Before you start combing the classifieds and cruising open houses, you need to know how much house you can afford. There’s no hard and fast rule about this, regardless of what you might read. How much house you can afford is primarily a function of how much you want to spend.
The Real Cost of a House
Your home costs more than just the mortgage. Your down payment is between 10 and 20 percent of the assessed value of the home. You need to have that up front, as lenders will not cover it. Homeowner’s insurance also might be required by your lender.
Either way, it’s a good idea to protect your investment with some kind of insurance. The average homeowners’ insurance premium stood at $880 in 2009, according to the Insurance Information Institute. Property taxes are also a significant cost of owning a home and vary widely from one municipality to another. Usually, your property tax ends up being between 1 and 2 percent of the home’s value.
How Much Can You Spend?
How much you can technically spend is not as important as how much you can reasonably afford. While there are different guidelines on how much of your monthly income you should spend — some say a quarter, some say a third, some say even more, lenders tend to say 28 percent, while still other experts suggest that it’s a function of your annual income — it’s really up to you to determine how much you can comfortably and realistically afford.
And, of course, the figure that you arrive at is something that you should be prepared to defend to your lender. Once you determine how much you can spend every month, it’s time to determine how much house you can afford using a home loan affordability calculator.
The Elephant in the Room: Your Credit Rating
Your credit rating can wildly impact your monthly mortgage payment. The interest rate on your mortgage is largely determined by your credit rating, and this impacts both the monthly cost and overall cost of owning your own home. Several percentage points lie between the interest rate of those with an 800 credit score and those with a 500 credit score.
Further, even a small difference in your credit score can impact your interest rate by as much as point and a half, depending on which side of the fence you lie on. For those with less than stellar credit, it’s worth holding off until your credit score is at least 660 or above until you buy a home to get optimum rates.
Mortgage Calculators: How Much House You Can Afford
Mortgage calculators help you determine how big your mortgage can be, showing you what a monthly payment will look like. Mortgage calculators factor in the value of the home, the amount of the mortgage, how good your credit score is, the loan’s term, property tax and interest rate. Mortgage calculators provide you with a to-the-dollar assessment of how much a mortgage will cost you every month. Consulting a mortgage calculator allows you to determine whether or not you can afford a house. Once you run the cost of a house or two, you’ll get a clearer idea of your price range.
Of course, there’s no reason to buy more house than you want, even if you can afford it. At the end of the day, money isn’t everything and you might be far happier in a house that is below your maximum limit than you are with the most expensive house that you can find. Know what you can spend, but don’t let it be the ultimate arbiter of what you choose to buy.
Nicholas Pell is a freelance writer based out of Los Angeles, CA. It’s currently financially wiser to rent than own there.