Mortgages

GLOSSARY:

• Fixed-rate mortgage
• Equity
• Gross income
• First-time home buyer

More Terms

RELATED LINKS:

• 5 steps to get the best possible mortgage rate
• Am I in a sound position to purchase a home?
• Would a 7/1 ARM be better for me than a 30-year, fixed-rate mortgage?
• Can you really afford a jumbo loan?
• Getting a mortgage: Finding the best loan

Q. I'm a first time home-buyer who has been approved for a stated-income home loan of $200,000. My loan, however, comes with an 8% interest rate. The actual home I buy will probably cost around $160,000. I need to buy this home on my own because my partner has horrible credit that would actually raise the interest rate more. And if I waited for an income-based loan, it would be for a lot less money (but likely a better interest rate).

Here is my question: Is it worth getting a loan now at 8% if that is the best I can do?

A. Your 8% loan is a little more than a percentage point higher than the current average rate for a 30-year, fixed-rate loan. So that's not a big penalty. If you had said 12% or 13%, waiting would make a lot of sense.

Now you need to figure out how much you can afford to spend on a house with your 8% loan.

Since you are a first-time home buyer, you don't have equity from a previous house to help with the down payment.

So let's assume you buy a $160,000 house, putting $5,000 down and borrowing the remaining $155,000 with a fixed-rate, 30-year loan. At 8%, you'd have to pay $1,137 a month for interest and principal. Taxes and insurance -- including mortgage insurance, since you are putting less than 20% down -- will add at least $200 a month to that and probably more like $300 to $400 a month.

Conservatively, your total monthly payments would be $1,337. But you shouldn't be surprised if it was more like $1,500 a month.

The general rules lenders use to determine if you can afford a house are:

• Housing costs -- including principal, interest, taxes, assessments or any other fees -- shouldn't exceed 28% of your gross, or pretax, income.
• Monthly debt payments -- including your mortgage, auto loans, utility and credit card bills -- shouldn't exceed 36% of your pretax income.

That means you'd need an annual income of $57,300 to $64,285 to keep those payments within 28% of your pretax income.

If you added just $500 a month for car payments, credit card, gas, electric and other recurring bills, that goes up to $61,233 to $66,666 a month to meet the total debt rule.

If you waited until you could qualify for a 30-year loan at the average interest rate of 6.9%, your payments would be about $117 a month less. Now your annual income could be as low as $52,285 a year to stay within the housing cost rule and $56,666 to stay within the total debt rule.

You didn't say how much you expect to be earning, but the biggest mistake first-time buyers make is spending more than they can afford. So work backwards from how much you expect to make to figure out the price range you should be looking at.

Follow Interest.com on Twitter.