Beginners Guide to Buying a Home– Week 3

This step-by-step series will take you through the entire home-buying process — from finding a buyer’s agent to settlement day, and all the details in between. Every first-time buyer will find this information-packed series easy to follow and understand. Make sure to tune in for the next few weeks!

One of the biggest mistakes I see homebuyers make is not taking the time to understand how much they can REALLY afford.  Which leads them to setting larger price ranges or a higher purchase price than they may ultimately be comfortable with.

Let’s pause before you go down those frustrating roads!

The last thing you want is to be “house poor” or feel that you shortchanged yourself and gave up features you really wanted. We are going to go through the numbers, so you know exactly how to figure out how much mortgage you can/want to afford and ultimately find the home you love at the right budget.

Remember there is the mortgage you can qualify for and then there is the mortgage you are comfortable with.  

Here’s how:

Think monthly payments first and foremost.

Don’t start with purchase price, let’s start with monthly payment for your home, one that you are comfortable with. This monthly payment needs to include your property taxes and homeowners’ insurance. In other words, just your housing costs, not utilities and general monthly maintenance.

By following this monthly Mortgage Rule of Thumb, you will ensure you get the home you want at the price you want.

Here’s why.

Even if two properties are selling for the same price, it doesn’t mean the monthly payments will be the same.

For example, the monthly payments for a $500,000 condo will be completely different than for a $500,000 single-family home. While the condo may have lower taxes, it will have homeowner association (HOA) fees you need to consider.  Two single family homes selling for the same price could have different property taxes depending on where the homes are located.  By focusing on the monthly payment, we can adjust the purchase price depending on these other factors such as taxes and HOA fees.

So rather than start with the price in mind, focus on the monthly payment, we can work with your lender to equate the monthly payment to a price that will actually work for you.

Don’t just accept what lenders say you can afford.

Unfortunately, many buyers start with that blanket statement of price because their lender pre-approved that amount for them. Don’t take that at face value.

You need to look closely at that number, understand what amount the lender allowed for property taxes, and what that monthly payment looks like. You may have a lower number in mind for your monthly payment.

Buyers may say, “I’ve been approved for $500,000 by my lender,” but when you dig a little deeper, this number is not in line with the monthly payments the you want to commit to.

Lenders will approve you for the highest purchase price possible based on several “big picture” financial factors, but it doesn’t really keep in mind what YOU want to pay per month on a home.  I always tell my clients there is the number the bank will approve you for and there is your “sleep at night” number.

Work backward to determine the correct purchase price for you.

First, you need to figure out how much you want to pay per month, and then you’ll need to back into the purchase price that will work with your target monthly payment.

This is the traditional way of determining how much you want to pay. In the past banks looked for housing (mortgage, taxes, homeowners’ insurance) to be about 25% of your gross monthly income, this percentage has risen over time so you have more leeway when setting your monthly mortgage payment.

Once you have your monthly housing payment figured out (Mortgage, property taxes, HOA, homeowners’ insurance), you can factor in your down payment and any homebuyer assistance programs.

You’ll also need to include other potential costs of owning a home that may not be included in your property taxes such as garbage collection, water bills, etc. While the bank won’t take these into consideration when calculating your Debt-to-income ratios, these can add up so make sure you don’t get surprised.

Keep in mind, every $10,000 in purchase price only adds an additional $50 -$70 to your monthly payment depending on the interest rate.  Similarly, the same goes for your down payment: Every additional $10K you put down; you are only saving yourself about $50-$70 per month.

So don’t feel you have to save for years for additional down-payment funds to afford a home.  And remember that there are some great options out there to help with your down payment.

Look at your budget to determine what you want to pay per month.

So now that you know to work backward, how do you determine what you want to spend per month when you own a home? It’s time to make a budget!

It’s important to consider all your expenses when making a budget, consider what you are willing to give-up, postpone, or replace with less expensive alternatives to afford your home.

Here’s what to include and consider when determining your budget:

• List all the costs of homeownership — property taxes, mortgage insurance, home insurance, maintenance, utilities (which includes heat), condo fees, and parking fees, if applicable. I can help with estimates!
• List all other expenses you expect to continue — such as gym memberships, day care payments, car loans, school loans, gas, or commuting fees, etc.
• Estimate yearly maintenance costs for a home. Plan to spend or save about 1% of your home’s purchase price each year. So, if you buy a $600,000 house, you should be putting about $6,000 per year into the home for maintenance or into a savings account for when you need to replace something in the future such as the hot water heater or roof.
• Include any tax advantages you’ll get as a homeowner. Owning a home provides tax advantages and you could get a larger refund depending on the deductions.
• Consider additional expenses, beyond your mortgage payment and maintenance costs. Consider a furniture budget which can make the early years of homeownership a little more expensive.
• What expenses are “mandatory” for your life and general happiness?  Look at your current lifestyle and figure out how owning a home could impact your budget. If you love to travel then then don’t buy a home that will leave you unable to afford to travel for years! That would not be worth it.
• What expenses could you tighten-up on to get the home you want?  What are you willing to trade or eliminate in order to own a home? Would you sell your car and bike or take mass transit everywhere? If so, may be you can spend more to live closer to work and other amenities.
• Remember that how much you can afford today can change next year and after that. Yes, your salary will increase but you’ll have new costs, such as kids or a new car. This is when you do want to look at the “big picture” of your life now and down the road.

Finish up the math to get an idea of how much you can afford.

You can pay a third more than your rent payment to own a home without changing your lifestyle.

You can get a quick SWAG on how much you can afford by multiplying your current rent by 1.33. This number considers the tax benefits you should experience from owning your own home.

For example, if you currently pay $2,000 per month in rent, you should be able to comfortably afford a $2,660 monthly mortgage payment after factoring in the tax benefits of homeownership.  Don’t take this as tax advice, after all I am not a licensed CPA, you need to consult your licensed accountant to get your specific numbers and the tax savings from being a homeowner.

Don’t hesitate to contact me if you have any questions about calculating a monthly budget. It’s an important first step before you start looking at homes.

Once you know your monthly budget, other steps will neatly follow. You’ll be able to determine your price range and then be able to work with your lender on available mortgage products along with any down-payment options.

Next up in my Beginners Guide to Buying a Homeseries is Where to Find Money for a Down Payment. Every buyer needs to be prepared for this and you’ll learn how!