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Before You Buy: Determining How Much House You Can Afford
The prospect of buying a new house, be it your first or second, is exciting and it is easy to get lost in the moment. But take a step back, look at the situation critically and ask yourself: How much house can I afford?
What Is Your Gross Monthly Income?
Your gross income is the income you make each month before taxes and other deductions are made. Gross income comes not only from your monthly paycheck, but other sources of income like:
Income like Social Security benefits and the money you received from the sale of a home is excluded from your gross income.
How Much Is The New House?
When you purchase a house, you are not only buying the house for how much it is advertised for or how much you haggle it down. You are also paying for:
- Down payment on the house
- House owners insurance each year
- Real estate taxes each year
- Closing costs
- Appraisal fees
- Underwriting fee
- Credit report fee
Some of these factors, like closing costs and down payment, are paid at closing and contain other fees such as:
- Mortgage application fees
- Title insurance and title search
- Recording fees
Thankfully, these costs are all paid at once and your lender will give you the estimate in advance. So be sure to use this number in addition to what you will potentially be paying for the home.
What Are Your Monthly Expenses?
There are three kinds of monthly expenses, all of which are important in determining how much house you can afford:
- Fixed expenses that are the same from month to month, like car payments and student loan payments.
- Flexible expenses that vary from month to month, like groceries and utility bills.
- Discretionary expenses that you have direct control over, like going out to eat.
Of course, this list is not all-inclusive as everyone’s circumstances are unique. For example, you may have already paid off your car or simply don’t have one. So you wouldn’t have to include it in your monthly expenses.
To calculate your monthly expenses, gather your monthly financial statements and create a list of what you’re paying—remember to include both bills and discretionary expenses like eating out. If you’re having trouble keeping track of your monthly expenses, a secure money manager like Mint can help.
The general rule of thumb is that your mortgage payment should not take up more than 28 percent of your income. In fact, many lenders won’t let you borrow more than 28 percent in order to protect you from paying off a loan you cannot afford.
Consult With A Professional
If you are having trouble calculating these numbers, there are a variety of online calculators available to help you out. It is important to remember that the number you get is merely an estimate to give you an idea of how much house you can afford. It is not a final number.
With your estimate in hand, talk to your financial advisor and lender to help you go more in depth about what to expect and how much you can reasonably afford. They’ll be more than happy to help you out.