How Much House You Can Afford?
(This is absolutely not my house.)
So you want to buy a house. I don't blame you. It's become an American rite of passage. A symbol of the "dream". A little space you can call your own. A place to plant your roots. Yada yada yada. You get the point.
Personally, I don't put a lot of emotional attachment into housing. First, I've moved around a lot. I went to a different elementary school every year from Kindergarten through 4th grade. I've spent the last 14 years or so bouncing around from place to place. I like adventure, I'm a little restless, I've also been trying to build my career and that can be difficult to do in one set spot. I don't like to get attached...I think this might be more a discussion for my therapist...but let's continue anyhow.
I've only been emotionally attached to one house and that was where I grew up in North Adams, Massachusetts. My family lived there from the time I was 9 until about five years ago when my parents decided they wanted to live in the middle of nowhere. I miss that house, I still have dreams about it. Is this also something I should mention to my therapist?
While I don't necessarily see houses as a "must-have" purchase in order to be a successful adult, I do actually own a home. It was purchased in a growing area and it's the shittiest house in a nice neighborhood (which is actually what you want). So while I rail against people buying houses before they're ready or feeling pressured by society, there's nothing wrong with buying a house if that's what you truly desire.
It's one thing to consider your motivations for purchasing a home, but once you've decided it's the move for you, how do you calculate how much you can afford?
(THIS is my house...in my mind.)
Per usual, there are several questions you need to answer:
What's Your Household Income?
A good rule of thumb is to keep your mortgage payments to 28% of your gross income. So let's say your household income is $100,000 per year (could be just you or you and a partner). You want to keep your annual mortgage (including principal, interest, taxes, and insurance) under $28,000 or $2,333 per month. Of course, this is just one factor to consider.
What's Your Debt-to-Income Ratio (DTI)?
Remember, DTF and DTI are two VERY different things. This ratio is simply all your monthly debt payments combined divided by your gross income. Mortgage lenders do not like high debt-to-income ratios. In fact, if your DTI is higher than 43% you probably aren't going to get a qualified mortgage (there are a few exceptions). If you're considering purchasing a house, calculate your DTI and then do what you can to get it as low as possible. *cough cough pay off your damn credit cards cough cough* Another good rule of thumb? Always keep your DTI under 36%.
How Much Do You Have Saved for a Down Payment?
In order to avoid the extra cost of Primary Mortgage Insurance (PMI), you need to have at least 20% equity in the house. You can do this right off the bat by providing a 20% down payment. Waiting until you have 20% of the purchase price can save you hundreds or thousands in PMI costs. For a $300,000 house, that means a down payment of $60,000. Of course, you can put down less than 20%, but again this is going to cost you more in the long run.
What's Your Credit Score?
It's crucial to get your credit score into the best position possible before purchasing a house. The better the credit score, the more favorable the terms of a mortgage. You want to be offered the lowest interest rates possible. A less than ideal credit score will potentially cost you thousands in interest payments over the life of the loan.
Just Because You're Pre-Approved for a Certain Amount Doesn't Mean You Should Buy That Much
Banks want to lend you as much money as possible. It's in their best interest, not yours. Just because a bank pre-approves you for a $250,000 mortgage, does not mean you should go out and buy yourself a $250,000+ house. This is how we finds ourselves cash-poor. We take on an illiquid investment (a house) and then have to make large monthly payments (a mortgage) and we find ourselves running low on cash each month (no more happy hours and dinners out).
To keep your monthly cash flow in good shape, buy less house than what you're approved for! Ask yourself, what do you really need? How many bedrooms and bathrooms? Then list what you want and what you don't want. It's easy to get caught up in the beauty and possibilities of a terrific house, but you don't want to jeopardize your financial future because you fell in love with a couple of bay windows and a marble fireplace. Stick to your needs, compromise on your wants, and don't max out your budget!
If you've got money saved, a good credit score, a place you really want to live for the long-term, and a stable income then you're probably ready to buy a house. If you aren't there yet, that's fine. Purchasing a home isn't for everyone. It doesn't fit into everybody's plans and there's nothing wrong with that. A home purchase is NOT a mandatory milestone and purchasing one before you're ready can be financially crushing.