Home ownership is a fantastic accomplishment and one that most anyone can achieve with him smart financial stewardship. When you are thinking of buying a home (you should start at least 5 years prior to your actual intended goal) you need to think about the bigger picture to ensure that you are working towards a realistic goal. What is the purpose of having a house if it makes you “house poor” and you struggle each month, diminishing your happiness and ability to enjoy other activities. Be smart and prepare to enjoy being a homeowner!
1. The simple math method: Take your gross income each month. Multiply your income by roughly 43% (debt to income ratio) to get your usable cash amount (hint. This should be a smaller number.) Add up all of your loan payments, car payment, school loan payments, credit card payments, etc. Then subtract your current bill total from your usable cash amount to get your potential mortgage. For example: $9k per month income, $600 car payment, $300 credit car, and $500 student loans.
Usable Cash: $9k x 43% = $3,870
Subtract bills: -$1,400
Possible Mortgage: $2,470
Of course there are loans that allow you to have a higher debt to income ratio that 43% but those commonly have higher interest rates.
2. Tech tools: Tons of lenders and banks have affordability calculators. Understand that these often tell you potential payments and not how much you can afford. Also consider that many calculators don’t include taxes and insurance so keep an eye out for those. Then, look at that number and compare it to your current mortgage or rent payment. If you are comfortable with your current payment then you can consider stretching to a higher payment but if you have months where you struggle to pay rent, perhaps consider finding a mortgage that is less than your current rent.
3. The cost of homeownership: While the two big pieces of the puzzle are income and payment, don’t forget that homeownership comes with other costs to consider. You may have higher utilities in a bigger home or if your current rental covers some of your utilities. You will have to maintain the home including the yard, appliances, roof, and in CA termites ... ick! Things break and they need fixing, no more calling the landlord. To estimate these things, the standard estimation is about 1% of the home cost per year. So a $500k house will have $5k upkeep per year, divide by 12 and you have $417 per month. That seems like a lot per month but look at it as an insurance account. Things don’t break every month, but when they do they tend to be pricey.