How Do You Know If A House You Want Is In Your Budget?
You’ve probably heard these words more times than you can count: Renting is just like throwing money out the window. No doubt you’re tired of hearing it, but you also hate to admit that there’s some truth to it. You’d rather pay a mortgage on a property you can invest in and call your own, rather than hand over a chunk of your paycheck to a landlord who’s invisible most of the time – until the rent is due, that is.
Deciding that you want to own a home is the first step. Determining how much home you can afford is the second. Before you start perusing the local real estate offerings, it’s important to calculate how much house you can realistically afford. After all, the last thing you want is for your dream home to turn into a financial nightmare.
These guidelines can help you decide if – and when – you’re financially ready for home ownership.
Calculate Your Take-Home Pay
Employers generally quote you the amount of your gross pay (what they pay out) rather than your net pay (the amount you take home). Depending on your workplace, several deductions are taken out of your paychecks for taxes, retirement contributions, insurance, and the like. When calculating how much house you can afford, consider your net pay amount, which is the amount of money you’ll have available to spend every month for living expenses.
Understand The Hidden Costs Of Home Ownership
As with many long-term investments, buying a home comes with rewards as well as costs. In addition to repairs and renovations, some of which can be unexpected and expensive, you’ll be required to pay other costs that can continue for however long you own your home.
Although you’re not legally required to have homeowner’s insurance on most mortgages, it’s not a good idea to opt out of this type of coverage. If disaster strikes, homeowner’s insurance may be the only thing that helps you repair or rebuild. There’s truth to the adage “If you can’t afford home insurance, you shouldn’t be buying a home.”
Another cost to consider when buying a home: Closing costs, which often need to be paid in cash and generally cost between 2% and 5% of the price of the home. These costs typically include taxes, lawyers’ fees, inspection costs, and other necessities that are part and parcel of buying real estate.
Finally, there are property taxes to take into account. Every jurisdiction determines its own property tax rate, which is often added to your monthly loan payment. When looking for a new home, you’ll generally find an annual total tax rate included on the listing that is just an estimate and will be intermittently updated by your municipality depending on the housing market. If you divide that amount by 12, you’ll get a sense of how much property taxes will add to your monthly payment.
Choose The Best Way To Finance Your Home
The value of the home that you’re eyeing looks good – and financially manageable – on paper. But due to added costs, including the long-term interest on the loan you’ll be taking out to buy it, most likely you’ll end up paying much more for that house over the life of the loan. Depending on the mortgage terms, you could end up paying almost double the sale price of the home. In general, experts recommend you spend no more than 25% of your take-home pay on your housing.
Your monthly mortgage payment is the total amount you’ll owe monthly for the length of the loan, based on the principal, the interest rate, and the term.
The principal is the total amount that the lender provides to you. For a home loan, it’s equal to the total value of the home minus your down payment. Unless your down payment is more than 20% of the home’s value, this payment will also include private mortgage insurance, which is a fee charged by a lender to insure them against default. The principal monthly payment typically determines how much house you can afford.
The term refers to the length of time it will take you to pay back both the principal and the interest. The shorter the term, the less interest you pay over time. For example, a 15-year term vs. a 30-year term will drastically cut down on the true price of your home.
The interest rate is the amount above and beyond the principal that you have to pay back to the lender. Home loan interest is compound interest, which means that the interest amount is calculated monthly based on the total amount owed. With a fixed-rate loan, your interest rate is locked in for the life of the loan. Good news if you secure a fixed-rate mortgage when rates are low — not so good if you lock in a rate when they’re sky high. With an adjustable rate, your interest rate can fluctuate with market changes.
Determine Your Down Payment
The amount of money you have available for a down payment on a house can significantly impact how much house you can afford. The size of the down payment can determine not only your house-buying price range but also the true cost of the loan you take out. It’s a fairly straightforward calculation: The more money you put down on a house, the less the total principal of the loan you take out. Most experts recommend paying no less than 10% of the price of your home as a down payment. Looking to lower your payment even more? Consider a 20% down payment, which will also eliminate the need for private mortgage insurance.