You can read article after article full of first-time home buyer tips, and the most important message in each and every one is to budget for a house you can afford. In theory, it’s simple advice, but it may leave you wondering, “How much house can I afford?” How can you make a financially-responsible choice when buying a house? We have the answers for you! With the information below, you can be confident that your new home budgeting plan makes sense for you.
Can I Afford a Home?
This is the first question you should ask yourself as a potential home buyer. Of course, there is no perfect time to buy a house, but if you can answer “yes!” to these questions, you’re probably in a good place financially to take the first steps.
Have I paid down all bad debt? Believe it or not, there is a difference between good debt and bad debt. Good debt, such as a mortgage or student loans, helps you increase your future net worth. Bad debt, however has no future potential. The number one example of bad debt is credit card debt. If you’re able to pay down your credit card balance each month, or you’ve worked hard to bring down your outstanding balance, then you’re on the right track.
Am I financially stable? A solid employment history is also important when you want to buy a new house. If you’ve been with the same employer for 2+ years and don’t anticipate any employment gaps in the near future, you have the stable income necessary to be a homeowner.
Have I saved for a down payment? When you create a budget for a new house, your down payment plays a big role. A larger down payment means less money you have to borrow from a lender. When you borrow less money, you pay less money back in interest. Ensuring you can offer a sizable down payment upfront can save you thousands of dollars in interest over the life of your loan. Programs like Diamond Credit Union’s First Time Home Buyer Share Savings Account can help you grow your down payment balance with market-leading interest rates.
Do I have an adequate emergency fund? Before making any big purchases, you should have an adequate emergency savings fund. An emergency fund is the money that will keep you afloat if you encounter a medical emergency, a costly home or auto repair, or loss of employment. Your emergency fund should be able to cover three to six months of expenses. As you look to buy a new home, you may want to adjust your emergency savings to account for increased housing expenses.
Another questions to ask while determining whether you can afford to buy a new home or not is, are we in a buyer’s or seller’s market? A buyer’s market will work to your advantage. When there are many homes for sale in your area, sellers know that they need to make their house as attractive as possible. This could include dropping the price which may allow you to get more house for your money.
How Much House Can I Afford?
Once you’ve determined if you can afford to buy a house, next ask yourself “what should my budget be for buying a house?” You don’t want to become “house poor,” meaning all your money goes towards housing expenses, leaving you very little money to spend on education, retirement planning, or other essentials. There are a few general rules you can use to guide you when you’re factoring how much you can afford to pay for a new house.
Rule of 28 — Your monthly mortgage payment should not be more than 28% of your gross monthly income. Your gross monthly income is your earnings before taxes are taken out.
Rule of 32 — Your total monthly housing payments should not be more than 32% of your gross monthly income. Your total housing payments include your mortgage, home owners insurance, PMI (if necessary), HOA fees (if necessary), and property taxes.
Rule of 43 — Your total monthly debt payments, including your mortgage, student loans, car loans, and minimum credit card payments, should not exceed 43% of your gross monthly income. This is also called your Debt-to-Income ratio, and you can learn more about it in our 3 Numbers You Should Know blog.
The very best thing to you can do when getting a picture of how much you can spend on a new house is to get pre-qualified with a mortgage lender. By analyzing your income, debt, and assets, a lender can tell you how much money they would be comfortable lending you. This will help you narrow down the price range of houses you can afford.
“If you aren’t sure whether you can take on a certain mortgage payment, try to save the target dollar amount for a few months,” advises Ben Huard, Sr. Real Estate Originator at Diamond Credit Union. Use what you need for your current rent or mortgage, then put the rest aside for your down payment or other costs. If you can save the full amount each month, it’s safe to say that you should be able to afford the new payment comfortably moving forward.”
Budgeting for a New House
When you finally have an idea of how much house you can afford, it’s time to start budgeting to buy your house. If you’re not in a rush (and buying a home is something you should never rush into — if you can avoid it), then take a few months to practice living on your new home budget.
Set aside the money that would go towards your new housing expenses (put that money towards your emergency savings, if you still have some work to do there!) and see if you can comfortably live on your remaining income. If things feel tight at first, make small adjustments along the way.