Episode 89: How Much House Can You Afford

Transcript

Hello and welcome to the Balanced Wealth Podcast. My name is Jarrett Topel.

On today’s episode I want to dive into a question that seems to be on many people minds these days, which is, “How Much House Can I Afford”. With interest rates higher than they’ve been in decades, the playing field has changed dramatically, and many people just don’t know where they stand right now.

Someone who bought a house 5 years ago, may very well not be able to buy a similarly priced house in today’s much changed economic environment. Whether you’re a first-time homebuyer, looking to upgrade, or even looking to downsize, understanding your budget for a home is crucial in making a sound financial decision and avoiding the stress and anxiety of buying something you really just can’t afford.

So, let me try and break it down into relatively simple steps that you can follow, to help determine just how much house you can actually afford.

First, of course, you need to take a close look at your income from all sources. A general rule of thumb is, that your total housing costs, should not exceed 28% of your gross total family income. This percentage includes amounts paid towards your principal payments, interest payments, property taxes, and insurance—this is often referred to as PITI. For example, if your total gross monthly family income is $10,000, aim to keep your total PITI at $2,800/month or less.

Next up, it’s important to understand, that beyond looking at just your anticipated housing costs, or PITI, lenders also look at your total debt-to-income ratio, to determine how much they’re willing to lend you. Your debt-to-income ratio is the percentage of your total family income that goes towards paying off all forms of debt. This includes your housing costs as well as any and all other debt you may have, such as; student loans, auto loans, home equity lines of credit, credit cards, you name it.

Ideally, your debt-to-income ratio should be no more than 36% of your total family income, including your new mortgage payment. For example, if your total gross monthly family income is $10,000, you want to try and keep your total monthly debt payments under $3,600/month. So, if you’re carrying significant debt—credit cards, car loans, student loans, whatever—it’s important to factor these into the equation when trying to figure out how much a lender is likely to offer you as a mortgage. Of course, these are not hard and fast rules, but simply good rules of thumb to use for a little cocktail napkin planning.

Moving on, you have to carefully consider down payment options when buying a home. The size of your down payment plays a huge role in how much house you can afford. A larger down payment means a lower mortgage and lower monthly payments. Typically, aiming for a 20% down payment is advisable, but there are loan options available on the market that allow for significantly lower down-payments. However, many of these lower percentage down-payment options then require you to pay mortgage insurance, which can add additional costs to your overall loan. That doesn’t mean it is never okay to use a lower downpayment, but just be sure you understand what you’re doing, and that you’re aware and okay with the true full cost of your loan, before signing on the dotted line.

Also, don’t forget closing costs, which typically range from 2% to 5% of the loan amount. Some closing costs can be rolled into the total amount of your loan and be amortized over the life of the loan, and some cannot.  Either way, they’re a significant cost to you as the borrower, and as such, it’s important to understand these costs upfront.

And, don’t forget to factor in other expenses that come with the joy of home ownership. It is important to remember, that owning a home isn’t just about paying the mortgage and property taxes. You’ll also need to budget for maintenance, repairs, utilities, and possibly homeowner association fees. A good rule-of-thump is to set aside around 1% of your home’s value annually for maintenance. For example, if you buy a $1,000,000 house, that’s $10,000 a year to budget upkeep. Of course, this also depends on the age and condition of your house as well. And, while you may not spend 1% every year on house repairs and upkeep, there will likely be some years where the number is much higher (for instance, when you need a new roof), so remember, this 1% is just a good overall average to keep in mind for our continued cocktail napkin planning.

Next up, always plan for the unexpected. It’s important to leave some wiggle room in your budget for unexpected expenses or life changes. Job loss, medical emergencies, or significant home repairs can strain your finances if you’ve stretched yourself too thin. Consider an emergency fund that covers at least 3 to 6 months of living expenses, including your mortgage payment. This emergency fund acts as a financial safety net, ensuring you can keep up with your mortgage payments and other home costs, even if something unexpected happens to your income or other assets.

Finally, before you get serious about house hunting, get pre-approved for a mortgage. This not only gives you a clear idea of what size mortgage you might qualify for, but it also shows sellers that you’re a serious buyer. Getting pre-approved doesn’t cost you anything but does require significant time and energy on both your part and on the part of the lender.

Keep in mind, though, that just because you’re approved for a certain amount doesn’t mean you should spend that much. It’s crucial that you stick to a budget that feels comfortable and leaves you room for other financial goals. As you can tell, understanding how much house you can afford involves a lot more than just looking at prices on Zillow. It requires careful consideration of your income, debt, down-payment, and ongoing expenses.

By following these steps and being honest about your financial situation, you’ll be better prepared to make a smart, informed decision when buying a home and to do so without compromising your financial and emotional health.