Whenever people walk by expensive, Million Dollar houses, they do question themselves: how do the owners have all this money to buy luxury houses? The deal gets real when we enter our 20’s or 30’s, because now the wishing ends and planning begins. It’s cool when Mom and Pap have the money and you can take advantage of it.
For example: I know someone whose parents bought a house in Virginia in 1972 for $54K. He inherited it with no mortgage. It is currently valued at $2.35M. But that’s not everyone’s case. Sometimes you just have to start from the bottom, do the maths, work hard and plan your finances well.
In this guide, we’ll cover in detail the elements that are essential for your information to make the endeavour of a million-dollar house more accessible and financially feasible.
Following information will give you an insight to the financial planning process to afford Million Dollar house:
Annual income/salary
We are not claiming to cover the specificities of buying a million dollar house, however as a general rule an annual income above $200k- 300k is normally a baseline to start the investment in a Million Dollar house purchase. Going further this base amount is contingent upon other related factors like how much you can pay as the down payment and interest rate.
The base amount in the form of annual income is generally to cover ongoing costs – mortgage payments, insurance, taxes and other costs like homeowners association and maintenance fee.
Next, either you need your savings or other sources of earnings to provide cash reserves for upfront expenses like closing costs – a tentative amount could go from $50k – $100k and above. The cash reserves are normally an equivalent amount to your six months of mortgage payment .
This stands as a warranty amount for the lender in case the buyer defaults on their loan or loses their job or their income source. The payment factors and percentages vary from lender to lender based on their requirements.
There is a financial rule in the banking language called “28/36 rule” to help maintain your income-debt bubble from bursting off – spend 28% above of your gross monthly income on housing costs or 36% on your other debt payments.
Mortgage payments and calculations to buy Million Dollar House
When you are to do your mortgage calculations to buy million dollar house, following factors must be considered:
- Annual income
- Debt-to-income ratio (DTI)
- Credit score
- Available down payment
- Current interest rates
- Cash reserves
For example: If you are applying for a mortgage to buy a $1 million home, you need 20%+ down payment ($200k and above) , a credit score of 700+, your DTI (Debt-to-income limit) is 40%+ of monthly income. Next comes the cash reserves to cover 6-12 months of mortgage payments.
When people apply for housing mortgages, for properties $1M and above, the loan qualifies as Jumbo loan. Depending upon your income and debt ratio the Jumbo loans have a big range from $700k plus up to $1M and above. But here’s a caveat to these loans, their lending features are stricter than other loans. Never forget Jumbo loans are not sponsored by the government and come with considerably higher interest rates, demand greater down payment or bigger cash reserves and higher closing costs.
Warning on Jumbo Loans – If you are offered a Jumbo loan with extremely reduced down payment or lowest to none Private Mortgage Insurance (PMI) it could be a bait; because to cover the risk the lender of the Jumbo loan can charge higher down payment, more interest and bigger closing cost and more.
Downpayment
Whether your mortgage is a government sponsored loan or a jumbo loan, normally its initial lending demands a down payment of 20% as minimum or more – so roughly from $200k – $300k in gross amount. As mentioned above, in case of securing a jumbo loan the down payment amount may vary as per criteria shared by your lended.
But here’s a simple maths – smaller down payment equal to higher monthly instalment, which also translated to the fact there will be more interest accrued over time as the number of instalments also increases with small down payment and vice versa.
Another case could be where depending upon your financial standing, you cannot afford to make a downpayment of 20% or above, you may have to apply for private mortgage insurance (PMI). The PMI protects your down payment if the buyer defaults on loan. If you are working through a real estate agent or financial advisor they will tell you that private mortgage insurance (PMI) incur an additional cost of hundreds of dollars to your monthly mortgage payments.
This is particularly the scenario if your down payment is lower than 20%, your lender, especially in case of Jumbo Loans, will likely require you to purchase private mortgage insurance (PMI), which protects them if you default on your loan. PMI premiums could hike your total housing costs by hundreds of dollars per month.
Private Mortgage Insurance (PMI)
For those aspirant home buyers who cannot afford to make a downpayment of 20% or above, in their house mortgage, can avail the Private mortgage insurance (PMI) – which is basically mortgage insurance. To begin, it’s a viable option in case you have financial constraint to avail mortgage or other conventional loans, however it can put your financial standing to default if you are unable to male loan payments.
The PMI refinance your mortgage, when your equity is lower than 20 percent of your house value. The lenders of PMI are private insurance companies, and PMI although refinance your mortgage, but it only protects the lender against loss caused by borrowers in case your financial standing reaches to default and you as a borrower either fall late or short in your loan payments.
There have been cases where the burrowers lost their $Million houses through foreclosure, as they could not make the loan payments to their Private Mortgage Insurance (PMI) and the lender company received all the compensation. So it’s safe to say that Private Mortgage Insurance (PMI) is a short term financial loan with higher risks, against zero protection by the lender insurance companies.
Homeowners Association (HOA) fees
When doing the monetary estimation and financial planning of a Million dollar house, there is an exponential cost termed as Homeowners Association (HOA) fees. The HOA fees cover maintenance costs of areas like gyms, swimming pools, etc in luxury homes.
The HOA fees depends on your house location and services offered – typically go from from $100-$700 per month
House ownership and other unexpected costs
Other than mortgage and down payment, there are other significant costs that will be incurred once you own the house, some are continuous and never ending, others are occasional, but all must be kept in account to avoid any financial stress.
The compulsory ones include the following:
- Property Taxes: For high end property these can go from $500 to $1,000 or more a month. Property taxes, on average 1.1% of the home’s assessed value, vary from state to state.
- HOA and Condo Fees: So basically your homeowners’ association (HOA) or a condominium association fee is a payment that occurs on monthly or quarterly bases for services that benefit the entire neighbourhood, like collection of the garbage and snow ploughing, or it depends on your area or state.
- Homeowners Insurance: This is basically a charge by the Banks or your mortgage lending financial institution, and it automatically includes in your mortgage payment. Usually, homeowners insurance are the premiums that are paid from your escrow account. The caveat about homeowners insurance is that these premiums rise annually.
Credit score
If you are looking for a conventional loan to finance your million dollar house then all the bank or the lender institute will look for is your credit scores, which should be 620 or above.
However, to cover up your minimum mortgage or down payment, if you’re applying for jumbo loans then it demands a minimum credit score of 740, however these requirements may vary depending upon your lender’s terms and conditions.
Debt to income ratio
The debt to service ratio is done to assess your financial situation as a mortgage buyer. It is a ratio of annual mortgage payments and some other significant costs to the amount of combined annual household income. Normally the lenders want a Debt to income ratio below 32%.
For instance if your annual income is $300,000 and the annual mortgage payment and related costs are $90,000, then your ratio would be 30% (90,000 / 300,000). But if the annual costs, let’s say, goes up to $100,000, then your ratio would rise up to 40%, and it may be a struggle to get loan approval.
Tax implications of a million-dollar home
It’s always prudent to think ahead about how your new million dollar house purchase will influence your income tax payment. It has multiple considerations to be kept in mind, like if the interest amount on your mortgage exceeds your present
You might not anticipate how your new home will affect your income taxes. For example, you can lose potential tax savings if your mortgage interest exceeds the current deduction threshold – it is the value that determines the limit of your tax-free activity. In most income tax systems no tax is payable until income reaches a tax threshold
Do not forget that your mortgage interest tax deduction has a limit of $750,000. So for instance if as a mortgage burrower you put down less than $250,000, you will lose your tax savings each subsequent year until your principal loan balance drops below $750,000.
Conclusion
Buying or financial planning of a million-dollar house could incur more costs and steps than ones mentioned above. As a buyer you are always advised to do maximum research before investing any money or filing for any mortgage process as there are multiple and multi layered costs, tax implications, and financing details. Take in your consideration all the factors when investing in a Million Dollar house.
If you’re interested in investing in an affordable million-dollar home, you can contact HR PROPERTY DOCTOR – our veteran estate agents will provide you complete information with financial options and risk management based on your income standing.