Buying a new house is a huge milestone in your life, which is all the more reason to approach it with financial caution. If you saddle yourself with a larger mortgage than you can afford, you risk becoming house-rich but cash-poor.
Use the following guidelines to make sure your new home fits your budget comfortably, rather than stretching it so far that it bursts.
Calculate Based on Income
Your income will pay for your monthly mortgage payments, so your income should be your top consideration as you calculate your new home budget.
First, add up your total monthly income. For example, if you make a net of $2,400 a month (after taxes!) and your spouse makes $2,600 a month, your total take-home pay comes out to $5,000.
Now multiply your total monthly income by 25% to find your ideal maximum mortgage payment. On a monthly income of $5,000, for instance, your maximum monthly house payment shouldn’t exceed $1,250. If it does, you’ll end up spending more than 25% of your total income on your housing costs, which could place strain on your other financial obligations.
However, buying a house involves more than a monthly mortgage payment. You also must consider:
- Down payment
- Property taxes
- Homeowner’s insurance
- Homeowner’s association (HOA)
- The interest rate on the mortgage
- Closing costs
- New costs of homeownership (utilities, appliances, repairs, routine services)
All of these costs add up! For example, a home that appears to require a monthly mortgage payment of $1,250 might actually cost $1,500 a month after considering taxes, insurance, and other costs. Use a mortgage calculator to play around with your numbers until you hit your sweet spot.
Save For a Larger Down Payment
You might have heard that it’s a good idea to put down at least 20% for a down payment. This is to avoid PMI (private mortgage insurance) and typically costs 1% of the total loan value, which are more fees.
On average though, first-time homebuyers put down only 6%.
It’s recommended that you at least save 10% down but if you can, bump it up to 20% or more. Having a larger down payment will save you thousands in interest and fees later!
Consider Your Other Debts
Experts recommend that your total amount of debt, including housing, student loans, car payments, credit cards, and other forms of debt, amount to no more than 36% of your gross monthly income.
For example, if you earn $5,000 a month but have $500 in existing monthly debt payments, your monthly mortgage payment shouldn’t exceed $1,300.
If you already have considerable debt on your plate, you may far exceed the benchmark of 36% if you spend a full 25% of your income on your new home. Not only will this make it harder for you to be approved by a mortgage lender, but it will also stretch your wallet thin over time.
Consider paying off old debts before purchasing a new house. If that’s not possible, try to spend less than 25% of your net income on a new monthly mortgage payment. Buying a house that amounts to 15% of your monthly income, for example, provides breathing room to afford your new home and continue paying down old debts.
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