Knowing how much home you can afford can help you narrow your search and find the right home, but there are a lot of different factors to consider. You’ll need to look at the price of the home, sure, but you’ll also need to think about the interest rate on your mortgage, the property taxes, the cost of insurance, how much cash you’ll need up front at closing (from your downpayment to closing costs), and how much the home could cost you in the long run (repairs, maintenance, remodeling). Some of the costs can’t be easily calculated, such as repairs – who can predict when their AC system will conk out on them (this would be a good time to be covered by a home warranty)? Costs like taxes and insurance can be figured out for now, but will more than likely rise over time. Unless you get an adjustable rate mortgage (which are not as common as they once were), your interest rate will remain solid and the amount you pay for the house will remain fixed, although your mortgage payments may change if you use an escrow account for your taxes and insurance.
Calculating How Much Home You Can Afford
There is no shortage of calculators for affordability online and most of them are based on the same basic principles. Like most things, the outcome of the calculator is only as good as the data you put into it. Most affordability calculators will ask you a few basics: your income, how much money you’re going to put down on the home, how much do your monthly debts (car payments, credit cards, etc.) cost, and what interest rate you’ll be paying on your mortgage. Of course, that number can vary greatly, but you can usually get a basic estimate using the latest rates available online (you should probably overestimate rather than underestimate). Remember, your interest rate is based on multiple factors, so what you see online or your friend’s interest rate, might not be the same as yours.
More advanced calculators will ask you about property taxes (which you can look up online at your county appraisal district’s website), insurance (often the hardest to estimate as it is based on the house you intend to buy, but call your insurance agent and ask them for some roundabout numbers), mortgage insurance, and HOA dues. Some will even allow you to work backwards from the amount you want to pay a month.
The best way to get a true picture of not only what you can afford, but also what kind of loan products (and interest rates) are available to you is to sit down with a local lender and talk. They will ask you for the basic info (which is all subject to verification in order to get the loan) and show you what they see as your potential target for both a monthly payment and how much home you can purchase. Lenders will often give you a price range you want to stick to – the closer to that ceiling you get, the more you will need to tighten the budget to afford it. We recommend you don’t max out your limit there, so that you still have a cushion for when your water heater explodes in the middle of the night!
image courtesy of robef