Do the Math – A Mortgage You Can Afford

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 you can make as a homebuyer is not knowing how much you can REALLY afford when purchasing a home. The next mistake is thinking too “big picture” when it comes to price range or purchase price.

Stop right here before you make these mistakes!

You’re going to learn the correct way to do the math so that you get a mortgage you can afford and, ultimately, a home you absolutely love on your budget. You won’t be “house poor” and you won’t shortchange yourself either.

Here’s how:

Think monthly payments first and foremost.

Don’t focus solely on the purchase price, but rather first start with your desired monthly payment for your home. This monthly payment should factor in your taxes and insurance, homeowners’ association fees if applicable, (but not utilities and general monthly maintenance).

This Mortgage Rule of Thumb may seem backward but it’s the one and only way to make sure you get the home you want for the price you want.

Here’s why.

Even if the purchase price is exactly the same, your monthly payment could be very different between two properties.

For example, the monthly payments for a $300,000 condo will be completely different than for a $300,000 single-family home. There are different costs you’d need to consider for each option, such as condo fees.  That’s why you should NOT focus on the purchase price first since monthly payments can vary depending on where and what you buy.

So never begin your search with a blanket statement, “I want to spend $300,000,” and not even know whether that amount will truly fit your monthly budget.

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 think you’ve hit the jackpot, since many lenders will approve a mortgage for you that could be way more than you are comfortable spending per month.

Buyers may say, “I’ve been approved for $400,000 by my lender,” but when you dig a little deeper, these buyers actually want to spend a lot less in order to get the payments they truly want to commit to each month.

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.

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 work backward to determine a purchase price that works with this monthly budget.

Yes, it does seem backward at first, but the traditional way of doing things is actually the backward way!

Once you know how much you want your monthly housing payments to be per month, you can then factor in your down payment and any homebuyer assistance programs. 

You’ll also need to include other potential costs of owning a home – taxes, insurance, condo fees – that will affect your monthly budget. With all these factors in mind, I can help you figure out the correct price range to shop in.

Keep in mind, every $10,000 in purchase price only adds an additional $60 to your monthly payment.  Similarly, the same goes for your down payment: Every additional $10K you put down, you are only saving yourself about $60 per month.

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

Take a 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!

Making a budget is an important step, so be honest about what you spend your money on each month right now, what you’re willing to forgo, and what you expect in the future.

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, and condo fees, parking fees, if applicable. I can help with estimates!
• List all other expenses you expect to continue — such as gym memberships, daycare 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 $300,000 home, you should be putting about $3,000 per year into the home for maintenance or into a savings account for when you need to replace something in the future!
• Include any tax advantages you’ll get as a homeowner. You may have deductions or equity in your home and can expect a larger refund that could go toward your savings.
• Consider additional expenses, beyond your mortgage payment and maintenance costs. Decorating costs such as new furniture purchases can add up in the early years of homeownership. 
• What expenses are “mandatory” for your life and general happiness?  Ask yourself some hard questions about your lifestyle now and for the future, and how that could impact your budget. For example, if you love to travel, then don’t buy a home that makes it impossible to go on a trip for years! That would not be worth it.
• What expenses could you tighten-up on to get the home you want?  Could you drive a car that costs less, maybe decrease or eliminate your car loan? Then that’s where you could cut some of your monthly expenses. You could then possibly afford to buy a home in the location you want.
• 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.

My rule of thumb for how much you can comfortably afford is 25% of your gross monthly income, and this is on the conservative side. For example, if your household income is $120,000 per year, your monthly income is $10,000, and your mortgage payment could be up to $2,500 using the 25% rule of thumb. Lenders may let you borrow up to 35%-40% depending on your credit score and other debts.

I do think it’s also important to consider your alternative housing costs. If your other option is to continue renting and you’re already paying $2,000 per month in rent, it may make sense to buy even if you’re mortgage payment will be a little higher than that $2,000. When you own a home, you are building equity in that home, through paying down your mortgage every month and market appreciation over time. When you pay rent, you are simply exchanging your money for housing and not building any wealth through that payment.

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 Buying a Home 101 series is Where to Find Money for a Down Payment. Every buyer needs to be prepared for this and you’ll learn how!