How Much Home Can You Afford?
Purchasing a home is often the biggest purchase most people make in their lives. Here is what you need to know when deciding your budget.
What can you afford?
This is often the most challenging question and it is important not to rely on the bank to determine what your budget should be. You will often be approved for a loan that is much larger than what your budget should be.
- One simple rule is not to spend more than 28% of gross income on the mortgage payment. For instance, if a couple makes $120,000 a year their gross income is $10,000 per month. In this scenario, the total mortgage payment (payment, taxes, insurance) should not exceed $2,800 a month. It should be noted that in particularly high tax or high cost of living areas, this figure may run closer to 35%. That said, the higher the ratio, the less financial capacity to save for other goals or pay down debt.
- Do not forget the cost of ownership. Heating and cooling a larger space, furnishings, and maintenance costs (typically 1% of the home's value each year) should all be taken into consideration when developing a budget.
- Part of the budget calculation involves a down payment, which is typically 5% to 20% of the purchase price. If the down payment is less than 20%, an additional payment will be required which is called PMI (Private Mortgage Insurance). PMI can run several hundred dollars a month on top of other mortgage expenses.
- Do not be overly rigid with the budget. Often there is a material shift in quality, location, or square footage when moving up in price from $50,000 to $100,000. Those two figures represent an additional payment of $200 to $400 a month on a 30-year loan at 3%. Ultimately, long-term appreciation potential and enjoyment of the home may be greater by stretching the budget.
- Cash flow is not static. Do you expect to make more money next year? In five years? If you have a stable career, consider the fact that your income will grow over time while the mortgage payment should stay largely constant.
Buying a home is one of the most exciting, nerve-wracking purchases one can experience. If you are patient and are willing to invest the time necessary to be an educated buyer, you will have an asset that will bring you enjoyment and potential for growth for years to come.
For more information on things to keep in mind when searching for a home, read 4 Considerations to Make When Searching.
This is not a recommendation and is not intended to be taken as a recommendation. This material was prepared for general distribution and is not directed to a specific individual.
LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.
