Disclaimer: This post is sponsored by PSECU, a Pennsylvania-based credit union.
Home ownership is often viewed as a critical component of the American dream. When you own a home, you can look forward to paying it off and retiring in it someday — option renters lack!
That being said, buying too much home as a first or even third time buyer can lead to serious financial consequences. As choosing your home represents one of the biggest investments decisions you will ever make, it behooves you to take your time when deciding on the perfect abode and to select one well within your purchasing means. Here’s several methods for determining how much home you can afford as well as which type of property may suit your unique needs best.
1. The Multiply Your Income Method
One simple method for determining how much home you can afford involves taking your net monthly income and multiplying it times three. This system works on the principle that as long as your home payment remains below a third of your income, you should qualify for an FHA loan as long as your debt-to-income ratio does not exceed 43 percent total.
The drawback to using this method is income can fluctuate over time. Of course, we all envision a career trajectory where our income goes up over the years. But in the real world, unexpected layoffs, serious illness or injury or even intolerable office politics derail the best laid employment paths.
2. Use the Standard 28 Percent
If you plan on getting a conventional mortgage, or even if you do go FHA anyway based on your debt-to-income ratio, the 28 percent rule is a good one to follow. Basically, your housing expenditure should not exceed 28 percent of your total income. Many property management companies prefer tenants stick to this ratio, also, but there’s less leeway when you purchase.
You can lower mortgage payments by saving enough of a down payment to waive the private mortgage insurance (PMI) requirement. You will need to provide 20 percent down to eliminate the need for this insurance.
3. Consider Your Debt-to-Income Ratio
Even if you have a 20 percent down payment and a solid credit rating, if you carry a ton of credit card, student loan or medical debt, you may need to pay it down prior to buying. Alternately, if you’re determined to buy even with substantial debt, you may want to opt for a condo or a townhouse which usually carry lower price points than single family homes.
4. Check the Balance of Your Emergency Fund
No matter how much debt you carry, keeping an emergency fund is critical, and you do well to pass on using this money toward a down payment. Why? If an unexpected job loss or other catastrophe occurs, you don’t want to lose your newly purchased digs to foreclosure. Before you buy, accumulate at least three months worth of income in a liquid savings account, preferably more.
5. Factor in Home Ownership Costs
Depending on which type of home you buy, costs other than mortgage payments can add up quickly. While those who own townhouses or condos in HOA neighborhoods generally need do nothing in regards to outdoor maintenance but pay their monthly fee, failure to pay can result in the loss of your home. If you buy a single-family home in an area= with an HOA, failure to keep your lawn landscaped neatly or keep the exterior of your home tidy can result in costly fines.
Even if you don’t live in an HOA neighborhood, you still need to factor in ownership costs. The costs of repairs and maintenance vary from tackling major remodels to simply buying gas to keep the lawnmower running. Make sure these expenses won’t make you end up short at the end of the month.
6. Insure and Protect Your Investment
The best way to keep catastrophes like hurricanes, fires and theft from decreasing the value of your home is to insure it properly. Be aware that homeowners’ insurance does not cover everything. For example, if you live in a flood zone, you need to invest in separate insurance to protect you in case such a disaster occurs.
Unexpected repairs such as a broken water heater can deplete savings and max out credit cards quickly. Protecting yourself with a solid home warranty means paying only a nominal sum of $75-$100 in case something breaks.
Finding an Affordable Dream (or Starter) Home
The amount of home you can afford depends on various factors such as your income, your total debt and your comfort level with risk. As home ownership marks a major investment, you do well to do your homework when looking to buy. This way, your home can remain a source of pride and comfort for a lifetime.