If you’re in the market for a new home or an investment property, one of the first questions you’ll ask is, “What can we afford?” Many buyers become so caught up in how much they can afford that they don’t realize their TOTAL BUYING POWER — that is, the total amount of purchasing potential they actually have.
Buying Power Defined
Your buying power is comprised of the total amount of money you have available each month for a mortgage payment. This means the money you have each month after fixed bills and expenses. Any money you’ve saved for a down payment, the proceeds from the sale of your current home, if applicable, and the amount of money you’re qualified to borrow all impact your buying power as well. When you take all of this into account, you may find you’re able to purchase a larger home or a home in a more desirable neighborhood, or you might realize you should be looking for homes in a lower price range.
What About Housing Affordability?
Housing affordability is a metric used by real estate experts to assess whether or not the average family earning an average wage could qualify for a mortgage on the average home. Although this figure is essential to creating a comprehensive overview of the real estate market, it’s not a factor you should consider in your home search. What may be considered affordable to you, based on your income and other factors, may be different than what’s affordable to the average buyer.
Why Buying Power Matters
A common misunderstanding is that a home’s list price determines whether or not you can purchase it. Although it’s important to look at the price tag, it’s essential to consider what your monthly payment will be if you own the home. After all, the purchase price doesn’t include the housing-related expenses, such as annual property taxes, homeowner insurance, associated monthly fees and any maintenance or repairs. Figuring out the payment will prevent you from overestimating or underestimating your buying power. After all, you’ll live with your monthly payment, not the sales price.
Once you have clarity on your buying power, you’ll be able to buy the home you want, instead of settling for a home because you feel it’s the only one you can afford. It will also prevent you from becoming “house poor,” a common term for someone who’s put all their money toward the down payment, leaving them nothing left over for fees outside of their monthly house payment.
Both scenarios can negatively impact the lifestyle you want to live. Understanding your buying power can help you get the home you want without sacrificing the lifestyle you desire.
4 Things That Impact Buying Power
1. Credit score. A great score can help you lock in a lower interest rate.
2. Debt-to-income ratio. The lower the ratio, the better risk you may be to lenders as long as you have an established credit history.
3. Assets. Your assets list should include the documentation of where the money for the purchase is coming from and the mix of your investments.
4. Down payment. The more you’re able to put down, the less you’ll have to borrow. With a down payment of 20% or more, you won’t have to purchase private mortgage insurance (PMI) and you may also be able to negotiate a lower interest rate.
How to Save for a Down Payment
If you’re thinking of buying a home one day, one of the first steps to take is to start saving for a down payment. Here’s how to make saving easier.
Tips for First-time buyers:
1. Set a savings goal. One way to figure out how much to save is to use the average sales price for homes that are similar to what you want and figure out your target down payment percentage. For example, if homes are selling for $200,000 in your area and you want to put 20 percent down, you’ll have to save $40,000. Set a goal to save that amount within a specific time frame. Just keep in mind the longer you have to save, the more the average selling price will change.
2. Cut back on expenses. Review your monthly expenses and look for ways to save. Think about items you can live without or cut back on temporarily while you’re saving.
3. Look for ways to boost your income. Get a side job, or sell items online or at a garage sale, to increase your income in a short amount of time. Be sure to save any windfalls you get, including your annual income tax refund or work bonuses.
4. Check out home-buying programs. Your state, county, or local government may offer special programs, such as grants, for first-time buyers to use.
If You’re a Repeat Buyer:
1. Make your money work for you. If you don’t plan to buy for at least five years, invest it and let the compound interest work for you. Discuss this option with your financial planner or broker to see if this is ideal for you and your goals.
2. Tap into your 401(k). If you have a 401(k) plan, you may be allowed to borrow a portion of it, the lessor of up to $50,000 or half of its value, for your down payment. Remember, it’s a loan so you’ll have to pay it back. If you leave or lose your job before you’ve repaid the loan, you’ll have between 60 to 90 days to repay the balance or face stiff taxes and penalties.
Want to Buy an Investment Property?
Whether you’re buying a second home or a rental property, here are a couple tips to save for a down payment.
1. Tap into your equity. If you’ve paid off or paid down your mortgage on your primary home, you may be able to tap into your equity to purchase another property. Contact your lender to learn more about a home equity loan.
2. Get a partner. Find a friend or relative who’s willing to purchase property with you. Typically, you’ll split the costs and profits equally. Just make sure to work with an attorney to create a partnership agreement to fit your situation.