Your first step is to determine how much money you are comfortable paying each month when it comes to your housing costs. There are rules of thumb that can help you decide how you want to proceed. The most common rule of thumb is the 30% rule; your housing costs should not exceed 30% of your income each month.
However, don’t assume that a rule of thumb is the best way for you to decide whether or not you can afford a house. Your true measure of your readiness to purchase a particular home should be how comfortable you are with the cost.
Take a realistic look at your finances. Add up your income, and then add up your expenses. Consider how much your housing costs would increase if you decided to buy a home. Would that added expenses stress your finances. Take a look at the amount that 30% of your income represents. If you feel as though you might have to stress to make it work, perhaps you shouldn’t go by the 30% rule. Maybe spending 25% or 20% of your income on housing costs makes more sense.
Be honest about your financial situation, and how stressed you are about money. Don’t buy a home that will require you to stretch in order to make payments. In those cases, you are one unexpected repair from being unable to meet your mortgage obligation. Determine what you are truly comfortable with, and stick with that amount for your total housing costs.
Acknowledge Other Housing Costs
You need to realize that the cost of buying a home is not limited just to your principal payment and your interest. There are other costs that come with home ownership:
- Homeowners insurance
- Property taxes
- Increased utility costs
- Repair and maintenance costs
Maybe you’re comfortable spending 25% of your net monthly income of $4,000 on housing expenses. That means you feel good about spending $1,000 on your monthly housing costs. This doesn’t mean that you can “afford” a $1,000 a month mortgage.
What you really need to do is consider your other costs. Your homeowners insurance might cost $600 a year. That’s $50 per month. Your property taxes might be $1,200 a year, or $100 per month. Utilities might add up to $300 per month, and you average about $50 per month in maintenance and repair costs.
If you add those costs up, that comes to $500 a month. Now, you either pay $1,500 a month on total housing costs — that’s almost 38% of your income — or you adjust your expectations for your mortgage payment to $500 a month so that you can stick with your 25% limit. If you want to follow the 30% rule of thumb, then your total costs would be $1,200 a month, $500 in non-mortgage costs, and $700 for your principal + interest.
Many people forget to include the extra costs of home ownership in their calculations when deciding how much home they can afford. They get a mortgage that pushes the limits of what they are comfortable with, and then are unpleasantly surprised when their total costs end up being much more than expected.
As you attempt to figure out how much home you can afford, don’t forget about all the costs of homeownership. You might need a smaller home, and a smaller mortgage, in order to ensure that all of your housing expenses are affordable.
Don’t Use “Creative Financing” to “Afford” a Bigger Mortgage
One of the issues that caused serious problems in the United States was that various financing methods were used to make homes seem more affordable. Low initial interest rates made it seem like a bigger mortgage was affordable, since the interest payments started out lower. But when the interest rates adjusted to something more “normal”, the situation changed. The payment went up, and suddenly the home was unaffordable.
Be careful of loan officers that try to tell you that you can “afford” a bigger mortgage with the help of special financing programs. You are better off making sure that you can truly afford a more conventional financing arrangement, even if it means that your home ends up being a little bit smaller than you originally thought. If financial trickery has to be used in order to allow you to feel as though you can “afford” your mortgage, the truth is that you can’t really afford it.
Take Your Mortgage Payment for a Test Drive
Before you sign the paperwork and commit to a mortgage, you should make sure that you truly can afford the increased costs. One way to do this is to take your mortgage payment for a test drive. Figure up how much you think you are comfortable paying toward your home expenses each month, whether you decide on a dollar amount, or whether you decide on a percentage of income.
Next, add up how much you pay right now for your housing expenses. So, if you currently pay $800 a month in housing expenses, and you think you are comfortable paying $1,200 a month, you take the difference and bank it. In this case, the difference is $400 a month. You keep paying your current housing expenses, and then you make an extra “payment” of the difference between what you pay now and what you expect to pay later to a bank account. A high yield account is ideal for this purpose.
By banking the extra amount you will have to pay when you buy a home, you are testing out the affordability of your new payment. Every month for six to nine months, bank the difference between what you pay now, and what you will pay as a homeowner. Gauge how your finances are handling the change.
Do you find yourself putting away a little less than the full amount some months? Do you feel stressed trying to make ends meet when you have that much extra going someplace else? Be honest about the impact setting this money aside is having on your finances, and your feelings about financial security. If you are struggling, then perhaps you can’t truly afford that big of a home, and that large of a mortgage.
If, on the other hand, you find that you can handle the increased payment, it is probably an indication that you are on the right track. Even better, you now have a decent amount of money saved up in a high yield savings account. You can add that money to your down payment, use it to pay points on your mortgage, or use it to buy something for your new home, such as furniture or new window treatments.
Buying a home is a big commitment. You have to be prepared to repay the loan over time, and you want to make sure that you can afford the payments. Before you even start looking for a home, sit down and look at your financial situation. Evaluate where you stand, and where you want to be. Decide how much money you can afford for mortgage payments each month. Once you know that, you can restrict your home search only to the houses that fit your criteria of affordability.
Don’t forget about your various expenses, and don’t forget that you have other goals, such as retirement or family vacations, to work toward. Don’t make the mistake of over-extending yourself and becoming house poor. You’ll get a home you can afford, and you’ll be a lot less stressed about money in the long run.