The Bottom Line
Finding and purchasing an affordable home is becoming more difficult. Housing prices and mortgage interest rates are rising, making it more expensive than any time in recent memory to buy a home. But for those in the market, careful preparation can help you identify the home and mortgage that best fits your budget.
Buy or Rent?
For military families, the first step in finding a new home is deciding whether to buy or rent. Moving is a fact of life for servicemembers, and it's critical that you evaluate all possible outcomes. There are many factors to consider, including: up-front expenses, how long you expect to remain in the home, the cost of upkeep, resale value in your neighborhood, and whether the home is one you want to live in after you leave the service.
For purposes of this article, we will assume you are in the market to purchase a new home and need help navigating the increasing costs of homes and mortgages.
Rising Mortgage Rates
Mortgage rates fell to record low levels within the past year. During that time, the rate for 30-yr mortgages dropped as low as 3.25% and 15-Yr mortgage rates fell below 2.5%. Rates remain quite low, even if they've risen. You can get a rate today that is still well below what's been available historically.
Borrowers shouldn't panic, but they should understand the impact of rates on their home buying plans. As rates increase, your purchasing power diminishes. A higher rate will force your monthly payment to increase to cover a larger interest. For example, a 30-yr mortgage for $150,000 at 3.5% has a monthly principal and interest payment of $674. If the rate increases to 5%, then your payment would grow to $806 per month.
This doesn't necessarily mean the home is suddenly out of reach, but borrowers should prepare accordingly and move to lock in current rates as quickly as possible.
Finding Affordable Housing
According to the Case-Schiller nationwide Price Index, home prices increased by more than 10% over the past year. Higher home prices mean that you'll either need a larger mortgage and bigger down-payment, or that you'll need to adjust your expectations downward and find a cheaper home.
But some careful research can still turn up hidden gems or at least turn you into a more educated buyer with a better sense of available homes and prices. Learn about potential neighborhoods and the features that you need - home prices can vary by state, city and even neighborhood. Research the price range of houses in your desired area and make a list of your target homes. Keep in mind that many experts counsel buyers to avoid buying the most expensive home in the neighborhood because of potential appreciation and resale issues.
Be a Prepared Borrower
In order to ensure that your home purchase goes smoothly, you should begin understanding the home buying process well before your first meeting with a banker or real estate agent. These are key terms and factors that will affect how much home you can afford to buy.
- Debt-to-income ratio (DTI): A lender compares your gross income to your monthly debt expenses plus the expected monthly principal, interest, tax, and insurance payments on the new mortgage. This comparison results in your DTI. Lenders have a threshold above which they won't lend you money. For example, you must have a DTI of less than 41% to qualify for a VA loan.
- Credit history and score: Your credit history is represented by a credit score – a numerical value that lenders use to evaluate how likely you are to repay the loan. All lenders require a minimum credit score, usually at least a 620 credit score. Lenders also examine your detailed credit history, weighing the presence of negative items such as a bankruptcy, collection accounts, late payments, and judgments.
- Down payment: This is how much money you can pay in cash on your home before you take out the mortgage. The size of your down payment has a major effect on your loan size and the size of your monthly payment. Some loans will require you to pay 20% of the home price out of your pocket. Some loans are available with small down-payments, but require you to pay a monthly mortgage insurance premium. VA loans are available with no down-payment and no mortgage insurance.
- Loan type: Borrowers can choose a fixed loan, where the interest rate remains fixed for the length of the loan, or an adjustable loan, where the rate can reset or change over time. Borrowers should consider how long they plan to stay in their home and whether they feel rates are likely to rise or fall in the future, when evaluating a fixed versus adjustable rate loan.
- Loan term: Most fixed loans are available in 15-year, 20-year, or 30-year terms. The longer your loan term, the smaller your monthly payment. However, a shorter term can save you money on the total amount of interest paid on a loan. Be sure to evaluate all options and compare the monthly payment amount with total cost of the loan.
VA Loans
The VA Home Loan program is a great advantage for military homebuyers. The major features of a VA loan include:
- No down-payment required
- No need for Mortgage Insurance
- Lower interest rates
- Limits on Closing Costs
However, even with these advantages it's important to evaluate all your options. No down payment saves you money up-front, but it can put you underwater if you are issued a PCS and the home price has dropped significantly. That means it would be impossible to pay your monthly note by renting out the home, and you couldn't sell it at a price that would satisfy your outstanding mortgage. Be sure to speak with your on-base financial advisor for more help with VA loans.
Action Plan
To begin your home search, here is a four-step action plan:
- Build a realistic household budget to identify how much you can afford each month on a home mortgage payment, and don't forget to include your property taxes and homeowner's insurance;
- Work to reduce your debt and monthly debt payments for a better DTI ratio;
- Don't buy the most expensive home you can afford – maxing out your home buying budget will likely stretch you too far and not leave you room for emergencies;
- Get pre-approved for a mortgage by speaking with a lender before you begin home shopping – this will make the process work faster and run more smoothly.
