How much home can you afford?
Buying a home should be a joyful event. But buying one that is too expensive, and requires too large of a monthly mortgage payment, can quickly turn that joy into a financial nightmare.
No one wants to be house-poor. That’s when the cost of owning your home, including making your monthly mortgage payments, is so high that paying to live in your residence becomes a financial burden.
Financial experts say that spending too much on a home can negatively impact your entire life. You might have landed what you think is a low mortgage interest rate. But if your overall monthly payment, including taxes and insurance, is still too high, that lower interest rate won’t matter.
You might struggle to sleep while worrying about paying your bills each month. Your three-digit credit score might plummet when you can’t afford to pay each of these bills by their due dates. And the pressure of making that high mortgage payment each month might make you hate that home you were once so eager to buy.
Fortunately, with just a bit of research into your finances you can avoid overspending on a home. And with this research, you’ll increase your odds of ending up with a monthly mortgage payment that you can comfortably afford.
Lenders’ debt-to-income ratio
Kevin Quinn, senior vice president of retail lending with First Internet Bank, said that it's important to determine early in the buying process just how much home you can afford. If you don't, you could feel the financial sting for years, he said.
"Spending too much on a home could leave you with little money for retirement, your children's college fund, family vacations or even everyday expenses," he said.
Quinn said that the key is to know exactly how much you make each month and how much you owe. Lenders do this by studying your gross income -- the money you make before any deductions -- and your estimated monthly expenses, including your estimated new mortgage payment. In general, lenders don't want your expenses to equal more than 43 percent of your gross monthly income.
Setting realistic goals
But Quinn said that what mortgage lenders approve you for is not always a loan that you can comfortably afford. Quinn recommends that instead of just focusing on your gross income, which you use to qualify for a mortgage, that you also look at your monthly net income. This is your take-home pay after all deductions are removed from your checks, and is a more realistic view of the money you actually have at your disposal each month.
Stuart Crawford, regional manager with Scottsdale, Arizona-based V.I.P. Mortgage, said that consumers need to be careful about taking on a mortgage payment that puts them right at that highest debt-to-income ratio.
"There is a difference from what the guidelines say you can do and what you should do," Crawford said. "If you go with the guidelines, you'll be pushing yourself to the absolute financial maximum. That could lead to trouble if anything changes with your finances."
Next, it's time to make a monthly household budget tracking your income and expenses, including estimated, and realistic, amounts for what you spend each month on such flexible items as groceries, entertainment and transportation.
Once you have these figures, you can determine how much room there is in your budget for a mortgage payment each month. You’ll be less likely, then, to overspend on a house that will come with a mortgage payment higher than this amount.
It's important, too, to understand your own spending habits. A lender might look at your income and debts and say you qualify for a mortgage payment -- including taxes and insurance -- of $2,000 a month. But if you tend to break your budget every month by overspending on meals out, movies and concerts, taking out such a large mortgage might be a bad financial choice.
"Be knowledgeable about how much you spend now and set real expectations around whether you'll need to change those spending habits once you become a homeowner," said Mary Weaver, minister of culture for Austin, Texas-based Sente Mortgage.
Weaver recommends meeting with a mortgage lender early in the home-buying process. That lender can then help you determine how realistic your budgeting and spending goals might be.
The fact is, not everyone is good at sticking to a budget. These homebuyers might do better to purchase a home that is below the top of their affordability range.
Sente Mortgage recently released a survey on homebuyer trends. According to the survey, 93 percent of buyers said they had the knowledge they needed to create a monthly household budget. But only 83 percent said that they were actually good at living within the budgets that they created.
"Assessing your budget and spending habits will keep you from overspending," Weaver said.
Focus on the neighborhood
Colby Sambrotto, president and chief executive officer of Womelsdorf, Pennsylvania-based USRealty.com, said that buyers who are worried about overspending on a home should focus on neighborhood amenities instead of on such amenities as modern kitchens or large master bathrooms.
That's because neighborhood amenities such as strong schools, abundant park space, proximity to public transportation and quiet streets can be less expensive to obtain. You can then later focus on improving your less expensive home, maybe with a home improvement loan, once your finances are stronger.
"Buy the neighborhood and improve the house to your standards," Sambrotto said. "If you hope to stay in the house for the foreseeable future, move neighborhood amenities up on your priority list. It might be cheaper and smarter to expand a basic ranch house located in a top school district than it is to buy a bigger house in the same school district."