What You Can Afford
Whether you’re a first-time buyer looking for the perfect starter house or you’re trading up to your waterfront dream home, you are probably asking the same questions: Can I afford this? And is this the right move at the right time?
To get a more accurate picture of what you can afford to borrow, you should analyze three things: you and your co-borrower’s income, your budget and your savings.
- Do you have job security?
- Do you work in a commission-based job? Are you confident that your commission structure and monthly income are stable?
- Do you expect your and your co-borrower’s income to increase or at least stay the same?
- Are you expecting or planning to have a child in the near future? Do you know if your salaries and budget will change once the baby is born? Will one of you be staying at home to take care of the baby (which may reduce your monthly take home salary)?
It’s very important to know not only how much you earn but how much you spend per month. Even with low mortgage rates, a mortgage payment and the additional monthly expenses that go along with owning a home could break your budget.
You should outline how much you currently spend on the following categories: auto and transportation, bills and utilities, education, entertainment, food and dining, gifts and donations, health and fitness, home, kids, personal care, pets, shopping, taxes, travel and other miscellaneous monthly expenses. How much do you have left over to put toward a mortgage?
A typical rule of thumb is you should not put more than 36 percent of your income toward debts (mortgage payments, school loans, car payments and credit card payments).
You will likely need a significant down payment in order to buy a new house (mostly likely 3.5 percent or more; 20 percent down is the most common). Do you think you will have enough money for the necessary down payment, closing costs, plus the new monthly mortgage payment? Do you have enough money in savings in case of an emergency such as an injury or a broken water heater?
It is important to not completely raid your savings when you buy a new house. It is always advised to expect the unexpected with homeownership. In general, you should budget 1 to 3 percent of your budget on house repairs and maintenance.
How much will I spend on maintenance expenses?
Experts generally agree that you can plan on annually spend 1 percent of the purchase price of your house on repairing gutters, caulking windows, sealing your driveway and the myriad other maintenance chores that come with the privilege of homeownership. Newer homes will cost less to maintain than older homes. It also depends on how well the house has been maintained over the years.
What is the standard debt-to-income ratio?
A standard ratio used by lenders limits the mortgage payment to 28 percent of the borrower’s gross income and the mortgage payment, combined with all other debts, to 36 percent of the total.
What can I afford?
Know what you can afford is the first rule of home buying, and that depends on how much income and how much debt you have. In general, lenders don’t want borrowers to spend more than 28 percent of their gross income per month on a mortgage payment or more than 36 percent on debts. It pays to check with several lenders before you start searching for a home. Most will be happy to roughly calculate what you can afford and prequalify you for a loan. The price you can afford to pay for a home will depend on six factors:
1. gross income
2. the amount of cash you have available for the down payment, closing costs and cash reserves required by the lender
3. your outstanding debts
4. your credit history
5. the type of mortgage you select
6. current interest rates