Preapproval vs What You Can Afford
Keep in mind that when the bank preapproves you for a loan amount they are only evaluating your income, debits and current assets. They don’t know whether or not you like to get a Venti from Starbucks twice a day or need to have the nicest clothes. All they care about is making money off of your interest. Do not take what they preapprove you for as your budget. You need to balance your income with all of your other expenses (car payments, electricity, gas, TV & internet) and what you want to save to determine what you can truly afford. It is not just the price of the home that you need to take into account when considering affordability. Property taxes, which vary from county to county, can be as much as 1/3 of you monthly payment. Understanding all upfront and monthly costs is critical to having an accurate idea of what you can afford.
Closing Costs & Down Payment
Knowing what you can afford in terms of upfront payments is relatively easy since it can only come from assets you have right now. You should be expecting an average of 5%-6% in closing costs on top of what you expect to place as a down payment. There are many fees from the bank, but you also usually have to pay for a year of many expenses up front at closing. You may have to pay the taxes for the remainder of the year if the previous owner has already paid for the full year. You will likely have to pay for a full year of homeowner’s insurance up front as well which can run about $1000.
Do not be too afraid of using a painfully large portion of your savings to put down on a house. All of that down payment is equity directly into the house. If you are young and have many earning years ahead of you, draining the savings is the right thing to do in the long run. It helps to make sure you have family who could help back you up if there is an emergency while your reserves are low.
What you can afford when it comes to a monthly payment depends directly on your monthly income after taxes and all of your other expenses. At the end of the day you should also be saving some amount of each paycheck for a rainy day.
LOADS of more information coming your way on the down payment, mortgage and taxes!