How Much House Can You Afford?
HOUSE POOR [adjective | hous – poo·r] A person who can afford his or her home mortgage payments, but can’t afford much of anything else. Discretionary spending on restaurants, furnishings, travel and clothes are severely cut back, due to a large proportion of his or her income going towards the mortgage payments, upkeep costs, and energy/utility bills.
You don’t want to find yourself stuck at home while your friends are out having fun. Buying more home than you can afford comfortably will place serious restraints on your financial life. This doesn’t sound like fun, does it?
Sure, you want a nice home. But you also want to make sure that it fits in the landscape of the rest of your life.
Here are the ABC’s of finding a dream house that you can reasonably afford.
Assess Your Ratios
Finding that magic mortgage number of how much home you can realistically afford.
- Front-End Ratio: A front-end ratio is also known as the mortgage-to-income ratio. You can find this ratio by using a debt to income calculator or simply by dividing your projected monthly mortgage payments by your gross monthly income. For example, if your monthly mortgage payment would be $1,500 and your monthly income is $6,000, your front-end ratio would be 1500/6000 or 25%This projected mortgage payment should include the principal, taxes, insurance, and interest payments. Many lenders have limits on the maximum front-end ratio that they’ll permit. If you’re seeking an FHA loan, the federal cap on front-end ratios is a 31% percent limit.
- Back-End Ratio: Your debt-to-income ratio is your back-end ratio. The back-end ratio can be found by adding all of your monthly debt payments, including your car payments, credit card payments and any other outstanding debt, then dividing this number by your gross monthly income, which is the amount earned before taxes or other deductions.The higher your back-end ratio is, the more difficult it is to meet your monthly mortgage payments. Lenders will also have maximum caps on this. The absolute highest back-end ratio you can have and still qualify for an FHA mortgage is 43%.
Pause and reflect on whether or not you should borrow as much as you qualify for.Consider your own ratios. Do you want to allocate your money elsewhere besides your mortgage? What percentage of your income do you feel comfortable spending on your mortgage?
Bet on Life
Are you starting a new career? Returning to graduate school? Do you plan on growing your family? If you don’t expect any big changes to your life or finances, then you may be able to afford a larger mortgage payment. If you do have life plans that will impact your finances in the near future, it may be best to secure a more manageable mortgage payment.
Also, job security is critical when deciding how much home you can afford. How long have you been working? Do you suspect any major upheavals in the company anytime soon? Have there been any major layoffs?
You never know what the future holds, make sure that you have an emergency fund that can cover all of your necessary expenses while you get back on your feet. An emergency fund should cover at least three to six months of your living expenses.
If you haven’t built this fund yet, plan out how you can put some dollars towards creating these reserves before you decide how much you want to spend on buying a house.
Calculate Other Monthly Expenses
Your total monthly expenses will affect how much home you’re able to afford.
Calculate all of your expenses, such as groceries, gas, dining out, clothes, miscellaneous goods, toiletries, cosmetics, utilities, and car expenses. Don’t forget to include line-items for travel, holidays and other annual expenses. Forgetting to calculate these annual or biannual expenses can have a reverberating impact on your ability to afford your home.
Once you’ve added these numbers, look at how much wiggle room you have left. Think about how much you want to spend on your home, while still leaving a buffer for any other costs that might creep up. After all, more savings is always a good thing.