Buying a home can be lots of fun. It’s exciting to see all those years of dreaming come to life in a place you can finally call your own.
My husband and I went house shopping yesterday and it was a wonderful feeling imagining ourselves living in these beautiful homes. We were so ecstatic that we unconsciously slowly started looking at houses over our budget. Not good! We had to focus on the logical side of our brains and kick our emotions to the curb.
It’s easy to get caught up in the excitement before asking yourself the most important question of all: How much house can I afford?
The hard truth is, it doesn’t matter if the kitchen is fabulous or the backyard is big. If you can’t pay the mortgage each month or find the cash to fix what’s broken, your home will be a the source of a lot of stress.
Our favorite way of calculating our calculating our mortgage affordability is from Dave Ramsey. We don’t agree with 100% of his teachings, but one thing we do agree on is determining how much house we can afford.
Figuring out how much house you can afford doesn’t have to be rocket science. Here are some smart tips to help you buy a home within your budget.
Calculate the Price You Can Afford Based on Your Income
Okay, all you really have to do is crunch a few numbers to figure out how much house you can afford. And if math isn’t your thing, hang in there. We’ll walk you through it step-by-step.
And, for you married folks, make sure you go over the results with your spouse. You both need to be on the same page when it comes to your budget and what you can actually pay. After all, shopping for your “home sweet home” will feel—dare I say— romantic once you and your sweetheart set shared expectations.
Simply follow the steps below.
1. Add up your total monthly income.
Let’s say you bring home $2,400 a month and your spouse brings home $2,600 a month. Your total monthly take-home pay would be $5,000.
2. Multiply it by 25% to get your maximum mortgage payment.
If you earn $5,000 a month, that means your monthly house payment should be no more than $1,250.
3. Use the link below to determine your mortgage budget.
I highly recommend using Dave’s Mortgage Calculator.
Sticking with our example of an income of $5,000 a month, you could afford these options on a 15-year fixed-rate mortgage with an interest rate of 3.0%:
- 10% down payment: $230,000
- 20% down payment: $275,000
- 30% down payment: $310,00
Remember: this is just a ballpark! Don’t forget that grown-up stuff like property taxes and homeowner’s insurance will top off your monthly payment with another few hundred dollars or so (icing on the cake). And if you think you’ll be buying a home that’s part of a homeowners association (HOA), you’ll need to factor those lovely fees in as well.
4. Factor in homeownership costs.
Okay, your emergency fund can cover major home disasters. But if you’ll be saving up for a few home upgrades or you’re a first-time homeowner, build room in your monthly budget for those expenses so there are no nasty surprises. These costs may include:
- Increased utilities
- New appliances
- Ongoing repairs
- Routine services (pest control, HVAC tune-ups, etc.)
Maximize Your Down Payment
Your down payment amount makes a big impact on how much home you can afford. The more cash you put down, the less money you’ll need to finance. That means lower mortgage payments each month and a faster timeline to pay off your home loan! Just imagine a home with zero payments!
I highly recommend saving up a down payment that’s 20% of the home price. That way you won’t have to pay private mortgage insurance (PMI). PMI protects the mortgage company in case you don’t make your payments and they have to take back the house (foreclose). PMI usually costs 1% of the total loan value and is—you guessed it—yet another fee that’s added to your monthly payment.
Let’s backtrack for a second: PMI may change how much house you thought you could afford, so be sure to include it in your calculations if your down payment will be less than 20%. Or, you can adjust your home price range so you can put down at least 20% in cash.
It’s worth taking the extra time to save for a big down payment. Otherwise, you’ll be suffocating under a budget-crushing mortgage and paying thousands more in interest and fees.
Don’t Forget to Budget for Closing Costs
Alright, don’t freak out here. But a down payment isn’t the only cash you’ll need to save up to buy a home. There’s also a hefty closing cost to consider. On average, closing costs are about 4% of the purchase price of your home. Your lender and real estate agent buddies will let you know exactly how much your closing costs are so you can pay for them on closing day. These costs cover important parts of the home-buying process, such as:
- Appraisal fees
- Home inspections
- Credit reports
- Homeowner’s insurance
Don’t forget to factor your closing costs into your overall home-buying budget. For example, if you’re purchasing a $400,000 home, multiply that by 4% and you’ll get an estimated closing cost of $16,000. Add that amount to your 20% down payment ($80,000), and the total cash you’ll need to purchase your home is $96,000.
If you don’t have the additional $16,000 for closing costs, you’ll either need to hold off on your home purchase until you’ve saved up the extra cash or you’ll have to shoot a little lower on your home price range. Whatever you do, don’t let the closing costs keep you from making the biggest down payment possible. The bigger the down payment, the less you’ll owe on your mortgage.
Know Which Mortgage Option Is Right for You
Okay, now let’s talk about types of mortgages. Most of them (ARM, FHA, VA, USDA) are garbage designed to help you pay for a home no matter your financial situation. When you do the math, you find that these mortgages charge you tens of thousands of dollars more in interest and fees and keep you in debt for decades longer than the option we recommend. That’s why getting the right mortgage is so important. Setting boundaries on the front end makes it easier to find a home you love that’s in your budget.
Here are the guidelines we recommend:
- A fixed-rate conventional loan. With this option, your interest rate is secure for the life of the loan, keeping you protected from the rising rates of an adjustable-rate loan.
- A 15-year term. Your monthly payment will be higher with a 15-year term, but you’ll pay off your mortgage in half the time as compared to a 30-year term—and save thousands in interest.
- A monthly payment that’s no more than 25% of your monthly take-home pay. This leaves plenty of room in your budget to achieve other goals like investing, saving for retirement, or putting money aside for your children’s college fund.
Get Preapproved for a Mortgage
When you get a mortgage, make sure you know the difference between fancy-sounding terms like getting prequalified and preapproved. A lender can prequalify you to buy a house in just a quick conversation with you about your income, assets and down payment.
Getting preapproved takes a little more work. A lender will need to make sure your financial information is accurate and submit your loan for something called preliminary underwriting, which is just another step in the approval process that determines how much money they’ll let you borrow.
Sure, it takes some extra time to get preapproved. But, boy, is worth it when you begin your home search. A preapproval letter shows sellers you’re a serious buyer and that they can sell their house faster if they choose your offer over competing offers that haven’t been preapproved.
But be careful! Your mortgage lender will most likely approve you for a bigger mortgage than you can actually afford. Do not let your lender set your home-buying budget. Ignore the bank’s numbers and stick with your own.
Know your house budget and stick to it at all costs. Don’t let others try and persuade you to spend more than you can afford. This only takes money from your pockets and puts in theirs.
Work With a Buyer’s Agent
Though your search for homes may start online, it shouldn’t end there. You can do a lot of research on your own, but you need the help of an expert when it comes to actually finding and securing your perfect home. An experienced real estate agent can help you figure out how much house you can afford and what kind of homes you can expect to find, considering your market and price range.
How does a buyer’s agent get paid? In most cases, the seller pays the fees, so using a buyer’s agent is free to you!
What should you look for in a buyer’s agent? You may know a lot of real estate agents in your area. But keep in mind that not all agents bring the same knowledge and experience to the table. You want an expert who can show you how to buy a home. A true rock star will have the following:
- Shared financial values and a respect for your budget
- Great communication skills that make you feel like you’re their only client
- An impressively long list of homes sold every year
- Extensive experience and networks in your local market
What are you tips on home buying?
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