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With Interest Rates Falling, How Much House Can I Afford Now?

Mar 12, 2008
The bad news about the housing market slump is well known. In fact, this is undoubtedly the most widely forecasted housing slump in the history of the world. Just a couple of years ago when the housing market was booming, the hot question was, "When will the housing bubble burst?"

Well, the housing market bubble has burst and though it is not nearly as bad as some people would lead you to believe, it is nonetheless a slump. The good news is, as housing sales have fallen, interest rates have fallen, as well.

Recently, I spoke to someone who had purchased a home last year. At that time, he barely qualified for enough mortgage dollars to buy it. In the course of our conversation he sounded very confident when he asked me, "If interest rates are falling, doesn't that mean I could afford a lot more house now?"

It is true when interest rates fall, mortgage payments become lower and so more expensive houses become more affordable. However, there is more to qualifying for a mortgage than that. Actually, there are four things you have to be concerned with when you are figuring how much house you will be able to afford.

First, the down payment

For a standard mortgage, a lender will require 20% down. So if a person has $40,000 available to put down, he would only be able to look for houses priced up to $200,000 because $40,000 is 20% of $200,000.

Of course, there are non-standard loans where you may qualify with 10% or even 5% down, but then you have other considerations such as payments to a private mortgage insurer and higher interest rates. This problem doesn't exist when a buyer has $100,000 available for a down payment because $100,000 is 20% of $500,000. So probably, this buyer wouldn't be limited by the down payment.

Second, the buyer's income

Many lenders have eased the limits on borrowing due to income considerations. No-Income verification is one very popular type of mortgage today. Still, though qualifying is the order of the day, it would be nice to know a foreclosure is not inevitable.

An ancient lending practice is to loan mortgage money to a homebuyer in an amount where the monthly payment doesn't cause the buyer's monthly obligation to exceed 36% of his income. So, in a case where the buyer has no credit card debt or car payments and other debts, and he earns $6,000 a month, he qualifies to make a monthly payment of 36% of $6,000, or $2,160. Of course, many people are not as debt free as this which brings us to...

Third, other monthly obligations

If a buyer has determined he qualifies to make a payment of $2,160 a month and he has credit card debt of $300 a month and a car payment of $250 a month he will be left having been deemed able to make a monthly mortgage payment of $2,160 - $300 - $250, or $1,610.

Finally, the interest rate

At 7%, a monthly payment of $1,610 on a 30-year mortgage would qualify a buyer to borrow $242,000. This would be 80% of the price of the house he could purchase. So, he could buy a house for $302,500, assuming he has the necessary 20% down payment of $60,500.

At 6%, the mortgage could be up to $268,000 and at 5%; it could be a very healthy $300,000! The total price of the house with this scenario could be up to $375,000 after the 20% down payment of $75,000 is applied. Of course, if the buyer has more money to use as a down payment, he could afford that much more.

So, you can see the gentleman who believes he could afford more house this year than he was able to buy last year has a very good point! When he closed last year, interest rates were 7%. In fact, if he has been a good boy and has made all his payments on time, he should consider a refinance.

Basically, there you have a way to generally assess how expensive a house you can purchase at a given time. Just let me leave you with two parting pieces of advice.

First, only apply for a fixed rate mortgage. This way the payment will never go up. Second, don't play the interest rate market. In other words, if you are ready to purchase a home now, do it. Waiting until you think the market is as low as it can get, may back fire. Interest rates are low today, you can't be sure they will be tomorrow.
About the Author
Ed Lathrop is a successful Real Estate investor. He has developed EzCalculator, a Mortgage Calculator that shows you how to save $100,000 on your mortgage. Come visit this free site at Free Financial Calculator. Also, find out how to get your amortization schedule and use it to save big money at: Amortization Schedules Free. These sites are not owned by any lender, so no one will harass you for visiting!
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