How Much Home Can I Afford?
So you're thinking you might want to buy a home. Or maybe, you're thinking you may want to upgrade to a better home. One of the first questions buyers ask themselves when beginning the home buying process is, "How much home can I afford?"
It's a great question. A very important question, in fact. One that should not be bypassed or considered lightly. You want to be happy and successful in everything you do, particularly in homeownership. As The Wyse Home Team's Chief Executive Officer Ron Wysocarski puts it, "you don't want to be making hard decisions like whether to pay your house payment this month or your healthcare costs."
But it can be tough to plan for the unexpected in life. More often, we tend to plan for the expected. Vacations. Holiday gifts. Bills like insurance and car payments. Sometimes, we even plan for the somewhat unexpected, like a minor car accident that might force us to cough up a deductible, or a storm that causes a small leak somewhere in our home or a power surge that damages some of your electronics. But most people don't plan to lose a job. Most people don't plan for major illness to strike their families. And when your house payment is at the top of your budget, an unexpected financial event can cause ripples in your financial stability that can make all the difference in your financial future. You might suddenly find you can no longer make your mortgage payment on time - or at all.
So how does one begin unraveling the real answer to the question, "How much home can I afford?"
How the banks answer that question
Banks, lending institutions and mortgage brokerages start by looking at your "debt to income ratio." There are two types of debt-to-income ratios that lenders look at when you apply for a mortgage:
- The housing ratio, which shows how much of your income would go toward your housing expenses. This figure includes not only the monthly mortgage payment, but also property taxes, homeowner's insurance and homeowner association dues.
- The overall ratio is how much of your income is needed to cover all of your monthly debt payments, including housing expenses, credit cards, car loans, student loans, child support, etc.
The housing ratio, is your expected housing expenses divided by your gross monthly income (before taxes). Multiply the result by 100 and that is the housing debt-to-income ratio.
To determine the overall ratio, add up your monthly debt payments, including those housing expenses and divide the number by your gross monthly income. Multiply the result by 100.
Greg Hively, branch manager at Waterstone Mortgage, says mortgage lenders generally look to keep a customer's overall debt levels around 45 percent of their income, and their housing debt at or below 30 percent.
And since the economic and banking meltdown of the nation's worst recession a few years ago, many lenders have tightened that debt to income ratio number back into figures at or below 43 percent. The Fannie Mae website indicates some home loan products want that ratio to be as low as 36 percent, depending on credit scores and loan structure.
Your bank approval and what you REALLY can afford might be different
While having your home related payments, such as the mortgage, insurance and taxes amount to less than 30 percent of the household income is a good rule of thumb, buyers have more to consider. These formulas and numbers banks often refer to in determining how much home someone can afford are cold calculations and devoid of considerations close to your home and family circumstances, Hively and Wysocarski said.
"This question is highly personalized to you and your family. You have to be comfortable with your monthly outflow," Hively said.
Take a close look at your family budget and be sure to consider ALL of your expenses. You will want to be sure to avoid "payment shock" from the new mortgage, Wysocarski said.
Spend some time playing with a mortgage calculator. You can click here to use ours. The calculator will show you the potential cost of your mortgage payment based on the down payment you want to make and the interest rate you think the bank may offer. That figure won't include your taxes, mortgage insurance, homeowner's insurance or HOA fees. Our calculator will offer you some estimates of what some of those costs could be, but not all.
Wysocarski said for many median price range buyers in this area, adding roughly $300 to the mortgage calculator's monthly total will give you a "reasonable place to start" and give you a rough ballpark idea of what your PITI (the sum of monthly principal, interest, taxes, and insurance) payments might be. (If you will be putting less than 20 percent down, or know you will be looking in a community with HOA fees, you may want to add a little more to your calculation.)
The real test when estimating future payments and answering the question, "how much home can I afford," is and always will be whether you can handle the payments for 10, 20, or 30 years. A lot can happen in a home and family's circumstances in three decades. It's important to look at ALL of your known costs and expenses.
Your bank won't consider the costs of soccer uniforms and summer vacations. It doesn't calculate today's high prices on diapers and baby formula. Nor does it account for rising daycare costs, price hikes at the gas pump, school field trips or what you pay in the checkout line at the grocery store for those bags of organic produce and bakery items.
"No bank can account for a person's spending habits, and recent years' economic conditions have proven that no buyer can depend on raises and promotions for future breathing room in their budget," Wysocarski said.
So, if the bank isn't considering those important things, YOU MUST consider them when seeking the answer to the question, "How much home can I afford?"
The truth is, for many families, it just doesn't make sense to spend as much on a home as the bank may qualify them for. And if you don't carefully consider and answer the question, "how much home can I afford," you could find yourself living the definition of "house poor." (That's a term famous financial adviser Dave Ramsey often uses when referring to people who are over-extended on their mortgage payments.) We'll get to more of Ramsey's advice for buyers in a minute.
The next steps
Now that you've calculated your debt to income ratio, looked at your budget, and spent some time playing with the mortgage calculator, the next thing you want to do is contact your lender and a real estate agent if you haven't already.
Many buyers begin to ask the question, "How much home can I afford," as many as 6, 12 or even 24 months before they are actually ready to buy, Wysocarski said. While signing on the dotted line for a new home may seem far off now, it's not. Getting both a lender and an agent working with you is something that should be done very early in the home buying process. In fact, making that phone call the moment you begin considering buying a home is most ideal.
"The sooner the better. That way, if there’s a blemish on the credit you don’t know about, an old collection or debt, or maybe an error on the credit report, we can help get that cleaned up so it’s not affecting the credit score when the bank sets the interest rates and approval amounts for your loan," Hively said.
Your agent and lender can be valuable help as you work to answer your question of "How much home can I afford." Here at The Wyse Home Team, Wysocarski has more than a decade of mortgage lending and real estate experience. He knows both sides of the transaction and is trusted by his clients to help them walk through the tough questions that often surround a family budget.
Your agent and lender also can bring key figures into the financial equation that you might otherwise overlook or be unaware of. For example, homes or condos in the area you are considering buying may have Homeowner Association (HOA) dues associated with them. Your agent can also give you some historical background on a home's property tax history, and much more. Essentially, your agent can help you assess what you can reasonably expect through the home buying and home financing process, and can help you find a home, and a pricing "sweet spot" that will best meet both your personal needs and financial abilities. A great agent can assist you in determining a good house hunting budget, prepare you for how the purchase will impact your personal budget, and can inform you in a way that prevents surprises as you move through the lending process and sit at the closing table.
Key things to consider and remember
- Look first at the big items in your budget. Start with your current rent or mortgage payment. Then consider whether you're comfortable with that payment or if you can afford to pay a bit more each month. If you think you can swing a higher payment, Wysocarski says you should immediately start setting aside the difference between your current payment and what you expect your new payment will be. That will help you get adjusted to the new payment and will assist in preventing payment shock down the road. It will also provide time for issues and monthly expenses you may have forgotten to include in your budget to become apparent since simple things like dog grooming, or bills that only come due annually or periodically can be forgotten when a budget is initially compiled. Then, if no concerns arise between the time you determined how much you want to spend on a home and the date when your first mortgage payments begin, you have a nice little savings for additional down payment on the home or for rainy day repairs that could arise after you have moved into your new place!
- Once you have begun to answer the question of "how much home can I afford," begin working with your agent and lender or using a mortgage calculator to determine what your total budget for a home will be based on the payment you have selected.
- Look for ways to save money both on the impending real estate transaction itself and over time as you live in the home. Although many banks offer loans and products that require very small or no down payment, Ramsey and Wysocarski recommend putting as large a down payment on your home as you can afford without dipping into key savings accounts like education or retirement funds, reserve accounts, and emergency funds. Ramsey and Wysocarski recommend putting at least 10 percent and preferably 20 percent down on your purchase. Putting at least 20 percent down on a home purchase helps to avoid costly monthly mortgage insurance premiums. "That's money you can never get back," Wysocarski said. Ramsey also recommends buyers stick with fixed rate mortgage terms at or below 15 years.
"Thirty-year mortgages are for people who enjoy slavery so much they want to extend it for 15 more years and pay thousands of dollars more for the privilege. If you must take out a mortgage, pretend only 15-year mortgages exist." (DaveRamsey.com)
- Then comes the fun part - searching for your new home! We recommend you use a local real estate site to conduct your search since some of the national real estate sites are notorious for showing inaccurate results and homes that are no longer available. If you're looking in the greater Daytona Beach, New Smyrna Beach, West Volusia or Flagler areas, you'll love all the great search tools on this site. Start your search by entering some criteria in the easy to use search bar at the top of every page on this website, then narrow the results further by clicking "more options" just below the red search button. Don't hesitate to give us a call anytime at 386-871-7697 if you want some help finding and making the most of the tools on our site, or if you would just rather we set up some searches for you and send you the results! If you're outside of our area, feel free to call us and we will be happy to refer you to an awesome agent we trust.
Remember, we're here to help and to make your home buying experience as easy and fun as possible! Take advantage of the free advice and extensive expertise we can offer you as you navigate the lending and home buying process. Call or email us frequently. We're happy to help! You can also fill out the form below and we'll reach out to you.