Are You Ready to Buy a House?
Before you snatch a great buy on a home you love, your first question should always be: “What can I afford?” No matter what you want in a home as far as age, style, location or size, you could end up with a beautiful house and no means of furnishing it if your mortgage payments eat up more than half of your income.
So let’s be sure you are truly ready. Following the same rule of thumb the Federal Housing Administration (FHA) uses for approving mortgages is a great place to start. The FHA requires a 43% debt to income ratio.
For example, if your monthly gross income is $4,000, multiply this number by 0.43. $1,720 is the total you should spend for all debt payments including housing. This should include credit card bills, student loans, and car loans. You should also include the cost of home owner’s insurance, property taxes, a budget for maintenance items and any required home owners’ association (HOA) fees. As you can see, this number begins to dwindle quickly.
You may also want to consider factors beyond debt. I refer to these as lifestyle factors. You may like to cook with gourmet ingredients, wear expensive shoes, go on expensive vacations, drink nice wine or do a lot of socializing and entertaining. Being a home owner can cramp your style, especially when unexpected maintenance items arise.
If you really want to be sure, play house…
Do a little internet research in order to establish a ballpark price to the house you want. From there, estimate the mortgage payment – a rough but good rule of thumb is for every $10,000 the house costs, the mortgage payment will increase by $100. For example, if a house lists for $200,000, a rough estimate of the monthly payment would be $2000 ($200,000/$10,000=20, 20*$100=$2000). Using this information, you are ready to play house.
Add to your estimated mortgage payment ballpark figures for home owner’s insurance, property taxes and any HOA fees. Subtract this total housing estimate from your current housing costs and deposit the difference into an investment account. If you can make the payments to the investment account for one year, without dipping into the pot, then you are ready. After the year is over, thanks to your discipline and the growth of your investment account, you will have a good start on your down payment.
While we are on the subject of down payments…
It’s best to put down 20% of your home price to avoid paying private mortgage insurance (PMI). PMI can cost an extra $50 to $100 per month of your mortgage, sometimes more and sometimes less. Also, the higher your down payment is, the lower your monthly mortgage payments will be and the more choices you will have for lenders. Some lenders will not finance unless you put at least 5-10% down.
A final thought… While there are a lot of benefits to a larger down payment, don’t sacrifice your emergency savings account completely to put more down on your home. You could end up in a pinch when an unexpected repair arises.