If the housing market crash taught us anything, it’s that Americans generally have no idea how much house they can afford. During the home mortgage selling spree, millions of mortgages were sold to buyers who were given low introductory rates, but had no ability to pay their mortgage payments once they ballooned to the standard rates. Home buying is largely an emotional process, since many people decide to buy a house because they simply want to be homeowners… and many people ultimately buy their particular house because they “fall in-love with it.” However, let’s bring a little rational sanity back to the process by discussing the answer to this all-important question: “How much house can I afford?”
How Much Home Can I Afford?
There are many different ways to answer this question, but ultimately, it all boils down to your monthly gross income and your monthly expenses. Look back over the last two years at your gross salary, bonuses, pension, dividends or child support payments. Divide this annual number by 12 for your gross monthly income. Then, add up all your fixed expenses like car loans, insurance payments, student loans, alimony / child support, and minimum monthly credit card payments. The Complete Idiot’s Guide To Buying and Selling a Home recommends that the first time home buyer borrow “roughly 2 to 2.5 times” one’s annual gross salary. So, for example, a couple earning $50,000/year each could expect to buy a home in the $100,000 – $150,000 range. However, authors Shelley O’Hara and Nancy D. Warner add that this is merely a ballpark figure and caution that interpretations change, depending on expenses. For example, one couple might have two car payments, poor credit history and no money saved for a downpayment, while another couple might have impeccable credit, $20,000 to put down and very few expenses.
Sometimes lenders use what is called a debt-to-income ratio to determine how much they should loan new home buyers. They will generally finance new home buyers whose monthly house payment (including loan amount, property taxes and insurance) is less than 28 percent of their gross monthly income. So, say you and your spouse bring in $6,000 a month; you would reasonably be able to afford a mortgage of $1,680 a month, assuming that you did not have any major ongoing expenses or poor credit history. Lenders will also look at your total monthly expenses, including minimum credit card payments, loans and other debts. This ratio should fall below 36 percent of your gross monthly income. So if this same couple spends less than $2,160 on outstanding loans, they should be fine. However, if they each have five credit cards with minimum monthly payments into the hundreds of dollars and they are paying thousands in student loans still, they will appear undesirable to a lender.
How To Pay For A House…
Finance Guru Dave Ramsey has a novel approach to answering the question, “How much home can I afford?” He suggests this: “The ideal way to buy a home is the 100%-down plan.” Sure, it would be “fun” to have no mortgage payments ever, but not everyone is able to wait to buy a home that long. If you can’t pay with cash, Ramsey recommends saving up a downpayment of at least 10 percent the purchase price (so $20,000 on a $200,000 home). He also recommends aiming for a 15-year fixed rate mortgage. “Limit your payment to 25 percent or less of your monthly take-home pay,” he adds.
A first home buyer often wonders how it would be even possible to afford a home with a full cash purchase. Crystal Paine, a Fox Business contributor, explains how she and her husband were able to save up and pay cash for their $100,000 starter home. “We divided $100,000 by 60 (since there are 60 months in 5 years) and set a goal to save $1,700 every month.” She explains that they didn’t have any student loans or debts, so it was easy to live frugally. She added, “We used coupons, ate a lot of meatless meals, shopped at thrift stores, cooked from scratch, brown bagged it, continued to use our old and worn-down furniture, didn’t replace anything that wasn’t an absolute necessity, limited our going out to eat, only had one car, stayed home a lot, used gift cards from Swagbucks to buy any non-necessities, bought eye glasses from Zenni optical, learned to be content with what we had, and continued to live on a strict written budget.” Meanwhile, they also increased their income by working longer hours and by picking up side work as bloggers and law consultants. “At the end of 2.5 years, we paid 100% down on our first home,” Paine recalls.
The Bottom Line:
Whether you are able to pay for your first home in cash or you take out a reasonable mortgage loan, it is wise to know what you should pay for a home and to take a realistic assessment of what is coming in and what is going out of your bank account each month. A home should be a blessing, not a curse, so be sure you are looking within your ideal price range and that you are not biting off more than you can chew.
Try this house calculator from Bankrate!