When you're shopping for a home in a competitive market, it can sometimes be tempting to stretch your budget. At a gut level, it's easy to justify spending a little extra on the space you and your family will call home. And while, on paper, spending outside your means can look like just a little extra per month, the fact is it's easy to get yourself into trouble.
If you've ever heard someone say they're house poor, it means they're spending a significant portion of their income on housing and related expenses. After all, owning a home isn't always as simple as making your mortgage payments on time – you must still consider maintenance (planned and unplanned), utilities, insurance, and taxes. By miscalculating those additional expenses, you could easily put yourself in a precarious financial situation that could be difficult to climb out of.
Here are a few tips for creating a budget and determining what you can realistically afford:
1. Crunch the Numbers
Before you ever start the process of shopping for homes, look at your numbers.
You'll need to consider how much you earn every month, and also your partner's earnings if applicable.
Tally up all of your recurring expenses like groceries, health care expenses, clothing, utility bills, insurance, gas and child care. Make sure to factor in outstanding debts like credit card bills, car loans and student loans. Then, look at your discretionary spending (entertainment, travel, hobbies) and include that as well.
Then, outline all of the housing costs, which include:
* The down payment
* Property taxes
* Homeowner's insurance
* Utilities and maintenance
2. Follow the 28/36% Rule
Many financial professionals advise that you spend no more than 28% of your gross monthly income on your housing expenses. You should also plan to spend no more than 36% on your total debt, including not just your home loan but your credit cards, car loan, and student loans.
3. Affordability Considerations
Some of the things that you should think about beyond your income and expenses include:
* How much savings do you have set aside? You want to have a reserve of cash in case something happens, and if your down payment or mortgage costs are going to dip into your savings, it's problematic. Your mortgage may also affect how much you can set aside in savings or retirement, so this is something to think about.
* How much of a down payment can you afford? The traditional wisdom is that you put 20% down. There are loans with options to put down as little as 3%, but you'll face a higher mortgage payment as well as private mortgage insurance.
* Is there a different type of mortgage outside of a traditional bank loan that you might qualify for? For example, FHA loans are backed by the Federal Housing Administration and you may qualify with a lower credit score and down payment compared to a traditional loan.
4. Take Steps to Get a Competitive Interest Rates
Interest rates are historically low right now, which is likely why the real estate market has been strong despite the economic fallout of the coronavirus. Even with rates low, you should take the time to put yourself in a position to get the most competitive possible rate.
Your credit score is going to either help you or hurt you as far as getting a low interest rate. Before you apply for a loan, look at your credit report, and clean it up if necessary.
Try to minimize how much debt you have compared to your income. You want to get the ratio of credit utilized to credit available low too.
5. Err on the Side of Caution
When you start looking at homes, you should always err on the side of caution. Keep your house hunt focused on the lower end of what you can technically afford. If you're a first-time buyer, it can be tempting to want to go all-in with the belief that you're buying your forever home. Your life can change over the years, and your first home is probably not your forever home.
Focus on a starter home that works for your current needs to avoid getting in over your head.
You can't just think about your current income either. Think about what might happen if you lost your job or your partner lost their income. How would that change the equation?
Finally, one option that can help you better stay within your budget is buying a fixer-upper. You can find a great deal, and then you have the option to gradually create the home of your dreams as your budget allows, rather than having to go all-in right away.
If you are thinking of buying a home and want to talk to a lender to help you figure out what you can afford, email me and I will connect you with my preferred lender to help answer any questions. Ready to buy, I'd be honored to talk to you and help you find that perfect home. Do not hesitate to contact me and even to start looking available homes on the market now.
- Heather Buchman, Realtor