Worried that you can't afford even an entry-level home in your market? You're not alone. John Burns Real Estate Consulting recently released a study showing that only 54 percent of U.S. consumers can afford a home priced at 20 percent of the median home price in their area.
That might sound discouraging. But the John Burns study found that housing affordability is increasing. That 54 percent figure has increased 3 percent because of mortgage interest rates that have steadily fallen. These lower rates equal lower mortgage payments, which makes homes affordable to a greater number of buyers.
And in more good news? You don’t have to wait for interest rates to fall even more. You can take steps on your own to make buying a home more affordable.
Lower interest rates mitigate rising prices
The good news for buyers worried about affordability? Fixed mortgage interest rates remain low.
According to the Freddie Mac Primary Mortgage Market Survey, the average interest rates for both 30-year and 15-year fixed-rate mortgages were hovering near three-year lows as of the week ending July 25.
The average rate on a 30-year fixed-rate mortgage was 3.75 percent, according to Freddie Mac, while this rate stood at 3.18 percent for a 15-year mortgage.
When your interest rate is lower, so is your mortgage payment, making your home loan more affordable.
Working against affordability today are housing prices. These, unlike mortgage interest rates, are going up. The National Association of REALTORS® reported that the median housing price across the country stood at $285,700 in June of this year. That’s an all-time high, and up from $273,800 a year earlier.
Put up a higher down payment
If you want to combat higher housing prices, and end up with a lower monthly mortgage payment, consider saving for a larger down payment.
It is possible to qualify for a mortgage today with a down payment as low as 3 percent of your home’s purchase price. But the larger your down payment, the more affordable your home will be.
First, if you put down at least 20 percent of your home’s final purchase price, you’ll avoid paying for private mortgage insurance, better known as PMI, when taking out a conventional mortgage, a loan not insured by a government agency.
How much you pay for PMI will vary, but you can expect to pay about 0.5 percent to 1 percent of your entire loan amount each year. On a loan of $200,000, then, you'd pay $1,000 to $2,000 a year. PMI goes away after you build up enough equity in your home, but it is a nice expense to avoid if you can.
Coming up with a higher down payment also usually means a lower interest rate. Lenders think you’re less of a risk to default on your mortgage payments if you’ve already committed more dollars to your home. Because you are then a safer borrower, lenders might reward you with a lower interest rate.
Finally, a larger down payment will leave you with a smaller mortgage to pay off, which will mean smaller monthly mortgage payments.
Say you buy a home that costs $200,000. If you put down 10 percent, you’ll be left with a mortgage of $180,000. If you take out a 30-year fixed-rate loan with an interest rate of 3.75 percent, your monthly payment, not including property taxes and insurance, will be $1,207. If you only come up with a down payment of 3 percent on the same home, you’ll be left with a total mortgage of $194,000. Your monthly payment, with the same 3.75 percent interest rate, will be $1,272, again not including property taxes or insurance.
That’s an extra $65 a month or $780 a year.
Saving for that down payment
You might wonder how you'll be able to save for a down payment. But it is possible, if you give yourself enough months to steadily build your savings. This, of course, requires that you start planning your savings long before you're ready to buy a home.
Cory Nichols, chief executive officer at Yes Life Financial in Richmond, Virginia, said that the best way to save for a down payment is to automate the process. He recommends setting up an automated direct deposit from your paycheck to a savings account created just for down payment dollars.
"Automation is the key," Nichols said. "Everybody has limited self-control. The more we can remove ourselves and emotion from saving for a down payment, the more successful we will be."
Boost your credit score
You can lower the cost of buying a home by increasing your three-digit FICO credit score. Lenders rely on this score to not only determine if you qualify for a mortgage but at what interest rate. Generally, the higher your credit score, the lower your interest rate.
Fortunately, it’s not difficult to increase your credit score. Pay your bills on time each month and reduce your credit card debt. These two steps will steadily increase your score. Just be sure to not close any credit card accounts you might pay off. Closing unused accounts could cause your credit score to fall.
A lower interest rate is important for affordability. Say you are paying off a 30-year fixed-rate mortgage of $225,000 with an interest rate of 5 percent. Your monthly payment, not including property taxes and insurance, will be $1,617.
If you instead qualify for an interest rate of 3.75 percent on the same loan, your monthly payment, again not including taxes or insurance, will be $1,452. That’s $165 less a month or $1,980 less each year.
Reduce your debt
Another figure that helps lower your interest rate and boost the affordability of a home? Your debt-to-income ratio.
This ratio measures how much of your gross monthly income your total monthly debts, including your estimated new mortgage payment, consumes. Lenders generally prefer that your debt equals no more than 43 percent of your gross monthly income. But the lower you can get this ratio, the better it is for your interest rates.
Logan Allec, a CPA based in Santa Clarita, California, and founder of the personal finance site Money Done Right, says that consumers can follow the 20/30/50 rule to keep their debts under control. This rule says that you should devote 20 percent of your after-tax income to long-term savings, 30 percent to things you want and 50 percent to things you need.
Allec says that things you need include car payments and mortgage payments, while things you want would include items such as vacations and high-end TVs.
"As wants tend to be more splurge items, such as a nice dinner out, it's easy to go over budget," Allec said.
Following the 20/30/50 rule, though, could prevent you from making this mistake and throwing your debt-to-income ratio out of whack.
Find a less expensive home
Of course, the easiest way to make buying a home less costly is to buy a more affordable home. That's the approach suggested by Deacon Hayes, Phoenix-based founder of financial blog WellKeptWallet.com.
Hayes said that you can't always afford to buy your dream home, at least not initially. What you can do, though, is to buy a home that you can comfortably afford and then steadily build home equity.
"Maybe your first home will be a starter home rather than your forever home," Hayes said. "As you build equity in your home, you might be able to upgrade in a few years to the home you've always dreamed of."
If you want a lower-priced home, you can search for a fixer-upper, a home that comes with a lower price tag because it needs renovations or remodeling work.
You can even take out a mortgage loan that allows you to roll the costs of fixing that home into your monthly mortgage payments, making it easier to handle the expenses of a renovation project. Freddie Mac now offers the CHOICERenovation mortgage that allows you to do this. You can also apply for the FHA 203K renovation loan that offers the same option.
Just be aware that there are several requirements you'll need to meet for either loan project, and that you will have to provide written estimates from contractors of the cost of your renovation project.