Before you start searching for your dream home, you need to figure out how much you can afford to spend. Having a realistic budget can help you and your real estate agent focus on houses that are in the right price range and avoid frustration and disappointment.
Your Pre-Approval Amount Is Not Necessarily the Amount You Should Spend on a House
Getting preapproved for a mortgage can show sellers that you’re serious and that your finances are in order, but you need to be careful. The amount a lender is willing to give you to put toward a home purchase is not necessarily the right amount for you to borrow.
A lender will only consider portions of your financial picture, such as your income, debts, and credit score, when calculating your pre-approval amount. You have to look at everything you spend money on and figure out how much you can comfortably afford to put toward a home.
How to Figure Out How Much You Can Really Afford
Compile information on your income, which can include money you earn from a full-time job, side hustle, investments, and other sources. Make a list of your debts, including any loans, credit card balances, and other obligations that you have to repay every month.
Write down all your expenses. Those can include necessities, plus things like dining out, entertainment, and clothing. Include information on things you’re saving for, such as your retirement, your children’s college education, a vacation, a wedding, and an emergency.
There are a couple of simple calculations that you can use to figure out roughly how much you can afford to spend on a house. A lender generally wants a borrower to put no more than 28% of gross monthly income toward housing costs (i.e., mortgage payment, taxes, and insurance) and no more than 36% of gross monthly income toward all debts.
Those guidelines are helpful, but they’re only meant to be used as reference. If you like to take several vacations every year or you want to put a large percentage of your income toward retirement, you’ll need to take that into consideration.
An online home affordability calculator can be a useful tool. You can input information on your income, expenses, anticipated interest rate, and other variables to figure out what price range is right for you.
How to Maximize Your Buying Power
The less you spend on mortgage interest every month, the more you’ll be able to put toward principal. Reducing your debts and boosting your credit score can help you get a lower interest rate. Making a substantial down payment can help you score a lower interest rate and avoid having to pay for private mortgage insurance.
Cutting back on unnecessary spending and putting more money toward debt and savings can be challenging. It might take longer to buy a house, but being disciplined now can give you more purchasing power and financial freedom later.
