By Ember E. Martin, CFP®
Living in Southern California is a dream. The weather is nice all year round with no snow in sight (except for the mountains). There are many things to do and many places to visit. Diverse communities with many cultures lend their own flair and personality to the area. It is no wonder why so many people want to own a home here.
But California living comes with a price—a high one at that. The national median home price for a single-family home is $226,800, (1) but in Southern California the median home price is $561,325. (2)
Before you put down roots for the long term, you need to know your numbers to figure out how much home you can afford.
Read below to start crunching the numbers.
What Is Your Total Household Income?
First things first, you need to know your total combined annual income for your entire household to serve as your baseline.
There are two ways to figure this out. First, retrieve your most recent W-2 and look at the “gross earnings” section. That is your gross income from the past year, before taxes and deductions. Do the same for every family member who contributes to the household. Then add it all up to get the grand total.
Or you can look at your most recent paycheck to find your gross income for one pay period. Take that number and multiply it by the total number of pay periods for the year. If there are other family members who contribute to the household budget, repeat the same process for them. Then combine everyone’s totals to get the total household annual income.
What Loans And Interests Can You Qualify For?
The type of loan you get will determine how long you will have to pay off the mortgage and how big or small your payments would be when broken down into monthly increments. Your credit score, with the help of a mortgage expert, will determine what interest rates you qualify for, which also impacts your monthly payments. Right now, the interest rate of a conventional fixed-rate loan is 3.660%. (3)
The most recommended loan is a conventional mortgage with a fixed interest rate. This loan typically is offered with 15-year, 20-year, 25-year, or 30-year options. The interest rate and the mortgage payments are always the same throughout the entire life of the loan, which makes it the most stable option.
Another loan option is an Adjusted Rate Mortgage (ARM). This is also offered with 15-year, 20-year, 25-year, and 30-year options. For this type of loan, the first few years of loan payments will be based on a fixed introductory rate. (4) This introductory rate can sometimes be lower than what you may qualify for for a conventional loan. However, once that introductory period is over, then the interest rate will change once per year because it will fluctuate with the market. You may pay a lower interest rate one year, but then it might spike the next year. Although lower interest rates allow opportunities to pay off more principal, the payments can be unpredictable year over year, which can be a source of stress and anxiety.
If you are a first-time home buyer, you may qualify for an FHA loan (5) (Federal Housing Administration), which would allow you to put down a lower down payment (as low as 3.5% as opposed to 20% of a conventional fixed-rate loan), but you would have to pay PMI (Private Mortgage Insurance). (6)
Note: If you are serving or have ever served in any branch of the armed forces, you can qualify for a special VA (Veterans Affairs) loan.
If you’re uncertain what you qualify for, a mortgage expert can provide you a list of loans you qualify for!
What Can You Put Down?
Buying a home always requires a down payment. Typically banks prefer home buyers to put down 20% of the home’s purchase price. If a home buyer puts down less than 20%, then the lender will need to include PMI in the home buyer’s monthly payments.
To figure out how much you can put down, first look at your savings account. Take stock as to how much you need for emergency savings (enough to pay household expenses for 3 to 6 months) (7) and how much you have leftover after to put toward your new home.
While it may be tempting to drain your savings account to get your dream home, don’t. Anything can happen and you always need to be prepared for a rainy day.
Affordability Ratio
The affordability of a new home needs to fit within your budget. Two factors to consider are the front-end ratio and the back-end ratio. The front-end ratio is the percentage of your annual gross income that can be dedicated to paying for the home, which includes principal, interest rate, taxes, and insurance (PITI). (8) PITI should not exceed more than 28% of your gross income. The back-end ratio is the percentage of your gross income dedicated to paying off debt, such as credit card payments and student loans. (9) Your back-end ratio should not exceed 36% of your gross income. A qualified mortgage expert will gather this information and calculate it for you.
Break Out The Calculator!
Buying your dream home in Southern California is more than possible. You just need to meet with a qualified expert to figure out your numbers as well as how much home you can afford so that not only can you buy a beautiful home, but you won’t break the bank either. Are you ready to figure out how much home you can afford? Schedule a call or meeting with our office at 1-844-548-2887 or make an appointment through our website here. If you need a little bit more time to think about it, we have free resources and content to provide you with the information you need. We are here to help!
About Ember
Ember E. Martin is founder and managing principal at Vested Wealth Advisors, an independent financial planning firm. With over 20 years of investment managing and financial planning experience, plus his CERTIFIED FINANCIAL PLANNER™ (CFP®) credential, Ember strives to help his clients live a high-quality life through customized advice and an unmatched level of personal service and confidentiality. Ember has become known for providing personalized guidance, creative solutions, and results-driven services that go beyond what many have come to expect from traditional financial advisors. When he’s not working, Ember enjoys sharing life with his high school sweetheart, Donna. You can also find him cooking, reading, traveling, hiking, playing chess, and spending time with his two teenage daughters, Lucie and Truly. To learn more about Ember, connect with him on LinkedIn.
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(1) https://www.businessinsider.com/cost-to-buy-a-house-in-every-state-ranked-2018-8
(2) https://www.zillow.com/ca/home-values/
(4) https://www.bankrate.com/mortgages/arm-vs-fixed-rate/
(5) https://www.hud.gov/program_offices/housing/fhahistory
(6) https://www.bankrate.com/mortgages/basics-of-private-mortgage-insurance-pmi/
(7) https://www.thebalance.com/is-your-emergency-fund-too-big-4142617