You probably already know that budget is a huge determining factor when buying a home. As a result, it’s important to figure out the maximum amount of money you can spend and refrain from going over said amount.
There are multiple factors determining exactly how much home you can afford. These include your income, debt-to-income ratio, property taxes, and homeowner’s insurance, as well as other monthly expenses.
Let’s take a closer look:
Your annual income is a vital component of any budget calculation, whether for a mortgage or rent. Either demands a down payment. You’ll also of course need to make the mortgage or rent payments once the purchase or lease is official. Additionally, there's any outstanding debt you may have, and other monthly expenses—which we’ll get to later.
Requiring too much of your income to pay for a home could make you so-called “house poor,” defined by finance education website Investopedia.com as someone who “spends a large proportion of his or her total income on home ownership, including mortgage payments, property taxes, maintenance and utilities.”
“House poor individuals are short of cash for discretionary items and tend to have trouble meeting other financial obligations like vehicle payments,” it continues.
Your debt-to-income (DTI) ratio can also significantly affect how much home you can afford, which is why it's a key detail reviewed by mortgage lenders when assessing loan qualifications.
Personal finance company Credit Karma® explains in a January 2019 article how “there are two types of DTI: front-end and back-end ratios,” with the former revealing "how much of your pretax income would go toward a mortgage payment.” While this is important, the latter is directly related to your debt.
“To determine if you can truly afford a mortgage loan, a lender may calculate your back-end DTI ratio, which shows how all of your debts—including your existing debts with a mortgage payment added in—compare to your pretax income," it continues. "If the number is too high, it could indicate that you may not have enough income to pay both your debts and day-to-day expenses.”
The amount of money you’ll have to pay in property taxes for your new home is also a critical component. Credit and financial resource Credit.com explains: “To determine your property tax, a local tax assessor will establish the tax rate for where you live and that amount will be multiplied by the value of your home.”
“So, for example,” the March 2017 article continues, “if your home is deemed to be worth $200,000 and your local tax rate is 1.5%, your property taxes would be $3,000 annually (or $250 each month, which is what you’ll pay into your escrow account—more on that in a minute). Keep in mind, there may be other fees or assessments that are applied to your property taxes as well, so this would be an approximate estimate and it’s a good idea to check with your local county tax assessor for more information. The rates and fees may also change over time, which will affect your taxes.”
As the U.S. Consumer Financial Protection Bureau states: “Homeowner’s insurance pays for losses and damage to your property if something unexpected happens, like a fire or burglary.”
Homeowner’s insurance varies, depending upon the age of the home you’re purchasing and its neighborhood, as well as other determinants. Therefore, it’s something to remember and research as you house hunt, because you’ll need to factor this cost into your future monthly expenses.
Besides various loans (plus interest), and taxes and insurance you have to pay, there is a long list of expenses you also need to consider, as they too influence how much money you can afford to spend on a home. These may include food, transportation, health, insurance (i.e., car, health care), clothing and child care (if applicable), among others.
With all that said, one option to consider is speaking with a trusted financial advisor, as he/she can help point you in the right direction and gain a better understanding about your finances and budgetary capabilities.
Contour Mortgage has been helping home buyers purchase their dream homes since 1993. Contact us today to find out how we can help you.