Beyond Financial Independence

Your Home: How Much House Do You Need – Part II

June 3, 2012 · Joe McLaughlin · Comments


I was asked to cover a few more topics on the issue of “How Much House Do You Really Need”. This article applies to first time home buyers primarily, but others can also take something of value from this article.

In this article we will cover how you can build equity in your home, the monetary waste of mortgage insurance and  how to not pay it and determining how much you can afford when looking to purchase a new home.

Building Equity (AKA Wealth) In Your Home

If you are in an apartment like I was for over 8 years and you take a look at the cost of your rent, you will see how much money you are wasting. My rent was $650. Now over a period of five years my rent averaged to be around $575. Now if we do some math we come up with $575 over 60 months which gives us $34,500. That’s a lot of money that I threw away.

If I was in a house I would have been paying off my mortgage with that money. Almost all of the money that you pay towards your mortgage in the beginning is paid towards interest. After a few years with you making your house payment more of your payment will be put towards the actual mortgage what banks call the principal.

Meaning if you have paid $10,000 in mortgage payments part of that goes to interest, and part of it goes towards the principal. The money that is paid towards the principal gives you direct equity in your home.

As I stated before if you have paid $10,000 on your mortgage perhaps $4,500 of that will paid to the principal, the rest is interest. But that $4,500 that you have paid is direct equity in your home. Meaning it’s not wasted like renters’ payments. So if you sell your home that is worth $100,000 you will get that equity back, plus whatever premium you get for selling the home at a higher price due to real-estate prices rising.

Over time this is one way that people build wealth in their home. This same principal is used by real-estate investors. They will buy homes and rent them out. The renters pay all the bills in the form of renter’s payments. This allows the real-estate investor to build considerable wealth, especially when more than one investment property is used in this method.


Mortgage Insurance

Mortgage Insurance also known as PMI. Do you need it? Well, no actually, but the banks require you to have it if you have put less than 20% down towards your mortgage. However, you can still avoid PMI by paying down your mortgage to 80% or lower of the total mortgage value. This means that if you purchased a home for $100,000 you will be paying PMI until you pay down the mortgage to $80,000. Once you reach this level inform your lender and they should remove the PMI fee that is added onto your mortgage payment each month.

Why is this important? It’s important because it puts money back in your pocket. Without PMI you can save $25-$150 or more per month depending on the value of your mortgaged home. That’s money that you can then set aside to pay off more unsecured debt (credit cards) or as Jay says, “Don’t even think about it. Put it right in your hoard”. More money in your hoard means you are that much closer to becoming financially independent.


Determining What Price You Can Afford

If you are looking for a home to buy you will often see the total price and then a monthly price next to it. The first thing that I could say is “Don’t believe it.” That is a marketing tactic that is used to draw people in. Usually that monthly price that is listed is only the principal. They leave out the interest, taxes, PMI and home owner’s insurance from the total payment. This usually results in the price being a couple hundred dollars more a month.

 So how much home can you afford? Well it helps to know what is actually in the mortgage payment. The acronym PITI is used to describe what’s in a mortgage. You have Principal, Interest, Taxes and Insurance. Now the insurance is home owner’s insurance, but if you don’t put down 20% you will be required to pay PMI as well.

The best way to determine what you can afford is to sum up all your monthly bills towards debt into what you call “your monthly debt bills”. Most mortgage companies if not all will ask you to do this anyway. Your total monthly debt payments cannot exceed 36% of your gross monthly income.

Your DTI or Debt to Income Ratio is also important. To figure out what your DTI is divide your pre-tax income by the amount used to pay off debts on a monthly basis. This will also include your credit cards, but it only uses the minimum payment per month in the calculation.

Knowing these two numbers can help you determine where you stand right now and help you determine if you can afford a house and if so how much of a payment can you afford. Don’t forget how to calculate the entire payment using PITI.

By understanding these mortgage calculation numbers and knowing about your current financial position, you will be in a much better position to deal with loan officers. You will understand their questions and be more comfortable with the entire process.

CommentsTags: Cache