When people decide that it’s time to purchase a new home, it is likely that one of the very first questions they will ask themselves is “How much home can I actually afford?”
Usually, their next step is to search the internet, which generates a substantial number of sites with affordability calculators. Then, they answer the required three or four questions to arrive at the “this is how much home I can afford” number. Although affordability calculators are useful to give buyers a general idea of what they can afford, their actual debts and plans are not a part of this equation. So, before using them, you must do a bit of research first.
Another way that most people figure how much home they can afford is to follow the rule of thumb which states that their monthly payments for the new home should not exceed 28% of their monthly gross income. While this is commonly accepted, there are other factors that can influence how much home they can actually afford. Particularly, factors such as the type of mortgage loan, the amount of the down payment, and the buyer’s credit history, all affect the final cost of a home and should be considered when making the decision. Equally important, but not included, are your actual household expenses.
Now that you know what sources to use as a reference point when making this crucial decision, we’ll discuss what to consider. When deciding how much home you can actually afford, check how much money is coming into your household and how much is committed to creditors. Start with your take-home pay, any other form of income, and your recurring monthly expenses. Additionally, expenses that will take place during and after the purchase of your home, savings goals, and even your future vacation plans must be taken into account. Only then will you be able to figure out how much money you actually have available for your new home. Even though it will take more of your time, we recommend that you sit down and carefully examine your particular financial situation. The following steps will help you get organized and on track.
Take-home Pay (After Deductions)
The first step is to see exactly how much money you take home every month, and unless you already have a detailed budget, the easiest way to find this information is to look at your pay stub. Your take-home pay, after deductions, is called net income, not to be confused with gross income or earnings without the required deductions. If you receive any additional income, such as dividends from investments, pensions, or alimony, they need to be included, too. The next step is to figure out your monthly expenses.
If you keep a budget to track your monthly expenses, most of the work is already done. If not, this is the perfect time to start. You can use the budget you make for this exercise to keep track of your finances in the future. There are many easy to follow Excel-type documents and applications available for free on the internet. If you prefer, you can even make your own budget planner.
Whether you are using a worksheet, an application, or your own budget planner, start by gathering all the necessary documents. Make sure that you have a recent pay stub, bank statements, utilities and credit card bills, student or other loan statements, and the like. Keep in mind that if your income is irregular or you work on commission, you are going to have to gather up to a year’s worth of pay stubs in order to have a clear idea of your income.
The budget should include absolutely everything, in other words, all monies coming into your household and all monies spent. Add up your income information. As stated before, include every form of income, salary, investments, and dividend income, if any. Next, include every payment and purchases you make. Add monthly or recurring payments, such as utilities, credit card payments, student or personal loans, and car insurance. You need to be as forthcoming as possible on this step. One way to make sure that everything is included is to use your checkbook or bank statement.
Once you have included all your income and expenses, decide which of the expenses you added are necessary and which ones could be tweaked, or even eliminated. This step can help you save some money. For instance, your phone bill could be tweaked, or you can opt to watch a movie at home, but your utilities are non-negotiable and necessary. An expense that should not be eliminated is the money that goes into savings. If you are thinking about buying the home with a cosigner, their financial information must also be used, so consider either including them in your budget or have them prepare one of their own.
Think about your future expenses. Buying a home will inevitably bring other expenses that you might not have had before. Now it’s the time to consider all the costs the new home will add to your household. Your monthly mortgage payments will include taxes and, based on your down payment or type of loan, one or more types of insurance. You could also be required to pay an HOA (Homeowners Association) fee. Finally, putting money away for maintenance and having an emergency fund for unexpected repairs should also be considered. The more prepared you are, the better.
Now, that you have taken the time to examine your financial situation, you are ready to answer the big question, conscientiously. How much home can I actually afford?
After doing this exercise, you will know how much money you have available to purchase a new home. Your new-found knowledge, current interest rates, and credit score will offer a better idea of how much your monthly mortgage loan payments will be. Some calculators will also factor in taxes for an even clearer picture of your future payment, which means you can look for, and fall in love with homes within your budget. If done right, the amount generated by all that number crunching will tell you just how much you have available for that new home. You are now ready to start researching mortgage lenders to make your dream home a reality.