Purchasing a home is exciting, and it’s a great investment you will likely be paying on for the next decade or two. You’ve decided now is the right time, and you’re ready to take the plunge — but you just have one question: how much should you spend on a home?
First Things First
Before you call the realtor or even step foot on the property of a potential purchase, determine how much you can afford. You want to be able to give your realtor a price range that’s realistic and stays on budget so you don’t fall in love with a home you can’t afford.
Wait a minute. Shouldn’t you just apply for a mortgage loan and let them tell you how much you can afford? Not exactly! Lenders profit from your loan, so they’re going to max out your budget. If you go solely by those numbers, you may end up in a house you can barely pay for.
Do the Math
To figure out how much you can afford to spend on a home, you need to look at your annual income as well as how much you could commit to a monthly mortgage payment.
To begin, calculate your home purchase price range. This method is simple and gives you a good estimate to start with. Simply take your annual salary and multiply it by three to get your minimum and multiply your salary again by four to get your maximum.
It looks like this: if your salary is $75,000 and you multiply that by three and four, you get a reasonable range of $225,000 to $300,000.
This is a large range, and you don’t want to just assume that because you did this simple math, you can afford a $300,000 home. This just gives you a general estimate without considering anything else.
Make the Numbers Apply to You
Now that you have an estimated range, it’s time to narrow down your numbers a bit further and look at your monthly mortgage payment.
Start with your after-tax income each month and deduct any debt payments from that number. Basically, you’ll want to consider anything that will be an ongoing expense, even when you’re in a new home, and ignore any expenses related to renting in your current situation.
Once you have that number, multiply it by 25%. The number you arrive at is a guaranteed amount that you can afford to pay monthly for a home, given your salary and expenses. You don’t have to stick to a purchase price that will give you this amount of mortgage exactly, but you also don’t want to go too far from it, because putting all of your money into your home will mean you won’t have any money to do anything else.
Reality Sucks — Now What?
If you’ve done the calculation and found your monthly payment won’t buy the home of your dreams, don’t get discouraged! You have other options to get into your dream home without getting in over your head.
The amount of down payment you put down will lower your mortgage amount and ultimately lower your monthly payment. Hang tight where you are for a few more years and save up more money for your down payment to get your future monthly payment into your reality zone.
If holding off on purchasing a home isn’t an option for you, you can focus on the right now. You don’t have to begin with your forever home. You can purchase a small starter home to take the plunge into homeownership now and save up money towards your future home. Keep in mind, though, that you need to stay in this home for about five years to break even and make this a smart option.
This may not sound like an appealing option, but beginning with a starter home lets you become a homeowner now and work towards your dream home. If you make a smart investment, you should be able to profit from selling the starter home in a few years, and have even more money to invest in your forever home.
The final option is to look for homes that need a lot of work. You can get a lot more home for your money this way, but you need to take into consideration the expenses you’ll incur getting the home into enjoyable condition.
You don’t want to purchase your dream home and then suddenly only barely be able to make ends meet and pay your bills. Where’s the fun in that? You won’t be able to meet savings goals, go on vacations or enjoy life much. Instead of setting yourself up for failure, take the time to find out how much you can really afford to spend on a home and look at all of your options before you buy a home on impulse.