May 15, 2018 / Homes

How to Determine What Type of Home You Can Afford

Long before most people cross the threshold of their new home, they have picked paint colors, carpets, and cabinets. But, most people have a harder time thinking ahead when it comes to deciding how much home they can afford. In part, that’s because “How much home can I afford?” may be the wrong question to be asking. Instead, it may be helpful to ask a few more basic questions that can help you evaluate your home-buying options.

How much monthly income do you have?

Determining how much home you can afford can feel like an overwhelming task. So start somewhere easy—your own income. Most people know, almost down to the dollar, how much money they’ll make this year. And you probably know how much of that annual income hits your bank account each month. For obvious reasons, the amount of income you have each month is a crucial piece of information in the home affordability puzzle. You need to know that you can cover your mortgage payment and other expenses associated with home ownership.

How much do you need to cover your monthly expenses?

Of course, nobody can put all of their money each month toward a mortgage and other home-related expenses. That’s why it’s also critical to have a handle on your monthly expenses. The key is to understand how much of your income is left after you pay all the bills. Keep in mind that you won’t have to pay your monthly rent after purchasing a home, so you can safely leave that expense out of the equation.

How much debt do you have?

Some of your expenses—those associated with servicing your debts—will factor into this process more heavily than others. That’s because they eat up a portion of your income each month and because your bank or credit union will factor them into their lending decisions. They’ll want to know who they’re competing with for your limited dollars each month and they want to make sure that debt doesn’t eat up an outsized portion of your income. For many lending institutions, the ideal “debt-to-income ratio” is 36%. In other words, the total amount of your monthly debt payments should be no more than 36% of your monthly income.

How much have you saved for a down payment?

Of course, your debts aren’t the only thing that a financial institution will want to see. Your bank or credit union will also want to know how much you’ve been able to save for a down payment. A down payment makes you a more attractive borrower because it demonstrates your ability to save money and because it creates buyer equity that the lender could absorb in the event of a default. Obviously, the larger your down payment, the lower your monthly mortgage payment will be and, therefore, the more home you can afford.

What would it cost to own the home you want?

Once you have a handle on your income and your expenses, you can finally start to think about the cost of your future home. Some experts suggest that no more than 28% of your income should go toward a mortgage payment. Keep in mind, though, that it’s not enough to calculate the monthly mortgage payment required to purchase a given home. You need to think about total cost of ownership. As a homeowner, you may have insurance, HOA, utility, repair, maintenance, and improvement costs, along with a variety of other ways to spend your money each month. Factor in all of those things, then ask yourself if your monthly income can comfortably cover those costs after covering all of your other expenses.

When you’re ready to buy a home, you may know exactly what color you want your front door to be. But figuring out how much home you can afford can be much more difficult. To decide what kind of mortgage payment your finances can bear, it’s helpful to take a step back and to ask a few basic questions about your savings, income, and expenses.