You know how much you make. You know how many credit cards you pay on each month and how much you spend on food to feed your family. But you’ve been thinking about buying a house or upgrading to a bigger home. But how do you really know what you can afford?
Lenders will do their factoring including your debt-to-income ratio or DTI. They want to make sure that you have enough income coming in to pay for a mortgage along with all the other monthly debts you are responsible for paying like a car payment, student loans and credit card charges.
“The golden rule to me is determining how much home you can afford so that your monthly mortgage payment does not exceed 28 percent of your gross monthly income (your income before taxes are taken out),” says David Weliver, founding editor MoneyUnder30.
The Maine resident is a cited authority on personal finance and the unique money issues faced by people in their first two decades as adults.
“I’m pretty conservative since I got involved in writing my website. I was a free spender in my early 20s,” he says. “My big thing was that I wanted to keep our house payments no more than 20 percent of our income. Bank guidelines go up to 30 or 35 percent.”
In some case such as New York City or San Francisco, you could never buy a house there for those conservative percentages, he says.
“If you live in a hot housing area, many people pay 50 percent of the income on housing. The other 50 percent goes to groceries, car payments and utilities. There’s not a lot leftover for anything else,” he says. “I didn’t want to live like that. But some people have to, to be able to have the luxury of buying a house.”
Extra Costs and Home Affordability
One of his best pieces of advice for people attempting to buy a house is to really nag your realtor about closing costs, taxes, insurance, inspections and appraisal costs in your area.
“For instance, there will always be surprises if you don’t ask. For example, in the Northeast almost everything is heated with oil, and it’s very expensive. When you buy a house, at closing time, they will charge you for the oil left in the tank. A half of a tank might cost $400,” he says.
When he bought his first house, they tacked on that extra $400 that he didn’t even realize he would have to pay.
He says that many people don’t understand that buying the house doesn’t end the draining of your money.
“In the first month of getting our first house, we had to buy a new dryer ($800) and a new range ($2,000). Everyone I know says the same thing. Something will break,” he says.
Setting aside about $10,000 for those unexpected expenses can help out in keeping things maintained and being able to not panic when the furnace goes haywire or you need to buy a lawnmower and a snow blower the same year because you never needed either one when you were a renter, Weliver says.
Can I Afford a House in a Hot Market?
Blake Schaefer, mortgage loan originator at Elevations Credit Union in Denver, says the market is very hot in Colorado – which is making affordability of buying a house a little sticky for some.
“Now when people write an offer on a house, they are one of 18 people in the bid for the house. You really have to find a way to make your offer stand out,” he says.
Sometimes, that means people are writing an earnest money check.
“They tell the sellers that if the inspections go well but the loan doesn’t come through, the earnest money is theirs,” he says. “It is a definitely a seller’s market. Many times in order to get a contract, buyers will have to write the contract ‘as if’ and except the home without major concessions (like a roof needs replaced or the furnace is going bad).”
Schaefer also sees many borrowers who want to put down 20 percent on the house to avoid private mortgage insurance.
“But if that’s all they have in cash. It doesn’t make sense to that. They will need money for furniture, moving expenses or new appliances,” he says.
Moving expenses alone can cost a few thousand dollars.
“You either have to have a lot of good friends that can help you, or you need to be ready to pay a moving company,” he says.
Check How Much House You Can Afford
The only way to know how much you can afford is to get an accurate quote from a qualified lender. They can work backward from your income and current expenses to determine your comfortable home purchase price and monthly payment.
From there, the lender will give you a pre-approval letter, which allows you to start looking for homes.