Set a Budget
Here's the hard part: setting a budget for how much "house" you can afford. Most of us make the mistake of dreaming beyond our means. Buying a home takes a lot of energy-don't expend it on regret.
The biggest single cash outlay associated with purchasing a home is usually the downpayment required by the mortgage lender. Typically, homebuyers must pay 20 percent of the purchase price. Lenders realize that it's difficult for many potential homebuyers to come up with $20,000 in cash for a $100,000 home, or $60,000 in cash for a $300,000 home, so lenders today are often willing to accept 15 percent, 10 percent or even 5 percent downpayments
Of course, the lower your downpayment, the harder it becomes to obtain a loan - especially on favorable terms. Lenders usually require private mortgage insurance (PMI) for down payments under 20 percent, and PMI will cost you a premium which can range from $800 up to $2,500 in cash due at closing.
So what can I afford?
Real estate agents and loan officers will suggest myriad formulas for figuring what you can afford in monthly house payments. For a quick estimate, take your total gross income and multiply that number by 2.5. That's how much you can spend, assuming you have no other debt.
Another quick estimate providing a useful budget benchmark is the 28/36 ratio favored by many lenders. If you're making $7,000 a month in gross income, and you have no other debt, then you can afford to pay 28 percent of that amount on house payments. That comes to $1960 per month.
But if you have outstanding credit card, automobile and furniture payments of $1500 per month, then you must factor that debt into the equation. The 28/36 ratio assumes that you can afford to spend 36 percent of your gross monthly pay on all debt. If you are taking home $7,000 gross per month, then you can afford to spend $2520 on debt of all kinds per month. When you subtract the $1500 per month you owe on credit cards, car and furniture payments, you find you can only afford $1020 per month on house payments.
This example dramatically illustrates an important fact about consumer indebtedness. The less debt you have the more house you can afford. In general, Americans have come to expect their homes to rise in value over time, so houses are considered a long term investment. Cars, clothes and furniture are generally not long term investments, so over the long term a smart consumer will want to incur less debt for luxuries in order to afford to pay more for a house that will be a good investment as well as a pleasant place to live. |
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