How Much House Can You Afford?
Date: November 29, 2016
Owning a home is part of the American dream – a place of your own where you can raise your kids and your grandchildren can come to visit. Part of that dream might be reaching for the stars to buy the biggest and the best, but your income and budget might make that hard to do. So how much house can you afford? Here are a number of methods that can help you figure it out.
Let Someone Else Do the Work
Determining how much house you can afford to buy doesn’t have to be a calculation you must do on your own. “The home-buying process can actually begin with a mortgage representative up to a year before even looking at homes,” says Maria Sacco Handle, a sales representative with Berkshire Hathaway HomeServices and Prudential Fox and Roach in Brigantine, New Jersey. “The mortgage rep will look at the buyer’s entire financial profile and let him know how much house he can afford and how soon he can buy,” notes Sacco Handle.
If you’re not quite ready to talk to a mortgage rep — maybe you’re more curious about what's out there than driven to buy in the immediate future— the Internet abounds with free mortgage calculators where you can plug in your pertinent information to get an idea of what you can afford.
Most Internet calculators base their formulas on the premise that you’ll be taking out a 30-year loan at whatever the prevailing interest rate is at the time. They include 1 percent for property taxes and 0.4 percent for property insurance. If rates in your area are higher or lower than these figures, you’ll probably get a more accurate forecast from a local mortgage representative.
Calculators do not typically include private mortgage insurance, which is often an added expense if you can’t come up with a down payment of at least 20 percent of the purchase price. Calculators also tend to focus on the amount of your mortgage, not on the numerous other expenses you’ll have to cover when you buy a house. You'll need to plan for additional expenses such as mortgage application fees and closing costs.
How Much Can You Dedicate to the Mortgage?
Do some math on your own if you don’t want to take the word of a mortgage representative or use an Internet calculator. Sit down with your monthly budget and tally up what you spend on car payments, credit cards and student loans. Include other must-pay monthly expenses such as childcare costs, insurance premiums and savings toward education or retirement.
Add mortgage payments and other expenses of home ownership to your mandatory budget items. Lenders want to know that the total represents no more than 43 percent of your gross income before taxes. Some calculators use a percentage of only 36 percent.
If you earn $80,000 a year, 43 percent works out to $34,400 or $2,867 a month. Then subtract the other monthly expenses and debts you must pay from this figure. What you’re left with is how much you can dedicate to mortgage payments. Studies have shown that borrowers who commit to paying higher percentages of their income than these often will have problems making their mortgage payments. After all, you must still buy groceries, pay taxes and fund other living expenses from your gross income.
Don’t Give Up
You’re not necessarily destined to rent for the rest of your life if your calculations look bleak, but you might want to work with a mortgage rep after all. “A good mortgage rep can tell you what you can do if you don’t qualify for the amount you were hoping for,” says Sacco Handle. “He can provide tips for paying down the correct debt to help you qualify, based on your individual circumstances.”