It is difficult to determine the amount you can borrow when buying a home. With many factors to consider (your credit, income, spending, and down payment), there are some general rules that can be followed.
25 Percent Rule
One of the main guidelines that some experts reference when advising people about buying a home is that your home payment should not be more than 25 percent of your monthly income. However, data from the U.S. Bureau of Labor Statistics indicates that most homeowners with children under six years old actually spend 36.3 percent of their income on housing costs, including mortgage payments.
You should consider your individual financial situation. For example, do you have a significant amount of student loan debt or other debts? In this case, you may want to target a lower percentage of your income when buying a home.
Note: It is important to understand that banks may be willing to lend you a larger amount than you can truly afford. It is your responsibility to determine the right amount for your budget.
Set Your Budget Before You Start Shopping
Before you start shopping for a new home, create a budget that includes your potential home payment. You need to make sure that you can actually afford the monthly mortgage payment.
In addition to the mortgage, you will also need to account for home insurance costs, property taxes, home repairs or improvements, and maintenance. According to a report by Angi in 2021, consumers spend an average of $3,018 on home maintenance and $10,341 on home improvements. This is another reason not to overextend yourself with the monthly mortgage payment.
Work with a Professional
When determining how much you can afford to spend on a home, it is wise to work with a professional. Look at the advice from your financial advisor about whether you are ready to buy a home and how much you can realistically afford. You should also consider your debt-to-income ratio when looking at the amount you can borrow to buy a new home.
Remember that the debt-to-income ratio is the total of all your monthly debt payments (such as the mortgage payment, credit card payment, car payments, and student loan payments) divided by your gross monthly income.
Note: Studies have shown that homeowners with a higher debt-to-income ratio are more likely to experience difficulties in making mortgage payments.
You should also talk to a loan officer at your local bank or credit union or mortgage lender. They can help you determine how much you can afford in a mortgage, as well as what you will need during the application process.
Other Considerations
Besides the down payment, you will also need to have an amount set aside for closing costs. Although this depends on the home price, real estate agent fees, and other factors, you should expect to pay between 3-5 percent of your home purchase price in closing costs.
You should also exercise caution when considering what type of mortgage you choose. Generally, you should opt for a fixed-rate mortgage rather than an adjustable-rate mortgage. The reason for this is that the interest rate on a fixed-rate mortgage remains constant for the life of the loan, while the amount can rise or fall on an adjustable-rate mortgage.
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Sources:
- Bureau of Labor Statistics. “Married couples with the oldest child under six years old spend 36.3 percent of total expenses on housing.”
- Angi.
“House Spending Situation.”
The article was reviewed by Margaret James, an expert in accounting, corporate finance, and personal finance. She is a certified accountant who owns her own accounting firm, serving small businesses, non-profit organizations, sole proprietors, freelancers, and individuals.
Source: https://www.thebalancemoney.com/what-house-can-i-afford-2385733
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