Perhaps, one of the toughest questions in choosing the right house is how much should one pay. Purchasing a house that is beyond your ability puts a lot of pressure on your wallet, and means that there is little cash that can be spent on other needs and the unexpected occurrences that life presents. Nonetheless, the purchase of too little house means that one might outgrow the house faster than they would have anticipated. Now how do you get this right? Here is how you can come up with a detailed budget to guide you when purchasing your home.
What’s Considered Affordable?
An ideal benchmark that you should bear in mind is that the sum of your housing costs, which includes the mortgage payment, property taxes, insurance, and HOA fees, should not go beyond 28% of your gross monthly income.
On a $70,000 annual salary, that comes out to:
- Annual Income: $70,000
- Monthly Income: $5,833 (The annual income of $70,000 divided by the number of months in a year).
- 28% of Monthly Income: The total amount of money spent by the company to earn these revenues was $1,633.
With a gross monthly income of $5,833, the sound advice is not to spend more than $1,633 on housing. When you tend to spend more than this much, there is a tendency that you cannot cover the other basic needs you have and at the same time, save some money. Housing should not be a luxury to afford when it is within 28% or less of your income.
Of course, this is just a guideline that can be applied as a framework to which a certain set of rules must be adhered to. This is because you will need to take a closer look at your specific circumstances, debts, living expenses, and financial objectives among other factors to pinpoint your maximum.
Factors That Impact Affordability
While the 28% rule keeps housing affordable for most, you also need to consider other factors that make homebuying more or less affordable specifically for you:
Down Payment Amount: The lower the mortgage loan amount, the larger the down payment that you need to put into the house. This leads to an overall reduction in the average housing cost in a particular month. For instance, paying 10% down means making higher monthly payments than when a person agrees to pay 20% down.
Debts: If you have high monthly student loans, auto, and credit card payments, the percentage that you will consider to pay the mortgage must be below 28 percent. Debt has the effect of reducing the money that a person has in his or her possession to make a mortgage payment.
Location: Your city, neighborhood, and zip code influence the cost of houses and the property taxes that are part of the housing expenses you incur each month. This means that if you want to save some cash, it will be easier if you buy in a cheaper location. The technique that is used when one needs to purchase a home in high-cost cities such as San Francisco is to buy a lower-priced home to be able to avoid an unaffordable mortgage.
Interest rates: The rates for mortgage and interest change often and hence influence the amount that one is expected to make in terms of mortgage. Lower rates increase your ability to purchase the house. When rates trend higher, you will find yourself having to buy a cheaper house than you would have wished to stick to the 28% upper limit. Check rates when planning to buy property or any home.
Private mortgage insurance (PMI): This also means that if less than 20% is deposited at the time of purchasing the home, normally the PMI has to be paid until the homeowner reaches at least 20% home value. This comes with an average of 0.5% – 1 % of the total loan amount for the year. PMI makes homeownership a less achievable goal.
Homeowners insurance: It is important to understand that they differ depending on the state, home value, age of home, past claims, and other factors. The fact that a certain area has high premium rates means that it takes a big chunk of an individual’s monthly rent budget.
HOA fees: When it comes to the cost of housing, monthly HOA fees have to be included in case the property is located in a homeowner’s association. These fees can vary from $100 to $700 and above based on the additional services and facilities offered in their communities.
I hope you see that, based on many variables, your maximum affordable mortgage payment and purchase price point can change. Now that we’ve gone through all the necessary equations, let’s put this into a basic scenario.
Example of a Budget and What You Can Buy on a $70 000 Salary
The actual income of Emma is $70,000 per year, and she has the aim to purchase the first house by following all the financial ratios. Here is a realistic look at how much house Emma may be able to afford based on her situation:
Annual base salary: $70,000
Monthly take-home pay (after tax): Total cost of the project: 4250/ Allocated cost of the project: 4250
Calculated based on federal income tax rate of 25% for the year 2009. These do not consider state taxes which lower the actual amount that may be taken home.
Minimum down payment: $14,000; the money for a 20 percent down payment is usually recommended because it helps to avoid paying for PMI.
Monthly debts: $320 student loan payment + $450 other debts = $770
Remainder monthly income: Gross earnings $ 4,250 Minus taxes $ 770 Net earning $ 3,480 Remaining balance each month $ 3,480
Max monthly housing costs per 28% rule: 3,480 dollar(s) x 0.28 = 975 dollar(s)
This implies that Emma can comfortably afford a minimum of $975 per month for housing expenses. This takes into account $70,000 of her income, the $12,000 she hopes to pay as down payment to make PMI unnecessary, and the debts leveled at her. With this budget, let’s determine the maximum amount able to spend when making a purchase.*
Homebuying Math for Emma
Here are the assumptions we’ll make based on Emma’s $70K income, location, and interest rate research:
- Down payment available: $14,000 with a 20 percent interest rate.
- Interest Rate: 6% for the 30-year fixed rate Mortgage
- Property Taxes: The insurance cost amounts to 1.25 percent of the home’s value, which has to be paid on an annual basis.
- Homeowners Insurance: calculation, means that the homeowner should budget 0.5 percent of the home value for the annual property taxes.
- PMI: Since the borrower is required to pay at least 20% down payment it does not fall under any of the above.
- HOA fees: $0 is to search for homes without an HOA
Using these assumptions and a mortgage calculator:
**If Emma spends $975 per month on rent/housing, then she would also be able to afford the $175,000 home and not exceed the 28% affordability ratio**.
This includes the mortgage loan amount and interest, taxes, and insurance on the property. It enables Emma to secure a good first home that she can afford for now given her income, debts, and savings.
Following are some useful tips that will help you stay on your budget.
Purchasing a home is one of the most thrilling experiences that a person can ever hope to undertake. However, this excitement should not lead to the inflation of prices to a level that ends up compromising one’s accommodation status by being house-poor.
Here are 6 tips to stay on budget:
1. Understanding your affordability before starting the house search - To use the approach illustrated earlier, first, determine the 28% affordability rule and the maximum purchase price allowed given your circumstances. This helps ensure that you do not set a pace that you cannot meet financially because it aligns your expectations with the amount of money you have.
2. Save for emergencies - It is recommended that for personal stability one should spend not more than 28 % of his or her income. Whether this is done to a small or large extent, it provides the leeway needed to accommodate future annual changes in property taxes, insurance, interest rates, and other customary housing cost escalations without wrecking the budget.
3. Be pre-qualified for a loan – before approaching lenders get pre-qualified for a mortgage. Do not take homes seriously that is beyond your pre-approval amount; go for homes that are within your pre-approval amount. This makes you avoid falling in love with other better houses that you can afford in the long run.
4. Affordability calculators such as bankrate.com’s affordability calculator: These entail entering the home’s purchase price, purchase price, interest rate, tax rate, insurance costs, etc to arrive at the real monthly installment. Make sure that this fits into the monthly amount that you have figured out that you would be able to comfortably pay.
5. Save for the deposit and other expenses in advance - Determine what you can afford to spend on your monthly mortgage repayment and set the upper limit for the house price. There will be no major increase in the amount of money that you have to spend from this point onward. However, you should establish your spending limit based on today’s actual expenditure and monetary objectives.
6. Think of all other associated costs aside from mortgage – Besides the cost of mortgage, there are other costs associated with owning a house such as maintenance fees, repair costs, utility bills, and costs incurred in case you decide to renovate your house. It’s wise to prepare for these because they accumulate significantly over the years.
Purchasing a home is one of the most thrilling events in most people’s lives! Choose an appropriate price range for a home based on your financial condition and the current budget, to begin with the home search. Make sure to borrow reasonable amounts of money and bid reasonable prices on homes so that you can safely get a home without being squeezed financially.
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