determines how much of a mortgage you can qualify for.
The "28" (known as the front-end ratio) means your monthly mortgage payment (including taxes and insurance), shouldn't exceed 28% of your pre-tax income.
The "36" (known as the back-end ratio), means your entire debt load, which includes your mortage as well as car payments, credit cards, student loans, and other monthly debt payments shouldn't exceed 36% of your pre-tax income.
Having a formula is nice, however what you can actually afford to buy will vary depending upon where you are buying (your geographic area), your spending habits, the cost of living in your region, and your overall financial health.
Enduro Financial utilizes industry standard benchmarks as a starting point. The decision to purchase a home is one of the most important financial decisions a client can make. We want to ensure that our client's have considered all of the financial impacts of this decision before they start the process of house hunting. It is also important for a client to consider the psychological aspects of purchasing a home- "Fear of Missing Out" and "Keeping up with the Jones'" can be two common mistakes. Before you house hunt, I recommend you speak with a fee-only financial planner to help you figure out how much you can afford now and account for your other financial goals.
"So bottom line, in Santa Clara County, for instance, your down payment would be around $260,000 on a $1.3M property. Avoid over-extending yourself, it is crucial to have extra funds to make up the difference should you get into contract and your home appraises lower than purchase price. You will make up the difference in cash, which is essentially increasing the amount of equity you have in your soon-to-be new home" explains Ryan Nickell.
Mr. Nickell also recommended, "Along with your offer submission, consider increasing your earnest money to make a stronger offer. Also keep in mind, cashier's checks or wire transfers are the preferred methods of depositing earnest money. Standard contract reflects 3 days to deposit in escrow, but if you write “Buyer to deposit earnest money deposit within 24 hours of Acceptance” you inspire confidence in the seller and listing agent to go with your offer in case of a tie-breaker. We don’t recommend using your credit card because it could negatively impact your credit score, which can hurt your chances of getting your mortgage loan."
Out of Pocket Costs
Most homebuyers have no idea of the additional costs not covered in the mortgage loan. The out-of-pocket costs include the down payment, home appraisal, cash reserves and a home inspection.
- Down payment percentages range from 3-20% depending on the loan type.
- Appraisals average from $300 to $600. The purpose is to confirm the purchase price does not exceed the market value of the home. The seller may pay this fee. If the home appraisal comes in lower than the purchase price, it may be time to renegotiate.
- Cash reserves in the bank are dependent on the loan conditions. It's a safety net for the bank, preventing early defaults on a new loan.
- Home inspection cost is $200 to $400 and worth the expense before closing, since the seller may be obligated to pay for the repairs.
Total Cash Needed
The numbers may change depending on the lender, your credit and the seller. Let’s say you found a home in Silicon Valley and made an offer to purchase it for $2,000,000.
- You’re approved for a 30-year fixed loan with 20% down – no private mortgage insurance (PMI).
- Appraisals average from $300 to $600. The purpose is to confirm the purchase price does not exceed the market value of the home. The seller may pay this fee. If the home appraisal comes in lower than the purchase price, it may be time to renegotiate, although not in Silicon Valley. To win, buyers are offering with no contingencies.
- Home inspection cost is $200 to $400 and worth the expense before closing, since the seller may be obligated to pay for the repairs. Sellers always perform the home inspection up front so buyers are purchasing “as-is” and the playing field is even because they want a bidding war.
- Reserves may include the loan principle and interest, annual real estate taxes, and insurance, along with two months of mortgage payments. Cash reserves in the bank are dependent on the loan conditions. It's a safety net for the bank, preventing early defaults on a new loan.
- Total cash to buy this $2,000,000 home could reach $440,000.
- As a side note, typically the seller pays the real estate commission fees which run about 5% of the purchase price.
Rolled into the loan are closing costs at 2-3% of the loan amount. Using the above sample – at 2%, fees could reach $40,000 dollars. You could negotiate with the seller to pay all or a portion of the closing costs.
Before you buy, make sure you run your numbers to make sure you will be 100% comfortable with your new mortgage payment. Also ensure you understand the terms and conditions of your loan, as they could significantly increase your out-of-pocket expenses. In addition, try to avoid closing delays, which could cost you prorated interest.
If you have specific questions regarding how much home you can afford, Enduro Financial is here to assist. Make a complimentary 30 minute "Get Acquainted" appointment here:
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
Enduro Financial is a Registered Investment Advisor registered in the State of California.
EQ1 Real Estate and Ryan Nickell are not affiliated with Enduro Financial.
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