How Much House Can I Afford

Dated: 09/12/2017

Views: 132

I often receive questions from my Kenosha home buyers concerning whether or not they can afford a particular house – or how much house they can afford. The stories vary a lot in detail – some people have a down payment, while others do not, and some people have other debts, while others are debt free.

Regardless of the situation, though, I give these people the same advice. Your total debt payment for a given month should not exceed 30% of your take-home pay. 

In other words, if you bring home $4,000 per month, your total debt payments for that month — including student loans, car payments, credit card bills, and your potential mortgage itself — shouldn’t exceed $1,200.

Now, that’s not necessarily what a bank thinks you can afford — lenders are often willing to stretch you farther than might be wise. We’ll get to that in a moment.

First, let’s walk through a few of the specifics of my 30% rule.

This is take-home pay, not gross pay. The only pre-tax number you might consider including is your 401(k) contributions, but I wouldn’t include those. I would never include taxes or other payroll deductions when thinking about this. Why? In the end, this is all about budgeting, and having 30% of your monthly income go straight into debt payments is a pretty hefty chunk of your money. This leaves the rest to cover all of your utilities, food, household supplies, gas, insurance, and other living expenses.

The percentage should be pretty close to that even if you’re earning a lot of money. Again, why? This is all about downside. You don’t want to have to sell your home in a panic if you lose your job or some other major lifestyle change occurs. You want to keep yourself afloat no matter where your ship goes.

Sticking with this policy usually implies a few things.

First, you’re going to be able to afford a bigger home if you’re otherwise debt-free. If you’re still paying hundreds per month in student loans or car loans, the burdens of home ownership are going to be intense. If you want a home in the next several years, focus hard on freeing yourself from that debt.

Second, you’re usually better off if you buy a smaller home rather than a larger one. Once you get beyond a certain point of home size, the excess space mostly just serves as storage for your extra stuff – mostly stuff you don’t really need in the first place.

When Sarah and I were house-hunting, we fell in love with a house that was about 50% larger than the one we ended up purchasing. We both just loved this house. We tried to find a way to afford it but, when we sat down and were realistic with our financial situation, we knew we couldn’t really afford it. We bought a smaller house, one within the range of what we could afford.

Guess what? We’ve never missed the extra space. In fact, as we’ve been designing our “dream home,” it’s not much bigger than the one we have now. It’s mostly just rearranged.

Third, overburdening your short-term future with expenses is a huge mistake. When you sign up for a mortgage, you’re signing up for a pretty hefty addition to your monthly pile of bills. However, when you initially sign up for them, those bills are likely within your ability to pay them each month.

The catch comes if something changes in your life. A job loss or a serious accident can derail lots of things in your life – and the last thing you need on top of those misfortunes is a difficult decision about your house when you’re unable to pay for it. It’s not worth it.

Finally, a full down payment is a tremendous help here. Not only does it reduce the size of your mortgage by up to 20% or more, it will also likely reduce your interest rate.

Given these factors, I strongly feel that a conservative approach to the question of “How much house can I afford?” is the right one.

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