If you’ve ever driven through a neighborhood of million-dollar homes, you probably wonder how on Earth these people can afford them. Did you ever stop to think if you could one of those people that own a million-dollar home, though? It may be more possible than you think.
It comes down to crunching the numbers. Here’s what you need to know.
Do You have the Down Payment?
It’s probably no secret that you will need a large down payment. We’re not talking 3.5% like you would find on an FHA loan or even the 5% on a conventional loan. At a minimum, you would need 20% down on a home. If the home cost $1,000,000, that means at least $200,000 down.
So let’s start there. Do you have that type of cash lying around? If you don’t have the money in a checking or savings account, think about your investments. Stocks, bonds, mutual funds, and ETFs all count. You can liquidate those investments and put the money down on the home. It’s just another investment, so to speak. Once you buy the home, you will gain the appreciation in the home, which turns into equity. Depending on where the home is located and the state of the market, you might even make more money investing your funds in the home rather than stocks and bonds.
Can You Pay the Closing Costs?
Don’t think that the $200,000 is all that you will need. There’s still that little matter of closing costs. Actually, it’s not little, as they could amount to as much as 5% of your loan amount. If you borrowed the full 80%, so $800,000, you could be looking at closing costs of as much as $40,000.
Again, you’ll need liquid funds to pay these costs. It could be your checking or savings funds or money tied up in an investment as long as you can get it out. Don’t include money you have tied up in a retirement account. You probably can’t touch those funds. If you can, it will likely be a loan that you would have to pay back and lenders frown upon that.
What’s Your Debt Ratio?
Assuming you have the cash and can prove it, now it comes down to your income and debt ratio. If you don’t work, but rather live off your investments, you may be able to use that money as your income. Basically the lender needs to see that you can afford the very large mortgage payment.
Just what debt ratios will they allow? You can count on the lender being a bit stricter than they would with a non-jumbo loan. We are talking about a million-dollar home here, so they have to cover their bases. Just what a lender will require will vary by lender. Let’s use the standard conventional guidelines for informational purposes. This means your housing payment can’t exceed 28% of your gross monthly income and your total debt ratio cannot exceed 36% of your gross monthly income.
If your ratios are slightly higher than this, you might be able to get an exception if you have compensating factors. In this case, we are talking about reserves. Once you put down the $200,000 and paid the $40,000 in closing costs, do you have anything left? Again, we are not talking about retirement accounts here – those don’t count. We are looking for liquid assets that you can liquidate in a matter of days and use to make your mortgage payment.
If you have that type of money somewhere, figure out how many months of mortgage payments it would cover. The more reserves (or monthly payments) you have, the better your chances of getting approved to buy a million-dollar home.
Figuring out if you can afford a million-dollar home works the same as figuring out if you can afford any other priced home. It comes down to your income and how much money you have. If you have assets that are not performing well, you might want to take that money and invest it in a home. Depending on how much you have, you may just be able to buy those million-dollar homes that you drool over as you drive through the fancy neighborhoods. You won’t know until you try.