How Much House Can You Afford?

What you Need to Know When Budgeting for a Home.

I just bought my second house recently. Why? Because I wanted to move to a new neighborhood, and the state of the real estate market is really good. Basically present day finds many people shopping for homes, and many people selling them as well.

However the inevitable question came up – how much house can we afford?

In order to properly answer this question, you might think about going straight to your mortgage broker or loan officer at your bank, but no, don’t do it! Mortgage lenders are the absolute worst people to ask how much house you can afford.

Time for some brutal honesty about the real estate market – yes, you’re mortgage broker might give you all the time and attention you need, but when it comes down to it, they are most interested in themselves – and that means they are looking to make a commission from your home purchase. Mortgage lenders make their money from getting you to sign for that loan – the bigger the loan the better – obviously! So oftentimes mortgage lenders will exaggerate how much of a mortgage you can afford. They will do this by manipulating the interest rates, adding variable rate mortgages, and adding bogus fees such as origination fees.

So it’s important to know the difference between what house you can actually afford vs. how much your mortgage lender claims you can afford, but how do you do that? The best thing you can do to find out how much home you can really afford is to do your own calculations. But where do you start? I’m so glad you asked. You can start by crunching some simple calculations at home like so:

Assess your financial state of affairs – Examine your monthly income, and cross reference it with what you currently spend on rent. It would make sense that you could afford a mortgage payment that was very close to what you pay in rent right? You can also take into consideration your personal assets, meaning any money you currently have tied up in investments or savings that you would be willing to use towards the down payment of a home.

Turn to an online mortgage calculator – Visit any financial site, Bankrate.com is a prime example, because it features a free mortgage calculator that measures your credit worth based on all of the factors that the mortgage lender will consider for your mortgage pre-qualification. Bankrate.com’s mortgage calculator will essentially tell you how much you can afford in monthly mortgage payments by calculating the following:

1. Mortgage amount - the price of the home you want to buy.
2. Mortgage length
3. Mortgage interest rate – you can base this on the current average interest rate if you’re credit score is above 720. Bankrate.com provides a live up-dated feed of the current average interest rates on their website as well. Keep in mind that if your credit score is low (below 700) you will likely be charged a higher interest rate on your mortgage.
4. Closing costs and extra payments – These are the costs aside from the purchase price of your home.

All of the above considerations will give you an idea of the monthly mortgage payment that you can afford – and essentially the maximum housing price you can afford. If you end up with a monthly mortgage payment that exceeds what you can comfortably afford – it’s time to lower the price range of homes you’re looking at.

Next:

Get your credit report – According the Federal Trade Commission’s (FTC) Fair Credit Reporting Act (FCRA), every credit using individual is entitled to a free copy of their credit report every 12 months. It’s vital that you know what’s on your credit report, prior to approaching a mortgage lender, because your lender will request a copy of your credit report – from one of the top credit reporting agencies - Equifax, Experian or TransUnion - to determine what amount of mortgage you are worthy of. Your credit report is a full report card, detailing your credit history – so how you pay your bills, if you’ve filed for bankruptcy or been found in default and undergone a repossession. Your mortgage pre-qualification will be largely affected by your credit report – so it’s vital to check it for any errors (accounts open that should be closed, etc.), prior to your mortgage lender. Visit the FTC online to find out how to get a copy for your free credit report.

Don’t trust the word of a mortgage lender – As stated above, mortgage lenders make money off the commission, based on the mortgage you sign. So if you go in knowing how much of a monthly mortgage payment you can afford, you will save yourself a lot of money and potential financial troubles later on.

Don’t accept a mortgage you can’t afford – Just because you qualify for a certain mortgage amount, doesn’t mean you should accept it. If the monthly mortgage payments exceed what you can afford you risk losing your house – when you can’t afford the monthly mortgage payments, plus utilities, upkeep, insurance and all the extras.

No one is aware of your spending habits better than you – The onus is on you, and it’s not always the mortgage lenders fault if they quote you on more of a mortgage than you can afford. Why is that? Because you should know how much you can afford based on your monthly spending. After all, your lender doesn’t know that you go on a shopping spree each month for a new wardrobe. They only know what you can afford based on the raw numbers – your monthly income, your credit score, and your personal assets. You might need to make some sacrifices if you want to afford the home your mortgage lender thinks you can afford.

3 tips for making the most of your home purchase price:

1. First-time homebuyers should be aware of all of the extras – minus the purchase price. Extras such as - property taxes, insurance, the moving costs and upkeep that goes along with a new home. Read our article The Costs of Purchasing Your Own Home for more information.
   
   
2. Save at minimum a 20 percent down payment on the home you want. That means if the home is $200,000, you should be putting $20,000 down on the purchase price. If you don’t put at least 20% down on the cost of your mortgage, the lender will often make you pay a private mortgage insurance (PMI), which protects the lender if you default on your loan. Putting 20% down in lieu of paying PMI, will save you thousands on the purchase price of your home. You can save 20% with some foresight. If you know you want to purchase a home within 1 year, start putting away $1000 a month in an emergency fund.
   
   
3. The cost of you home shouldn’t exceed 25 percent of your net income. Anything more may find you with a home you can’t afford – and that you have to sell to get out of financial trouble.