March 1, 2018
March 1, 2018
That’s the big question when you start house hunting. Figuring out how much home you can afford before you start looking is vital to avoid over-extending your finances and to wind up house poor. Your best option is to pay attention to your income and go from there.
There are plenty of rules of thumb when it comes to deciding how much you should spend on your home. Some of the most common rules you see from experts and lenders include:
There are other rules of thumb related to deciding on how much home you can afford. However, the most important factor is what you’re comfortable with financially.
When deciding how much home you can afford, your best bet is to base your calculations on your net income. Your pre-tax income (gross) doesn’t paint an accurate picture of what you have available for spending on a monthly basis. Instead, it makes more sense to consider your after-tax income (net) when determining how much home you can afford. Your net income is a closer look at how much money you have to spend each month.
Relying on your gross income can result in choosing a home that is more expensive than you can afford. You feel as though you have enough money to make your payments, but once the practical considerations are factored in, the story changes. If your gross income is $3,400 per month, but your take home pay is $3,000 after taxes and retirement and health care contributions, it changes what you can easily afford for a housing payment.
If you base your calculations on your gross income, it looks like you can afford a monthly mortgage payment of $850 if you limit your mortgage payment to 25% of your income. With your net income, the amount comes to $750. That’s a difference of $100 — and can make a big difference in your budget. If you base your mortgage payment on your gross income but have to make your budget work with your net income, it can leave you feeling pinched for cash.
Too often, when figuring out how much we can afford, we forget to take into account the other costs that come with owning a home. Home ownership costs aren’t just about the mortgage payment. You also need to factor in property taxes, insurance, utilities, maintenance, and repairs. These are regular costs that come with homeownership, and you need to include them in your budget.
Including these other household costs can change the equation when you think about how much home you can afford. One way to do this is to take your expected mortgage payment and add 30% to it in order to estimate your true monthly costs. If your mortgage payment is $850, you would add another $255 to the total to estimate your true home costs, bringing your monthly home cost to $1,105. This suddenly means your costs amount to 38% of your $3,000 monthly net income. While there are some rules of thumb that purport that it’s acceptable to spend up to 45% of your income on household costs, you might not be personally comfortable with spending that much.
When deciding on what you can afford, remember to consider your other debts, and take into account what else you might spend on your home. You might need to adjust your mortgage and home buying expectations to ensure that you can still handle emergencies and pay for your other needs without breaking your budget.