The new year is always a time of reflection for what we want to accomplish for the year. If you are thinking of buying your first home or moving up the homeowner ladder, there is always the question of “how much can I afford?”. Sorry to say: there is no one stop, one calculation, or one answer to this question. It is a deeply personal process that is unique to you that only you can answer.
What you should consider when answering this question for yourself:
| What are my goals in homeownership? | For some, it might simply be a place to live, others may see it as an opportunity to build wealth or to raise a family. Some might have more nuanced goals – a place to live that allows them to be part of a community or live below their means to allow for other financial goals. Do you want a move in ready home, a fixer upper or somewhere in between? Have an idea of what you are trying to achieve through homeownership. |
| How long do I intend to stay in home? | Sometimes this is not an easy question to answer. The idea is to have a rough idea for how long you plan to stay in the home, but its okay to change as the future does. It’s important to know the difference, if this is a short-term place or is this your forever home? |
| What is my future income potential? | Have I made the same income year over year with no plans to significantly change it? Or am I on a career path with significant income appreciation in the years to come? If you predict income growth potential in the future, it will be more acceptable to stretch your mortgage payment in the early years. |
| Do I have a sufficient emergency fund established that will remain intact after the home purchase? | Meaning, do you have 3-8 months (this varies based on your personal situation and career/level) of expenses saved that will not be needed for down payment, closing and moving costs? |
| How much do I have saved for a down payment? | And am I willing to pay for mortgage insurance for down payments less than 20% of the purchase price? |
| Do you have a budget currently and how does your spending stack up to your plans? | Create a second draft budget for your future home. Plan for maintenance costs and potential higher or new utilities. Consider additional costs, such as window treatments, furniture, tools and yard equipment you may need to purchase the first year in the home. |
| What is more important to you in your budget and where you choose to spend your money? | Do you have to sacrifice traveling, dining out or entertainment in order to meet a higher monthly mortgage payment? Only you can answer what you are comfortable with and it starts with having a budget and knowing where your money goes. Check out this personal spending flow chart for prioritizing spending. |
Rules of thumb to help you establish some guard rails
Lenders will typically limit your monthly mortgage payment (including taxes & insurance) to 28-36% of your gross monthly income, called the front end ratio of the debt to income ratio (DTI). They will also look at your debt obligations (student loans, car loans, credit cards, child support, etc.) to limit your ratio of total debt payments or back end ratio including the proposed mortgage payment, to 38-45% of your gross income.
Example:
| Gross income | Max mortgage payment 36% of monthly gross income | Max debt payments (including mortgage) 45% of monthly gross income |
| $100,000 annually or $8333 a monthly | $3,000 | $3,750 |
A good rule of thumb for the max you would want to borrow would be 28-32% of your gross income for the mortgage payment. With the same $100k income example, that would put the monthly mortgage payment in the $2,333 to $2,666 range.
Summary
Just because the bank will lend you a certain amount does not mean you can afford it. Everyone has different priorities and this is one you need to answer for yourself.
Review your budget and expenses to determine a monthly mortgage payment you are comfortable with. From there, utilize tools like NerdWallet’s home affordability calculator to back into the total mortgage amount that meets your budget. Look at a few properties in the area you are considering to understand how much property taxes are based on your proposed price range in order ensure you are factoring in accurate taxes in your monthly payment.
Still not sure or convinced if you can afford the higher payment? Try making the higher mortgage payment each month now as a trail run, with the difference between your current and proposed payment going to your savings and see how you feel after several months. If you are having to go to your savings to meet your monthly spending, then you know the higher payment might be too much to take on. If you feel good with the higher payment, you now also have some additional savings set aside.
As a buyers agent, I would love to talk through your goals for homeownership and how I can help you prepare, whether you are ready to buy now or thinking about it for the future.