When you start thinking about buying a home, most likely you begin with how much house can you afford to buy. I know that’s how I started. But the way to really look at how much you can afford is to think of your Buying Power in terms of your monthly payment.
There are many factors that go into calculating the actual price range of homes you can afford, but for simplicity we will make some assumptions. You have a 20% down payment toward a 30-year fixed rate loan, good credit with FICO scores in the mid-high 700s, and you have a stable job where you can show pay stubs each month — basically, a solid buyer.
In our example, let’s say you have decided you don’t want to spend more than $3,000/month on your mortgage (of course there are other expenses like property taxes, insurance, HOA, etc). If interest rates are 6.25% today, then this means you can have a loan amount of $487,000; add your 20% down payment and this gives a purchase price of $609,000.
I know there are quite a few buyers “on the fence” right now who would like to take a “wait and see” position because they think prices are going to drop further due to all the bad news in the media. I completely understand, and waiting for prices to drop may make sense depending on your underlying reason for buying a home.
However, waiting also comes with a risk. For the same example above, lets say you are determined to wait until home prices drop further before you jump in to buy a home. If during the time you are waiting, interest rates go up 1/2 of a percent (from 6.25% to 6.75%) this will impact on your Buying Power. Now, at 6.75% your same $3000/month mortgage budget can only get you a loan of $462k, and with your 20% down payment, your Buying Power came down to $578k — basically the 1/2 percent of interest increase has cut down your Buying Power by 5%.
In the end, your Buying Power is the most important component of buying your home. It may not make sense to wait for home prices to come down 5% (from $609,000 to $578,000 in our example) because if interest rates go up 1/2 of a percent during the time you are waiting, the same home will still cost you $3,000/month mortgage.
So while you are waiting the home prices to come down more, you also need to pay attention which direction the interest rate would go in the future. Put together your Buying Power profile and when you feel it is as strong as you can get, you should focus on finding the right home that fits your profile no matter what is happening in the overall market.