Lining up your finances for a home purchase this year? Spring is right around the corner. Here’s how to gauge if you should put more money down, or pay off debt to improve your figures.
Key questions to ask yourself:
- How much house payment can I manage while still being able to save money?
- How much house payment can I managing while saving money and paying off my consumer debts?
Fact is if you have access to the extra cash, you have choices determining how much house payment you can really handle to best position yourself for the long haul so you’re not married to your mortgage and your other obligations.
The key is being able to deduce the best use of your dollars so as to reduce debt while being able to manage a mortgage payment. Put simply, take a consider a mortgage payment low enough that you still have funds left over to allocate towards debts if applicable or to savings, i.e. don’t bite off more than you can chew. Easier said than done right?
No so fast cowboy, perhaps extra- dollars go into prepaying your mortgage every month which would save you thousands of dollars of interest over the term of the loan, that’s a no brainer benefit. Alternatively, maybe it might mean putting more down on the house in freeing up a lower mortgage payment to focus on paying off the consumer debt.
What it ultimately boils down to-what does is your long-term housing plan look like? Don’t know? Start with 5 – 7 year projection. Optimally, the best possible scenario from a good financial planning standpoint would be to have no consumer obligations of any kind or very little consumer obligations and carry a bigger mortgage payment meaning buying the house with less money down. Why? Well in most scenarios consumer obligations carry no tax benefit. A bigger mortgage means a higher mortgage payment, certainly true, but when you factor in after tax ramifications of having a mortgage payment knowing that your deductions improve by having a slightly bigger mortgage on your home, it might make more sense to pay off the consumer obligations first and use less down for the home sale.
Using the following example our home buyer has the following stats:
725 credit score
$8000 per month of income
$40,000 of consumer debts with payments at $700 per month
$450,000 home price
Total monies available to spend on buying a home including down payment and closing costs $100,000
Breaking It Down:
20% down would mean $90,000 as a down payment assuming a 30 year fixed rate mortgages 3.875%
Total mortgage payment including insurance and taxes would be $2210 per month.
Total liabilities each month $2,910 per month consumer debts+ mortgage payment + max debt allowance often called Debt To Income
Buy the house with 10% down with lender paid mortgage insurance for example so as to avoid an extra $175 per month in PMI
New loan amount at 405,000
Other cash used to pay off consumer debts
30 year fixed rate at 4.125% means the mortgage payment would be 2480 per month including taxes and insurance, but with out the consumer debt– make sense?
Instead of putting down the full 20%, at 10% down loan would actually be better on the monthly pocketbook if the other 10% that would have went to down payment instead went to getting rid of the consumer obligations, the net difference in these two scenarios is a whopping $429 per month. $429 per month means 40-50K in purchase price buying power meaning, buying more home with a lower payment giving you financial strength in competitive market.
The extra $429 per month generating by re-positing your dollars could very easily be used to either prepay the mortgage payment especially if you’re already used to making a higher debt load on a monthly basis, meaning no disturbance to cash flow. Another smart step to take- pocket the monies and build your savings for leaner times.
Not What You Pay, But What You Owe That Matters When Buying A Home
Not in all cases, but in the majority of the cases, investing the cash to get rid of the consumer obligations even if the consumer obligations are 0% interest more than likely is going to pencil favorably in the eyes of the mortgage company. Why? Mortgage companies look at minimum payment on each obligation each month. If you pay more great, but don’t expect the bank pat you on the back.
Know this: what might be a low risk loan for the lender does not necessarily translate to what might be a low risk loan for you as a would be home buyer, so it’s important to work with your loan officer in buttoning up your pre-approval to make sure you’re getting the best scenario to maximize your home purchasing velocity.
If you know for certain even if you put more cash down while keeping consumer debts, that you can pay off the consumer obligations while maintaining a mortgage payment that could be win-win at whatever point the future the consumer obligations are paid off. For example this type of approach could sandwich very nicely if your income is poised to rise in the future or if you’re going to be coming into some cash perhaps a gift, an inheritance, a promotion, a big commission whatever the case may be.
Those are all scenarios where getting the lowest possible mortgage payment might be the best approach, despite continuing to carry consumer debts. The challenge when buying a home is when you already, pre-home purchase, carry large consumer obligations. This is what the mortgage company uses to decide how much home you can qualify for. In this situation, using a small down payment down drives your buying power down. Meaning an offset would be required to this type of scenario anyone the following may work:
• Paying down the consumer obligations either with your own funds, possibly with retirement funds if necessary or a gift
• Switching loan programs– for example going with a loan with traditional mortgage insurance to a loan with lender paid mortgage insurance-reducing the ever present debt to income ratio
• If you changed jobs and got a salary increase -this can be considered (note lender will need an offer letter and a supporting pay stub)
• Possible new job with higher income in relationship to when you think you might be in contract if you are home searching on a longer time frame
• Getting a cosigner– in this scenario if you are completely maxed out with the mortgage payment against your income plus consumer obligations, while a cosigner will help you qualify for the mortgage, it does not necessarily paint a good financial picture from a personal financial planning standpoint. While it will help you qualify in the short term, the underlining support in the future i.e. income poised to rise or some way to get to a more stable financial picture should be evaluated closely.
Mortgage Tip: even as much as $500 per month in consumer obligations can very easily carry over to $100,000 in buying ability in a purchase offer situation. In other words, if you’re buying a home in competitive real estate market or will be, you put your best foot forward in really making sure you can compete while exercising good financial advice in reducing or eliminating consumer obligations. Whichever option you chose, more down or less down ultimately is yours to make, but, allocating your cash to whichever route gives you a more manageable financial picture should be a top priority.
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