The girl: Katie
Job: government contractor
Where she calls home: the Midwest
The place she wants: $127,000
Her sitch: Katie wants to buy a home, and she has her eye on one in particular: a foreclosed two-bedroom condo in a neighborhood she describes as "absolutely perfect."
Asking price: $127,000.
"Eventually I'd like to buy a townhome," she says, "but I see this as a great starting point".
Her finances: Katie makes about $38,000 a year doing government contract work, but her job isn't permanent and she has no health benefits -- she's still on her parents' insurance for now. She has about $40,000 in student loans, and sends $475 a month toward the balance. She also has about $20,000 in cash, and her parents would likely help her out with a down payment, if necessary. She rents an apartment for about $650 a month, not including utilities, and she's saving $700 a month toward an eventual down payment.
The expert's take: It might be a good time for Katie to take the home ownership plunge, says Boston financial planner Cheryl Costa. "She can probably more than afford this home," Costa says. But there are a few things she should keep in mind before plunking down her hard-earned savings. For one thing, Katie may not meet certain bank requirements. When you're purchasing a home, banks like to see that all of your home-related expenses (principal, interest, taxes and insurance) don't exceed 28 percent of your gross monthly income. And they typically require that all of your long-term debts (including the house) don't exceed 36 percent either.
If Katie picks up a 30-year mortgage for $127,000 at 5 percent, she'll owe $682 a month. Assuming about $150 a month for property taxes and homeowner's insurance, the house would cost less than $887, or 28 percent of her monthly pay. If she puts down a 10 percent down payment (or more), she'll have even more breathing room. The problem is her student loans: The additional $475 a month puts Katie's total debt over the 36 percent that some banks require.
How She Can Get in the Door: Get prequalified. Many banks buy into the 36 percent number, but not all. "Sometimes there's a lot of leeway on that," Costa says. But Katie won't know either way until she picks a bank and goes through prequalification. The bank will do a detailed analysis (including a credit check) and tell her how much she's approved to borrow -- or if she's approved at all. "You'll find out in advance whether they think the student loan thing is a deal-breaker," Costa says.
Extend her student loan terms. Katie's student loans are currently on a 10-year term, but if she extends them to 25 years, her monthly payments drop to $288 a month -- which would probably get her in under the 36 percent mark. If prequalification reveals that she needs to do that, it's a smart move. Then -- and here's the secret -- she can keep paying it off at the 10-year rate to nix the debt sooner. (So long as she can swing it.)
Put down as much as possible. "Nowadays, banks like you to have at least 10 percent and even 20 percent for a down payment," Costa says. Twenty percent for this condo is $25,400, which is more than Katie has in the bank, but if her parents can help her make up the difference, she should take them up on it. A down payment of that size could keep her from having to pay PMI, or private mortgage insurance.
But don't put down everything. Katie has $20,000 in savings, but that doesn't mean she should clean out her bank account. Home ownership comes with surprises, and it's wise to have some cash on hand, just in case. "They could raise condo fees," Costa says. "Or any number of unexpected things could happen that she might need some padding for." Consider a new gig. Katie's job now is contract work, meaning she has no guarantee that she'll still be employed when the contract ends. "If she were to lose her job, she's kind of screwed," Costa says. "If she really senses that her job is uncertain, I'd encourage her to be looking for a new job before she commits herself to a mortgage that she may or may not be able to afford."