If you’re shopping around for your first home, congratulations! Few things in life are more exhilarating than strolling through houses and imagining yourself living in a new neighborhood as a bona fide homeowner.
To prepare for serious real estate hunting, though, you should be armed with a firm price range in mind. How much house can your really afford? Most experts recommend that your monthly mortgage payment not exceed 28 percent of your monthly pre-tax income.
For example, if you bring home $3,600 per month in wages, your mortgage payment should be no more than $1,008 per month. Any more than that, and you’re likely to have trouble making your payments at some point.
Can You Really Afford the Payment?
The 28 percent figure sounds great on paper, but will it work in your life? The best way to find out is by conducting a financial experiment while you shop for a house and get pre-approved for a loan. Follow these steps to see if you’re ready to take on a mortgage payment.
1. Choose a Fantasy House to Buy
No, you’re not (necessarily) going to buy this house, but go online to a real estate site like Zillow or Redfin and find one you like for a price you think you can afford. Make note of the total price as well as the yearly property taxes.
2. Research Mortgage and Insurance Rates
If you’ve already started the pre-approval process for a home loan, you may already have an idea of the interest rates available to you. If not, go online to find your local bank’s current mortgage rates. If you have good credit, use the rate you see advertised. If your credit is shaky, add a percentage point to the rate to be more realistic about the type of mortgage you’ll be able to get.
You also can go online for an insurance quote for your fantasy house. Just type in the address and answer the questions about the property based on the information you found on Zillow or Redfin. Most new home buyers pay for their insurance through their lender’s escrow accounts, so this is important in calculating an accurate monthly mortgage payment.
3. Use an Online Mortgage Calculator to Find Your Monthly Payment
Using your research about the home price, taxes, mortgage rates and insurance costs, type the values into an online mortgage calculator to find out your monthly payment. If the calculator doesn’t ask for insurance or taxes, you’ll need to add those values together yourself, divided by 12, and add that number to the monthly mortgage payment to be sure you’re covering everything.
4. Live With Your Fantasy Mortgage for at Least Three Months
Test out life with a mortgage by paying yourself each month. To do this, subtract your rent payment from the total of your fantasy mortgage payment. This amount is the money you’ll be transferring into a savings account each time you pay the rent.
After three months of living with your fantasy mortgage, assess how well you did. Were you able to make payments easily, or did you have to bail on the experiment? Did life go on as planned, or were you stuck with ramen noodles for dinner? If an emergency came up, could you handle it?
If you could live comfortably with your fantasy mortgage, you can afford the house you “bought” and should feel comfortable shopping for a real house in that price range. If not, you can try again with a lower mortgage amount. Either way, the beauty of this experiment is that you are able to build up an additional nest egg of savings by paying yourself, and that’s something that will only help you with your eventual down payment on your dream house.