Advice On How Much Home Can You Afford?

by tbailey

posted on 10/07/2009

Home ownership is often the big goal a person works towards in their life. For many people, going to the bank and applying for a mortgage is their first step without giving a thought to the most important step of all-deciding how much home you can afford on the income you currently make. Reading this article should help with the ever important question-exactly how much home can you afford?

Deciding How Much Home Your Income Can Buy
The first step is figuring out how much your monthly gross income is. This is the amount of money you make before taxes. Once you have this number, the next step is figuring out what your monthly housing cost is. The rule of thumb is that your housing costs should not exceed 28% of your monthly gross income. To figure out your cost, take your gross income and multiply it by .28. Let's use an example. John Doe's gross income is $3,800 a month. Following the 28% rule, the maximum amount he should spend on his mortgage, taxes, and homeowner's insurance would be $1,064. (3800x.28=$1064). Now that he has this number, there is just one more thing he needs to know.

Don't Fall Into The Debt Trap
Finding out your debt to income ratio is important as it figures into how much house you can afford. The ideal debt to income ratio should not exceed 36%. Debt to income ratio is simple to figure out. You should already have your gross monthly income figured out. Now take all of your monthly debt, such as credit cards, car payments, and any other credit accounts you pay monthly and add them together, along with the housing cost you figured in the first paragraph. Example-John Doe has a car payment of $230, credit card payments of $120, and a store account payment of $55. Add in the housing cost of $1064, and you get $1469(1064+230+120+55=$1469). Now divide the total monthly debt by gross income. The number we come up with is 39% since we rounded up.(1469/3800=38.65) This exceeds the 36% ratio. John will need to lower his housing costs in order to drop his debt to income ratio.

What's This Down Payment Thing About
In addition to figuring how much home you can afford on a monthly basis, you need to take a look and see if you have enough for a down payment on a home. Most places recommend saving until you have about 20% for a down payment. If John Doe is looking at houses in the $90,000 price range, he would need at least $18,000 for a down payment. However, some places will let you borrow more than 80% of the home's value. The only downside to this is that they will most likely require you to pay private mortgage insurance, or PMI. This insures that the mortgage lender is protected if you default on the loan. It is usually between .5 to 1% of the total cost of the home. On a $90,000 house this comes out to be between $4,500-9,000. The money that you pay towards PMI does not go to pay for any part of the loan. For this reason, it is usually a good idea to save up the 20% down payment before looking for your house.

Unexpected Costs Associated With Home Buying
Another thing to take into consideration are the fees associated with buying a home, such as paying for a home inspection, closing costs, and earnest money. Home inspections can start at around $150 and go upwards in cost. Then the closing costs have many fees associated with them. There's attorney fees, survey fees, appraisal fees, title transfer fees, and many other types of fees. A good rule of thumb is that these fees will add between 2-8% onto your total home cost. And once you've bought the house, the costs don't end there! You are now responsible if your furnace needs replaced, your roof starts leaking, or an appliance doesn't work.

Be Prepared
Once you have done all the cost calculating, it is then you can decide if purchasing a house is something you can do with your income. If you do decide to go forth and purchase, make sure to do further research to ensure you get the best deal that you can. Shop around, be smart, and most of all, enjoy it!

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