How to determine how much house you can afford
Planning is key
Not many things are more exciting than buying your first home. It doesn't matter if you're purchasing a downtown loft or a country cottage; you probably knew it was meant for you the moment you saw it. But, before you sign all the papers and move into your new living quarters, you simply have to determine how much house you can afford.
Separating emotion from wisdom can be tricky, especially in this case. At the end of the day, it's a place where you picture many of your future memories will happen. So, when you find a home that matches your fantasies and the desires of your loved ones, it can be intoxicating enough to throw all the caution to the wind. This usually leads to committing to a larger house than you can afford. And if you want to avoid financial stress, this certainly isn't a thing you want to do.
Why you need to be cautious
We all want to live in a house that makes us feel carefree and to which we can't wait to get back after a long day. The idea that the home is a nest that makes you feel warm and safe is appealing to everyone. However, as data shows, the reality is often different. There are more and more foreclosures every year.
If you do your budgeting based on good times, you're basically working on a recipe for foreclosure. As the past has shown us, recessions arrive with some regularity. Therefore, if you're not careful, a thing like a once-in-a-century pandemic might catch you off-guard.
People forget that there's a bit more to buying a home than making the monthly payment. You can't forget about the cost of homeownership and downturns in the economy that may occur.
So, there are a couple of different ways to think about monthly mortgage costs relative to your income. Only when one of them checks out can you think about preparing and looking for a moving company that will ensure a relocation that goes smoothly. Here are the two rules that you should consider.
It's crucial to stay cautious when trying to determine how much house you can afford.
The 28% rule
In reality, there are dozens of formulas for the ideal housing expenditure. One of the most common among them is the 28% rule. It is based on the premise that you should spend 28% or less of your gross monthly income on house-related costs and expenses.
For instance, if you earn $60,000 a year, that means your total housing costs shouldn't be more than $1,400 a month. Now, you need to understand that we're not talking just about the mortgage here. This money should cover all of the following:
Mortgage principal and interest
Insurance and taxes
Homeowner association dues
Private mortgage insurance (if you need any)
A well-accepted name for this is the front-end ratio. It's one of two debt-to-income ratios that pretty much all mortgage lenders use to determine whether you can or cannot afford to purchase a particular home.
Of course, if you're buying a home with your significant other, you can always join the funds and calculate it that way. However, if you go down this path, make sure that both of you will have the same or higher income over the next years.
The 36% rule
The second way you can determine how much house you can afford is popularly called the back-end ratio. It encompasses your total monthly housing costs, but also any other existing debt payments and obligations. These include:
Housing costs (everything from the 28% rule)
Loan payments (car, boat, or personal loans)
Child support
Alimony
Credit card debt
If we apply this rule to the $60,000 per year scenario, we learn that your monthly payments shouldn't be over $1,800. There are mortgage lenders that will allow for a higher front-end or back-end ratio. However, it's strongly advisable to make sure you're not over-stretching your finances if this is the case.
Front-end and back-end ratios are what lenders use to determine if you're viable for purchasing a home.
Additional expenses
Once you buy your home, you can't expect everything to be and stay as perfect as you may wish. There will always be a thing like a garage door opener or a water heater that goes on the fritz. So, making repairs is an unavoidable part of being a homeowner. Luckily, there are ways to plan for maintenance.
Plan to spend at least 1% of your home value each year to keep it functioning correctly. So, if your home is worth $300,000, you'll need about $250 a month for repairs.
Put aside 10% of your mortgage costs each month for repairs. For instance, if your total expenses are about $1,600, plan to spend $160 a month on maintenance.
Don't forget to ask your real estate agent about tax records for the past five years on the property you're considering. If the taxes have risen in the past few years, that can indicate that the trend will continue. Also, check out copies of bills for the past six months, just in case.
Performing all of these checks is a great way to manage your home buying anxiety. You just need to make sure that you have enough for three to six months of living expenses tucked away as an emergency fund, and you can be completely carefree.
Always make sure to have enough money left over for additional expenses.
Before you fall in love with your new home
If you're following a dream of creating a warm nest for your family, but you also want to sleep well at night, doing everything right with the numbers is one of the most essential things. One thing you need to understand is that it's not about how much you want to spend, but how much you can spend. Keep that in mind when trying to determine how much house you can afford.
