If you’re thinking about buying a house – or upgrading from your current house, you may be wondering about price. How much house can you afford? In what price range should you be shopping?
These are not always easy questions to answer, but with a bit of knowledge they can become easier. A home purchase is a major life event, so it’s important to gather as much information as possible.
What types of questions should you consider? What do you need to know before taking the plunge into home ownership? Check out these tips for helping you buy a house you can afford.
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Buying a House You Can Afford
The last thing you want as you move into your new home is to be strapped for cash. Home ownership comes with a lot of little extra expenses that renters may not have.
There are repair bills, maintenance bills and home improvement costs. There are annual property taxes, homeowner insurance costs and more.
Here are some things to think about as you decide on how much to spend on your home purchase. We’ll also share a calculator designed to help you figure out how much to spend on your new home.
Knowing the information that can help you choose a comfortable home purchase price will help make the home-buying process smoother.
Calculator: How Much House Can I Afford?
This online calculator will help you determine how much house you can afford. Note that the calculations here are simply an example. Only you can truly determine how much house you can afford.
We’ve set the calculator up so that it chooses a home amount based on certain DTI parameters. The calculator will help you stay within a 28% front-end ratio and a 36% back-end ratio.
These parameters are lower than what you’ll find at most lenders, however they’ll help ensure you avoid overborrowing. Mortgage Calculator
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What did the numbers show? Did the calculator show that you could afford more house than you thought you could, or less?
While only you can determine what is a comfortable house payment for you, getting other opinions can be helpful. Just be sure to choose a home that will allow you to have enough financial flexibility to live your life.
What is Your Current Financial Situation?
It can be a good idea before buying a home to get a clear picture of your current financial state. Use a spreadsheet or piece of paper to write down your current financial numbers.
Write down all of your assets, liabilities and current monthly expenses. Create a monthly budget of your current expenses if you don’t already have one. Don’t forget to include little, extra expenses such as entertainment expenses and miscellaneous spending.
Assess your savings account and the equity in your current home if you own it. Determine how much money you have to put down on your new home purchase.
Knowing exactly where you stand financially will help you as you make your purchase decision.
What Kind of House Do You Desire?
Now that you know exactly where you stand financially you’ll want to consider another question. That question is “What kind of house do I really want?”
Yes, it’s tempting to buy the biggest and best house you can possibly afford. After all, the home we own is a symbol of our success, isn’t it?
I noticed something interesting after 15 years of working in consumer banking and mortgage. Working in banking taught me that the wealthiest people didn’t always have the best houses. Conversely, I also learned that the people with the best houses weren’t always wealthy.
The take away here is that while a house may appear to be a symbol of your success, it can also be a huge burden if you buy more than you can afford.
So, when considering how much house you can afford, you need to consider other factors as well. Factors such as:
- Am I prepared to repair and maintain a big house?
- Do I want to clean a huge house?
- How much of my income to I want to spend on housing each month?
- How many years do I want to be tied to my job in order to have this house?
The type of house you choose will have an impact on many other areas of your life. It will determine how much discretionary income you have left over at the end of each month. It will dictate how much of your time is used to pay for the house and maintain it.
Although it might seem tempting to buy the biggest house you can afford, it’s important to think long-term. You may not need a 3,500 square foot house for you, your spouse and your two kids.
And if buying one that size will take all of your weekends to clean and maintain, you may want to consider something cheaper.
Cheaper Isn’t Always Better
Conversely, you don’t want to buy something that’s too inexpensive or small for your needs. Don’t buy a fixer upper if you don’t want to spend every weekend working on it. Think twice about buying a 1,000 square foot house that will have the kids tripping over each other.
Don’t buy a two-bedroom house if you have two kids and plan on adding two more soon. Buy a home that will fit you for as long as you plan on living there. And buy a home you’ll be happy staying in if you have to.
Be wary of buying something that you don’t like or is too big or small. And buy something you can love even if it’s not perfect. Too many people sacrifice important home characteristics with the thought that they will simply move if they want to.
You may plan on moving in five years, but things have a way of changing. If you can’t stand the idea of being stuck in a house forever, you may want to keep looking. Especially if there are things about the home or neighborhood that drive you crazy.
Every person and family has different personal and group needs. Your income, your need for personal space, the time you spend in your home; it all matters. And it should all come into factor as you determine what type of home you want to buy.
My advice? Shop a LOT. Look at several different types of houses and sizes of houses before making a purchase decision. If you don’t want to do outside maintenance, consider a townhome or condo. Or, consider hiring out each week for lawn service.
Buy the right amount of house for your needs – both long and short term.
What are Your Other Financial Goals?
Your other financial goals may not seem as if they have a bearing on your home purchase, but they do. The amount of money you spend on your home will have a direct impact on your other financial goals.
Every dime you spend on the house you buy is a dime you can’t spend on your other goals. This is a major reason why price consideration is SO important.
If a primary goal for you is travel, you’ll want to make sure your house payment doesn’t hinder that goal. If you want to reach financial independence soon, the same goes.
It may be helpful to figure out your other financial goals before you decide how much house you can afford. That way you can determine how much of your income you need to funnel toward those other goals. The leftover can then be used to decide how much you want to spend on housing.
We often don’t think about other financial goals in relation to our housing purchase. It’s not until we see our mortgage payment hindering other purchases that it becomes clear.
You read a book on financial independence and it shows you how you can get there in 10 years. However, your massive house payment means you don’t have the extra money to save.
Or you want to save to pay for your kid’s college but you just don’t have the extra money. Being house poor means your house payment is so big that there’s nothing left over to pay for extras.
Whether that’s saving for college, for retirement or just having money to go out to eat, it all matters. Your mortgage payment should be small enough that your discretionary income allows you to live as you wish.
But My Loan Officer Says…
I know – I know. Your loan officer says you can afford a much bigger house that what this article says you can.
And maybe you can. However, working 5 years as a sales assistant in a nationally recognized mortgage company taught me some things.
First, your loan officer will likely want to qualify you for the maximum mortgage amount he or she can. Second, that amount will likely put a burden on your finances.
Let me explain a little bit about how the mortgage industry works. For each type of loan (conventional, FHA, etc.) there are “front-end” and “back-end” debt-to-income ratios (DTI).
Your front-end ratio is your DTI with just your house payment alone. Your back-end ratio is your DTI including your mortgage payment and all other debts.
For example, let’s say your gross income is $5,000 per month. If your projected house payment is $1500, your front-end DTI is 30 percent. Let’s say you also have a car payment of $300 and a student loan payment of $100 each month. Added up, this means your back-end DTI is 38 percent.
A lender might have a rule about a 35/41 back-end, front-end DTI on a conventional loan (this is typical). If so, your mortgage payment can’t take up any more than 35 percent of your gross income. And your combined debts can’t take up any more than 41 percent of your gross income.
The problem is that you really don’t take home $5,000 a month. After taxes, benefits deductions etc., you probably take home more like $3700 per month.
A $1750 payment (35% of $5,000) will have a bigger impact on your net income than on your gross income.
Therefore, it’s important for you to use your net income when factoring how big of a mortgage payment you want.
Your House Shouldn’t Be Your Only Financial Goal
It’s also important to consider your other expenses and your other financial goals. Just because the “system” says you can afford a payment doesn’t mean that payment won’t hinder your lifestyle.
Although your loan officer likely has the best of intentions in helping you, the system’s goal is to make money.
When I was in the mortgage business, we were constantly trained to “help” clients by approving them for larger loans. We were told over and over how it was our “job” to help them achieve their home ownership dreams.
The bigger the loan we could get them approved for, the more we were “helping” them reach their dreams. As a loan assistant it felt good to be praised for being such a big “help” to clients.
But looking back and living through the housing market crash, I see things much differently now. Five years of working directly with people on how to gain control over their finances has taught me different. It’s taught me that financial security is much more helpful than having your dream house.
So be your own advocate when determining how big of a payment you can truly live with. Take your loan officer’s words into consideration but be the one who ultimately determines what you can afford.
More Tips for Buying Affordably
As I’ve mentioned before, lenders often have much higher front-end/back-end allowable ratios than what I’ve suggested here. In fact, when we bought our current house the lender allowed a back-end ratio of 45%.
Our mortgage payment was truly uncomfortable for our income level, but because we had excellent credit they stretched the ratios.
Those first few years of making such a big mortgage payment were NOT fun. There was no going out to eat, and every unexpected expense was a financial burden. This is called being “house poor”.
Some people have trouble making payments or finding discretionary income because they’re not managing income well. These types of scenarios can be solved simply by setting up and utilizing a monthly budget.
Don’t Become House Poor
However, if you’re budgeting strictly and still struggling to make ends meet, you may be house poor. As far as numbers go, “house poor” could be defined as having a mortgage payment exceeding 40% of your income. I talk about that more in this article on how to avoid becoming house poor.
Simply put, house poor means that you have too big of a house payment for your income. It means your mortgage payment is so large that you have little left over in your budget for other things.
When deciding how big of a house to buy, it’s important to remember that your payment isn’t the only factor. Houses always come with extra expenses. There are repair costs. And there are maintenance costs.
There are replacement costs – and those costs are often quite large. It’s not uncommon for a new furnace or central air unit to cost thousands of dollars. Replacement roofs, windows and appliances are also quite expensive.
How can you avoid having your house put you into a situation where you are or feel house poor? Here are some recommendations.
Keep Your Front-End Ratio at Twenty-Eight Percent or Lower
As I mentioned above, the calculator we created uses a front-end/back-end ratio of 28/36. Some financial experts would even say 28% is high and suggest keeping your mortgage payment under 25% of your income.
The less of your income your mortgage payment takes up, the less of a burden your home will be. Keep that in mind as you shop for homes.
Start a Home Repair Fund
Another way to avoid becoming house poor is to start a separate savings account for future house related expenses. We all know that furnaces, windows and appliances will need to be replaced eventually.
The problem is that you never know when those items will begin to fail. It could be next month or it could be in five years. Either way, you don’t want to be caught unprepared.
One way to prepare for those types of expenses is to modify your budget to include money for home emergencies. Add a line item in your monthly budget for your “home repair fund”. Put some cash in it every month.
As the home repair account grows, you’ll become more prepared to pay cash to replace items such as windows. If an appliance goes out or if the roof needs replacing, you’ll have it covered.
Then you can avoid the shock of being presented with a large bill and not having cash to pay it. You’ll simply pull the money out of your home repair fund and go on your way.
Create an Emergency Fund
Another way to avoid having your house payment hinder your money is to have a basic emergency fund. While your home repair fund will specifically cover items for the home, and emergency fund is different.
An emergency fund will help you pay your bills should you become unemployed. If you get laid off from your job, you may have a period of time where your income is down.
This could make your house payment a burden as well. An emergency fund would help you make house payments (or some of your house payment) during this “no income” time.
The money in an emergency fund is used specifically as income replacement during a job loss. How much cash should you have in your emergency fund?
We suggest a minimum of three months of living expenses, preferably six to twelve months of living expenses. This will give you a solid financial cushion until you find replacement income.
Think Twice About Choosing a Variable Loan Rate
Variable mortgage loan rates can be attractive to prospective homeowners because they’re generally lower than fixed rates. However, unexpected rate increases – and the resulting higher mortgage payments that come with them – can be burdensome to home owners.
A variable/adjustable rate mortgage can be a good deal if you don’t plan on owning the house for long. But if you think you’ll own the house for longer than 3 to 5 years, a fixed rate is best.
It will provide you with a stable house payment you can count on for years to come. Of course, tax and insurance amounts can change, but the basic principal and interest payment will remain steady.
Put at Least Twenty Percent Down
Although a large down payment on its own won’t help you avoid being house poor, it will save you money. Conventional loans with less than 20% down are required to carry private mortgage insurance.
Private mortgage insurance can cost upwards of a couple of hundred dollars a month depending on your initial mortgage amount.
If you put 20% down and avoid having to carry mortgage insurance, that’s one less expense to worry about. That “one less expense” will add up over the long term and help make getting through income fluctuations easier too.
Home ownership comes with many great benefits. It allows you to have something of your own and design it as you wish. There are also financial benefits such as mortgage interest deductions and equity buildup.
Many people have increased their net worth considerably through home ownership. They key is in buying wise. Choose a house that will allow for comfortable payments – even through periods of extensive repairs that are needed.
Plan financially for all aspects of home ownership and choose a home purchase price that doesn’t hinder your other dreams.
Be sure your mortgage payment amount allows you to travel, play and do the other things you love to do. Part of what makes home ownership fun is being able to still afford to live life outside of your home.
Make careful assessments of your financial situation before you buy, so that you don’t spend too much. Create a large down payment fund, a home repair fund and an emergency fund to give yourself added financial security.
Are you a home owner, or considering becoming one? If so, what steps are you taking – or did you take – to buy affordably? Share in the comments below.