Whether you're a first-time homebuyer or a veteran house hunter, determining how much you can afford to spend on a new property isn't always simple. You can use online tools and consult a lender or mortgage broker for guidance, but the best approach is to take a close look at your own financial situation before you make a decision. Here's what you should consider.
When you submit a mortgage application, lenders will tell you how much money they're willing to lend you. To determine this, lenders will generally look at these factors:
-- Your gross income -- higher, of course, is better
-- The size of your down payment: The larger your down payment, the more you will be able to borrow, and the more house you can afford. If your down payment is at least 20 percent on a conventional mortgage, you will avoid the monthly cost of private mortgage insurance, or PMI.
-- Your monthly financial obligations: This can include debt payments like car or student loans and your current rent or mortgage payments.
-- Your credit score: A better score will generally get you lower interest rates and better terms.
Beyond these general factors, they will look at other costs associated with the home you are looking to buy, such as local property taxes, to come up with a payment amount that you can afford.
[Read: The Best Mortgage Lenders of 2018.]
This is only part of the answer, however.
How Much House Can You Actually Afford?
Just because a lender approves you for a mortgage doesn't mean you should use the full amount.
"'Afford' and 'qualify for' are two different things," says Casey Fleming , author of "The Loan Guide: How to Get the Best Possible Mortgage" and a mortgage advisor for C2 Financial Corp. "Most people probably can't afford what they can qualify for. The key is whether or not you can really live on what you have left over after making your housing payment."
In addition to your mortgage principal and interest, you'll need to pay property taxes and homeowners insurance. And if you live in a condo or a co-op, you'll generally have to pay a monthly association fee, which covers the costs of running the building, yard work, garbage collection and everything outside of your unit. These costs can increase if needed, and there can also be a special assessment for something like a major repair.
Overall, you may have to shoulder a lot of expenses that you didn't have when you were in a rental, according to Cathy Curtis, founder of Curtis Financial Planning, a financial advisory firm that specializes in serving women and their families. "Remember that after you buy a house, your housing-related expenses may go up -- you may pay more for utilities, you may need new furnishings and you might have to hire a gardener," Curtis says.
And over time, things wear out and need to be replaced. For example, you might need a new roof, a new furnace or a new water heater. While these big expenditures don't happen every day, they do come up over the years. Buying too much house can leave you without adequate cash to cover the big and small unexpected extra costs that come with owning a home.
What Fits My Budget and Lifestyle?
Perhaps the question you should ask when looking for a home is not "How much home can I afford?" but rather "What home fits my financial goals, budget and lifestyle?"
"After all, there are other things in life that are important, like food, clothing, insurance, etc., let alone being able to enjoy the occasional vacation or weekend getaway," Curtis says. "I have seen many people that push the limits and buy the most expensive house they can qualify for, and then struggle afterward to make ends meet."
As you evaluate how much you can spend on a home, consider asking yourself how much you can spend on a house payment each month and then work backward.
To do this, make a housing budget. If your home purchase is likely to involve an increase in your monthly cost of housing, try living with those extra costs by setting aside that amount each month. For example, if you anticipate that you'll have to increase your monthly housing costs by $500, set that amount aside in a separate account and try living on $500 less per month. Can you do this without altering your lifestyle and skimping on your savings goals?
Anna Sergunina, president and CEO at MainStreet Financial Planning Inc., suggests looking at your monthly and yearly cash flow to determine what would work for your budget. "Work out a spending plan without a home purchase and with a home purchase. No more than 30 percent of income should be spent on debt service, including mortgage and other debts. I want [clients] to have enough discretionary income to be able to save and have enough to pay other expenses."
Look for Homes That Fit Your Budget
After you create a budget to determine how much you can spend each month on your mortgage, use that to guide your search. A home should fit your budget -- not the other way around.
Home buying and the costs of home ownership can vary greatly by location. If you're looking for a home in an area that you are not familiar with or if you're relocating to an entirely new part of the country, it's important to get the lay of the land.
Elizabeth Colegrove, owner of multiple rental properties and of the website The Reluctant Landlord, says after you use a budget to determine how much you can spend on mortgage payments, "the goal is to ask a trusted mortgage broker what that number means for sales prices in your area. Once you know that number, you can start to talk to a Realtor and look at what houses are going for in your price range."
Remember that while owning your own home is a wonderful thing, it's also likely the biggest single investment you'll ever make. At the end of the day, it's important to view the purchase of a home in the context of how the cost will impact your monthly budget and your overall financial situation.
Key Points to Remember
Purchasing a home, especially your first home, can come with some financial sacrifices. But when those sacrifices include cutting back on the amount you're saving for goals like retirement or college for your kids, that's a sure sign you need to keep looking.
When you're shopping for a mortgage:
-- Become a knowledgeable buyer. Understand the market you're looking in, know where interest rates are heading and, most of all, be on top of your financial situation.
-- Work with a mortgage broker who is not tied to one lender. The best ones can serve as consultants, helping you find the best combination of a low interest rate and a low overall cost of borrowing. They can help you determine how much home you can comfortably afford.
The question of how much house you can afford is not a simple one. Take time to analyze the factors so you can come up with an answer that will put you in a house you love -- without ruining your finances.
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