Housing Costs...Buying and Closing

How Much House Can You Afford?

Buying a house involves a thorough examination of your financial resources. For years, potential buyers were advised monthly housing costs should not exceed 25 percent of their net (after taxes) monthly income -- or the purchase price of the house should be no more than 2 to 2.5 times the annual income. In times of inflation, it drops to 1.5 to 2 times your annual income.

To determine how much house you can afford, take into consideration four issues: your monthly cash flow, your cash reserves or savings, your future monthly housing expenses, and your purchase cost.

Before looking for a home, determine how much you can spend on your home monthly, how much you can afford to spend for a down payment, and the costs involved in closing.

Analyze your present spending and saving patterns. Use the worksheet to calculate your monthly income, monthly non-housing expenses, and monthly housing expenses present and proposed.

Figure your monthly income -- your take-home pay, and profits from business ventures, interest and dividends, and any other monthly income.

Next, estimate your monthly living expenses. Be realistic. Do not leave out expenses because they don't occur every month. Remember -- most months have unforeseen expenditures. Add a safe sum for savings and emergencies.

Calculate your present monthly housing expenses. Divide any annual expenses by 12 to get the average monthly cost.

Add your housing and non-housing expenses. Subtract this total from your net monthly income to determine how much money you have, if any, to use in upgrading your housing. Evaluate your proposed housing expenses now.

In addition to the monthly cost, be prepared to pay initial or one-time costs when you purchase a house. These costs include the down payment, closing costs, moving expenses, and any improvements you wish to make on the property you purchase. The initial cost may run anywhere from a couple of thousand to many thousands of dollars. Much depends on the cost of housing and the size of the down payment required by the lending institution.

After you determine how much money you have for future housing expenses, contact local mortgage loan offices for estimates of the maximum mortgage you can obtain and the maximum monthly payment you will be able to meet. This will help you determine how much you can spend for housing and still stay within your budget. In doing so, you will excessively trim other day-to-day expenses to pay for more expensive housing. Make a firm resolution not to overextend yourself.

Remember Closing Costs

The final step in buying a home is the "closing." In most cases, this is the meeting of the buyer and the seller, representatives of the lending institution, real estate broker (if one is involved), and attorneys representing the buyer, seller, and lending institution.

The down payment is made, the mortgage signed, and the deed is conveyed at the closing. In addition, many settlement costs are paid by the buyer at the time of the closing. The seller is responsible for the real estate broker's fee, for any points charged to the seller by the lending institution on the mortgage, and for any fees the seller has agreed to pay for or divide with the buyer.

Settlement and closing costs vary from one area to another and even from one lending institution to another. There are reasons for differences, including variances in local real estate practices and laws; the possibility of splitting costs between buyer and seller, or the assignment of cost to one party or the other; the type of mortgage obtained; and the buyer's efforts to shop around successfully and bargain with suppliers of closing services.

The Real Estate Settlement Procedures Act (RESPA), a Federal statute, helps protect the buyer at settlement. Although local practices and laws may vary, lenders are required at the time a borrower applies for a loan to provide a good faith estimate of the cost of settlement services and a copy of a booklet titled "Settlement Costs and You." Estimates help the buyer compare costs between lending institutions.

A uniform settlement statement also is available to the borrower one business day before closing. This shows the figures available at that time for settlement charges. At the settlement, the uniform statement is given to the borrower or mailed if there is no actual settlement meeting.

Settlement costs between buyer and seller. If a builder or a seller pays an entire year's property expenses in advance but sells it before the year is out, the amount paid beyond the date of selling is adjusted at the closing. The buyer reimburses the seller or builder the amount due. These adjustments include property insurance, if the policy is transferred from the seller to the buyer, and if applicable, any memberships that are a part of the home ownership. Your attorney can assist you in establishing how much ready cash at the closing you must have available to cover these costs.

Title search and insurance. The title of the property being purchased is as important as the house or lot. The title provides evidence of the ownership and may vary in quality. A clear title is not affected by any liens, spouse's rights, or easements. Before a property transaction takes place, a title search is made to discover if any problems exist. Occasionally, the cost of the title search is assumed by the seller or the cost is split between buyer and seller. A title search is usually performed by an attorney and is included in the attorney's fee.

Attorney's fees. The lending institution may charge for the services of its attorney to draw up the necessary mortgage documents. This may be a flat fee or may be based on a percentage of the mortgage loan. If you hire an attorney to represent you through the various stages of home purchase, that fee will be due at the time of closing or shortly thereafter.

Origination or application fee. This is the fee charged by the lender to cover the cost involved with processing the mortgage loan application. In some cases, the lending institution's attorney's fees are included with this charge. The fee varies with FHA- and VA-insured mortgages. With conventional mortgages, it may be a flat amount or percentage of the loan.

Property survey. If a large amount of land is involved, or if there is some question about property boundaries, the lender may require a survey of the property. Cost of the survey depends on the size and complexity of the property and, in many cases, the seller bears the cost of a property survey.

Credit report. The lender may charge a fee to cover the cost of obtaining a report of the credit history of the buyer.

Points. To increase profit on a mortgage, lending institutions sometime charge "points," an additional interest cost for the borrower. One point equals one percent of the mortgage loan. For example, if 4 points are charged on a $90,000 mortgage, you will be paying $3,600 in points. This is essentially up-front interest charges. Another way to look at this is that you are paying $3,600 to borrow $90,000. In other words, you are putting up $3,600 of the $90,000. You will be borrowing $86,400 from the lending institution while paying interest on $90,000. The wise consumer shops carefully for a mortgage and chooses the plan that charges the fewest or no points, all else being equal. For an FHA- or VA-insured loan, points may be charged to the seller as well as the buyer. When points are charged to the seller, often this increases the cost of the house.

Appraisal fee. The lending institution appraises property before a mortgage commitment is made. With conventional mortgages, the cost varies. With FHA- and VA-insured loans, the fee is established by government regulations. With a new house, several inspections may be made as the house is constructed and fees charged accordingly.

Recording fee. This is the charge made by a county to record documents pertaining to the purchase of property.

Mortgage insurance. This fee is paid by the buyer to a government agency or private insurer that guarantees the lender against loss if the buyer should default on a mortgage. Such insurance is required for FHA-insured mortgages and frequently for conventional mortgages if the loan exceeds 80 percent of the property value. The mortgage insurance premium is included in regular payments to the lender and usually equals 0.05 percent per year on the unpaid principle balance.

Although not required, many homeowners choose to take out life or disability insurance, the term of which coincides with the length of the mortgage. Such policies are designed to pay off the mortgage in the event of death or physical disability.

Escrow fees and accounts. Lenders often require an amount of money to be set aside for the payment of real estate taxes, assessments, and insurance premiums. The amount, if required, varies according to the type of financing, the time of the year the closing takes place, and local lending practices.

If a borrower is required to establish an escrow account, monthly mortgage payments may include the principle interest plus 1/12 of the annual total of real estate taxes, property insurance premiums, and other assessments (water and sewer taxes). The lending institution, drawing on the escrow account, pays the taxes and premiums as they are due.

Insurance. The lender requires the buyer to purchase fire and hazard insurance on the property at least in an amount to cover the mortgage loan. At the closing, the buyer must present proof of insurance.

If an appraisal of the property reveals it is in a flood plain as identified by the U.S. Department of Housing and Urban Development Flood Insurance Map, the buyer may be required to take out Federal Flood Insurance. This government-financed plan is administered by HUD but may be obtained through a regular insurance agent.

Miscellaneous. Your closing fee statement may also include special inspection fees, notary fees, and other incidental expenses. Any fee you are charged should be specified. Closing costs vary widely throughout Mississippi. Much depends on the price of the property and the manner in which it is financed. The buyer can take steps to reduce closing costs by following these suggestions:

• Before signing the sales contract, negotiate with the seller to share the cost of some of the items.
• Determine if an old survey and an affidavit from the seller will be acceptable in lieu of a new survey if one is required and no changes have been made since the seller purchased the property.
• Make a careful study of fees and charges made by various lending institutions. Choose the one with the best overall package.
• Compare the fees and services offered by at least three attorneys; select the one who will do the best and most economical job for you.

The closing of a house can be a frightening experience, especially for the first-time buyer. Documents are signed and checks are made out and passed back and forth across the table in rapid succession. You may be overwhelmed by it all but if you have prepared yourself carefully with your attorney and your real estate broker, you can have your closing costs closely calculated.

Step 1. Calculate monthly income Net pay (after taxes) $ ____________ 
Net profit (from business) ____________ Interest and dividends ____________ 
Other income ____________
Total net income (add) $ ____________ 

Step 2. Calculate monthly non-housing expenses  
Food (home and away) $ ____________ Transportation ____________
Installment payments on car, furniture, and other items ____________
Entertainment and recreation ____________ Clothing and grooming ____________
Medical care ____________ Child care ____________ Education ____________
Charity ____________ Insurance (life and health) ____________ Savings ____________ 
Other ____________ Total monthly non-housing expenses (add) ____________ 

Step 3. Calculate monthly housing expenses Present Future 
Mortage payment or rent $ ____________ 
$ ____________ Property taxes ____________ ____________ 
Insurance ____________ ____________ 
Utilities (gas, electric, water, phone) ____________ ____________ 
Maintenance (repairs, furnishings) ____________ ____________ 
Special services (yard care, trash pickup, etc.) ____________ ____________ 
Total monthly housing expenses (add) (3A) $ ____________ (3B)__________ 
(3B) $________________ 
Minus (3A) $______________________________ Equals (3C) $______________
Additional money needed for future house expenses  

Step 4. Total net income (Step 1) $ ____________ 
Minus total monthly non-housing expenses (Step 2) ____________ 
Minus total present monthly housing expenses (Step 3A) ____________ 
Amount available for future housing expenses $ ____________ 

Step 5. If the amount available for future housing expenses does not equal
or exceed the increase in future monthly housing expenses (3C), 
you must reevaluate your budget and resources.  

Mississippi State University does not discriminate on the basis of race, color, religion, national origin, sex, age, disability, or veteran status.

Publication 1661
Extension Service of Mississippi State University, cooperating with U.S. Department of Agriculture. Published in furtherance of Acts of Congress, May 8 and June 30, 1914. Ronald A. Brown, Director