If you’ve decided to buy a house, then first off, congratulations. Buying your own house is one of the most incredible and exciting experiences you’ll ever have. It’s something not everyone is able to do, and a landmark life moment that most people spend years waiting (and saving) for.
Once you buy a house, you have a level of freedom. You can do whatever you want to your home. You can paint it any color, landscape it however you choose, decorate and renovate it in any style that you’d like. It’s quite freeing.
Unfortunately, there’s one large deterrent that keeps many people from buying a home: the cost. Houses are very expensive, and they’re a serious financial investment and commitment. So, if you’re going to buy a house, the most important thing you can do is make sure that it’s a house you can actually afford to buy.
Figure out how much you can afford to put down
There’s an old myth that your down payment should be at least 20% of the cost of your home. But that myth is exactly that: a myth. A 20% down payment is great, because that’s the minimum amount you need to put down in order to avoid having to pay for mortgage insurance. However, you don’t need to put anywhere near that much down; in fact, with an FHA loan you only need to put 3.5% down, and with a USDA or VA loan you may be eligible to buy a house with no down payment at all.
But here’s the thing: the higher your down payment, the lower your monthly mortgage rates relative to the price of your home. That means that the more you’re able to comfortably put down, the more expensive of a home you can afford while still staying within your monthly budget.
In other words, if you’re committed to paying no more than $2,000 a month in mortgage payments, you can afford a more expensive house if you put $100,000 down than $10,000 down.
Follow the 28% and 36% rules
While the old 20% down payment rule may be a myth, the 28% and 36% debt-to-income rules are still a great thing to follow. These “rules” (they’re really guidelines) state that your mortgage should not exceed 28% of your income, and that your total debts should not exceed 36% of your income.
Here’s an example: if your income is $10,000 a month, your mortgage payment should not exceed $2,800 a month. However, your total debts should not exceed $3,600 a month, so if you already owe $1,000 a month in car payments and student loan repayments, then your mortgage should not exceed $2,600 a month.
By following the 28% and 36% rules you can assure yourself that you’ll stay financially responsible, and begin to figure out what type of home you can afford. This is a good thing to keep in mind, because lenders are perfectly happy to give you a loan that far exceeds this debt-to-income ratio. If you’re comfortable with that, all the better; but it’s important to manage your risks and be aware of what you’re getting into.
Account for your job stability
The 28% and 36% rules are just guidelines. It’s not recommended that you purposely exceed those numbers, but you don’t need to push up against them, either. If you have a career in a field with limited job security, or if you’re paid more than most people in your field and know that you’ll take a salary reduction if you ever have to find a new job, you might want to lower those figures to something like 20% and 30%, to give yourself a little more comfort and stability.
However, if you have a long-term contract, or work in a field that’s always hiring, you can be more comfortable hitting exactly 28% or 36%.
With all these factors, you should be able to work backwards to figure out how much you can afford to spend on a new house. When in doubt, it’s always smart to consult with a realtor and make sure your figures are correct.