Q. We live in a very expensive part of the United States and we need help deciding how much house we can afford and not overextend ourselves. We moved here for better employment opportunities, and between the two of us, we make a decent living. We also have three young children, so after preschool and child care costs, there isn’t a lot of extra money.
We have been able to save an average of $800 a month for the past few years in addition to making small contributions to our company retirement plans so we are eligible for the match. We had a small house in North Carolina and sold it right before the housing crash. Thanks to some appreciation and gifting toward our first house from both sets of parents, we were able to walk away with about a $65,000 profit. We have almost $120,000 between what we’ve saved on a monthly basis and what is left from the sale of our first home. Since our current rent is $1,600 a month, and now we are saving over $800 a month, we are confident that we could easily afford a mortgage where the monthly payments were $2,400 or maybe even higher.
A mortgage broker has told us we’d qualify for a fixed 30-year mortgage with a rate of 4.75 percent or lower. He has told us we could look at homes in the $750,000 to $850,000 price range. This would be great, since there aren’t many nice homes in the area selling for much less money.
Since our income will increase and the cost of child care will decrease as our children enter public school, he is suggesting we make less than a 20 percent down payment. We could then use the remaining savings to help make our mortgage payments until we get raises and the kids are all in public school. He also mentioned the possibility of a piggyback loan if we wanted to avoid PMI. What do you think?
A. I think this type of thought process is what got so many homeowners and mortgage brokers in trouble when the housing market collapsed in 2008.
If you feel certain that you can make a principal and interest payment of $2,400 plus taxes, insurance, higher utilities and have a contingency for unexpected maintenance issues, I would look at homes priced at $575,000 or below. This will enable you to make a 20 percent down payment and have a principal and interest payment of $2,400.
Do some research and find out what taxes and insurance on a $575,000 home in your area would be and begin saving that amount in addition to the current $800 a month. This will give you a good idea of what your lifestyle will be once you have the mortgage. You should also make a commitment to use your current furnishings until you do receive those anticipated raises (which don’t always materialize) or experience the decreased child care costs.
I know a higher-priced home is tempting, but before you decide to ignore my advice, you should know a few facts about private mortgage insurance and piggyback loans. Both can be expensive, and if you decide to put less than 20 percent down so that your loan-to-value ratio is below 80 percent, run the numbers to see which will cost more, PMI or the piggyback loan.
PMI protects the lender in case you default on the payments. You, the borrower, pay the premiums and the lender is the beneficiary. PMI fees vary depending on the size of the down payment, the loan amount, the lender and your credit scores. Typical fees range from 0.3 percent to 1.15 percent of the original loan amount per year. If you put 10 percent down on a $750,000 home and your mortgage was $675,000, PMI would probably add more than $3,000 a year to your payment. Once your loan-to-value ratio hits 80 percent, you should be able to cancel your PMI. Some government loans require mortgage insurance premiums for the life of the loan.
Piggyback loans are rare these days compared to the number made prior to the housing market collapse. You are basically taking out a second mortgage on the home to avoid PMI. They are usually an adjustable-rate mortgage, so your payments can rise over time.
You should be proud of yourselves that you still have all or most of the proceeds from your first home and have been able to save what you have while living in an expensive city.
On a final note, many people who had anticipated job security and/or pay increases have been surprised and disappointed when neither event occurred.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624