Rules of Thumb to Determine How Much to Spend on a House
NEW YORK ( MainStreet) Buying a home is a rite of passage in America, one that 90% of us will make at some point in our lives, according to estimates from Freddie Mac.
In recent years, a lot of Americans bought homes that were simply too expensive, and many people still feel entitled to spend more than they should. But few things are more stressful than owning a home you can barely afford. How can you make sure to avoid that fate? Here's what you need to know.
Advice You Can Trust
When you start looking at properties, keep in mind that real estate agents and mortgage brokers are not objective financial advisors in the home buying process. Their opinions on what you can afford are likely to skew high, because that's in their best interest. Even family and friends can lead you astray. Your best bet is to have a trusted financial planner recommend an affordable price range based on your personal situation.
Rules of Thumb
If you want to do the math on your own, the quickest way to estimate a reasonable range for your home purchase is to multiply your annual salary by 3 on the low end and 4 on the high end. So, if you make $80,000 a year, you should be looking at homes priced between $240,000 to $320,000.
You can further limit this range by figuring out a comfortable monthly mortgage payment. To do this, take your monthly after-tax income, subtract all current debt payments and then multiply that number by 25%. For someone making $80,000 a year, that will come out to $1200 a month or less, depending on where you live and your debt load. That number may seem low at first, but it's the only way to guarantee you can afford your home while also balancing other priorities like saving for retirement or your child's education. Let alone taking family vacations each year.
When you go to the bank to take out a mortgage, they'll use slightly different calculations. From the bank's perspective you can afford to spend 36% of your pre-tax income on debt payments, including up to 28% of your pre-tax income on a mortgage payment.
Of course, they're earning interest on your monthly mortgage payment so they're willing to push your budget to the absolute maximum. It might be tempting to use every mortgage dollar offered to you, but the term house poor exists for a reason. It's up to you to limit your mortgage to something you can comfortably afford. If it helps, picture how happy you'll be when you're both a homeowner and a vacation taker.