If you’re shopping for a new home, you may be slightly overwhelmed. There are so many options available on the market: new, old, fixer-uppers, attached, detached, rural, and urban. The list goes on. It can be difficult to know what you want, as well as how much you want to spend. You may also be asking yourself, “How much home can I afford?”
There are many “new home calculators” available online that provide an estimate of how much you can afford to spend on a home. Aside from filling in the boxes provided on the website, hitting enter, and then displaying an estimated amount, there is usually very little explanation provided to the user. This article will break down these calculations to better explain how much home you can afford.
There are three key factors you need to consider when determining your home budget: the buyer’s monthly income, other monthly expenses, and information about the home purchase.
The first factor you must consider is your monthly income. This includes your significant other’s income as well. As yourself the following questions:
- How much money do I earn each month (before taxes)?
- How much money does my significant other earn each month (before taxes)?
- Do I receive any additional earnings each month from my investments, alimony, and/or government assistance programs?
Once you’ve answered these questions, figure out your total monthly household income.
You likely have certain expenses each month, which you pay using your earnings from your job or other sources. Many people have monthly installment loans, such as car payments and school loans. This amount is usually the same each month, and therefore a predictable expense. Other expenses may include alimony to a former spouse, credit card payments, insurance, and a cell phone bill. These are all monthly payments that are not tied to a particular residence. For example, your current utility bills should not factor into your “other expenses” because these will likely change after you move into a new home.
Now, take the total amount of other expenses and subtract it from the monthly income total. This is your net income after all monthly debts are paid.
Next, consider how much you can afford in a down payment. This is the amount that you will pay up front for the purchase of your new home. It is money out of your own pocket and is paid to the home’s seller. The mortgage lender pays for the rest of the home price in order for the sale to be processed. The down payment is important for several reasons. First, the mortgage company will ensure that you can afford to pay a minimum percentage of the home’s sale price in the form of a down payment before providing you with a loan. The lender wants to know that you can afford the home and will be responsible with paying your monthly loan installment. Each lender is different. For a Federal Housing Authority (FHA) loan, the minimum down payment is 3.5% while a conventional loan will be 3% or higher.
Second, the down payment reduces the overall loan amount. This lowers your monthly loan payment as well as the interest you will pay during the lifetime of the loan. For example, if you put 20% down on a $200,000 home, then your loan will be $160,000. On a 30-year loan, the amount you need to pay back each month is far less than if you had only put 10% down.
Third, the amount you pay in a down payment determines whether or not you have to purchase mortgage insurance. If you are unable to pay at least 20% of the home price in a down payment, then your lender will require you to have this type of policy. The coverage protects the mortgage company in the event that you default on the loan. The premium cost is added to your monthly mortgage payment. So, having a small down payment means paying additional interest on the home over the lifetime of the loan plus mortgage insurance, which can really add up.
In addition to the down payment, you also need to consider the type of loan. Your mortgage lender will speak with you about the loan terms they can offer, but the most common options are a fixed-rate home loan, adjustable-rate, and hybrid adjustable-rate. This will affect your loan’s interest rate, the amount you pay in interest from year-to-year, and the length of the loan.
There are additional yearly costs to owning a home that should factor into your calculations. The first are property taxes, which are paid to your local and state government. The amount you are expected to pay depends upon the tax rate in your region and the value of the property. The states with the highest property taxes include New Jersey, Illinois, New Hampshire, Connecticut, and Wisconsin. So, consider the location and cost of the home in order to determine whether or not you can afford this additional annual expense.
The second additional cost is homeowners insurance. If you plan to have a mortgage, then you will be required to have enough coverage to protect 100% of the unpaid loan balance. However, most homeowners purchase coverage for the entire value of the home instead. This type of insurance provides peace of mind and protection in the event of bad weather, fire, theft, and vandalism. It covers both the outside of the property as well as the contents inside the home. There are many different homeowners insurance policies available, so it is recommended that you speak with an independent insurance agent to select the policy that best fits your needs.
Now, let’s look at an example. Imagine that you and your spouse make $80,000 in combined annual wages before taxes. You have no other sources of income from investments or anything else. Your monthly expenses include a $300 car payment and $300 school loan payment. You do not have any credit card debt. Thanks to years of saving and good credit, you are able to put down $40,000 and have secured a 30-year fixed-rate home loan with a 5% interest rate. Your yearly property taxes are $2,000 and your homeowners insurance costs $800 per year. You would be able to afford a $300,000 home and would pay a monthly loan payment of $1,800.
When determining how much home you can afford, you need to take a hard look at your finances. Think about the expenses you already have, and how much you can realistically afford for a monthly mortgage payment. If you do not have anything saved for a down payment, start saving today. Remember: you are not just paying for the price of the home, but will also be expected to pay the closing costs and insurance.
If you are only able to estimate the information you provide for the new home online calculator, then that is just fine. Speaking with a real estate agent, independent insurance agent, and lending company will help to clarify any questions you may have.
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Enhanced Insurance is not written by attorneys. If you’re looking for legal advice, you need to contact a lawyer. Further, insurance practices and forms change constantly and are varied from state to state. For definitive answers in your area, contact a local agent.
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