FOR MANY PEOPLE, buying a home is the largest purchase they endeavor upon during their lifetime. While this is often exciting, it can be stressful, especially if you are a first-time buyer. One of the first steps in the process is to decide how much home you can afford. This is an integral step to ensuring your finances are on track to accomplish your goals and you don’t become “house poor.”
There are some rules of thumb that can approximate how much you should allocate toward housing. For example, a “tried-and-true” guide is 25 percent of your income. Of course, there are circumstances where this is not feasible, but it still serves as a guidepost. Below are more detailed steps to hone in on a number specific for you.
First, determine your monthly income and subtract your savings toward retirement and other large or irregular purchases. These should come right off the top to pay yourself first. Then you need to determine the amount of your nonhousing-related expenses. If you aren’t sure what you spend, this could take some time and effort. Keep track of your expenses for a while to give you a solid idea of the numbers. Numerous tracking software systems are available that aid this process. Apps such as Mint, Mvelopes and GoodBudget are free options that are worth exploring to see which one suits your needs. After this step, you should have your monthly income after your savings and nonhousing related expenses.
Before you scour online home listings for your next home based on this figure, consider the operating costs. Houses require maintenance, utilities, real estate taxes and, sometimes, homeowner’s association or condominium fees. Don’t forget the cost of homeowner’s insurance as well. You might even need flood or earthquake insurance. You also might need to increase your life and disability insurance. Do some research to get an idea of what these items can cost because they add up quickly.
Subtract the operating costs from the total housing allocation, and the result will give you a target for your mortgage payment. Using an online calculator and an interest rate estimate, you can work backward to determine the amount of house this payment will afford. If you have less than 20 percent to put down, you will most likely incur private mortgage insurance (PMI) and that should be factored into your monthly payment.
At this point talk with various mortgage brokers and banks. It’s best to shop around and discuss the prequalification process with lenders. They should also be able to give you an estimate of all the other closing costs associated with a home transaction. In New Hampshire we have the real estate transfer tax, half of which is the buyer’s responsibility. In addition, there are appraisal fees, inspections, title insurance, and recording fees, all of which need to be factored into your down payment and cost of acquisition.
Emergencies might happen; you might need a new car in a few years or maybe you incur unexpected medical expenses. Spending down to your last dollar to buy and maintain a house does not make financial sense, not to mention the emotional burden and stress constantly overhanging you when you’re strapped financially.
It’s also important to note there are numerous instances in which it doesn’t make sense to buy a house at all. If you think you might want to move in five years or less, the transaction costs involved with a home sale usually do not favor moving in short periods of time. Also, uncertainty about your income or job prospects might be a reason to pause the purchase. Overall, be patient throughout the process and live within your means.