How much should I spend on a home?

As you embark on the exciting journey of home shopping, it’s crucial to assess your financial capacity. In today’s market, soaring home values and interest rates necessitate careful consideration. According to the National Association of Realtors, the median existing-home sale price reached a record high of $407,100 in August 2023. Additionally, as of October 2023, the average rate for a 30-year mortgage surged to nearly 8 percent, the highest it’s been in over two decades.

However, it’s important to remember that home values and interest rates are just two pieces of the puzzle. There are various other expenses associated with homeownership that should factor into your decision-making process. To strike the right balance between what you can spend and what you should spend on a home, here’s a comprehensive guide to help you navigate this crucial financial decision.

Determining Your Affordability:

When determining how much you can spend on a home, it’s wise to consider more than just your maximum budget. As Taylor Kovar, CFP and CEO of Kovar Wealth Management, points out, it’s essential to take into account other financial goals, monthly expenses, and potential emergencies. Being ‘house poor’ can have long-term repercussions, so maintaining financial flexibility is key.

Here are some key factors to consider:

1. Location:

   • The area you choose to buy in significantly impacts your spending calculations. While the national median home price exceeds $400,000, prices vary widely across the country. Consider the overall cost of living in your desired area, as higher daily expenses leave less room for monthly mortgage payments.

2. Income:

   • Your monthly income and its stability are fundamental considerations. There isn’t a specific income threshold for buying a home, but you’ll need to cover a down payment, closing costs, monthly mortgage payments, and other existing debt.

3. Savings:

   • Building healthy cash reserves is crucial for meeting the financial responsibilities of homeownership. The more you have saved, the better you can handle unexpected emergencies while meeting your mortgage obligations.

4. Credit:

   • Your credit score plays a significant role in the mortgage interest rate offered by lenders. Higher scores lead to more competitive rates, making monthly payments more affordable. If your credit score needs improvement, consider working on it before applying for a mortgage.

Calculating DTI (Debt-to-Income Ratio):

Your Debt-to-Income ratio (DTI) is another critical factor when determining your home budget. This ratio, which measures your monthly debt against your total income, helps lenders assess their lending risk.

The 28/36 rule is a valuable guideline to follow. It suggests that no more than 28 percent of your gross monthly income should be spent on housing expenses, while your total debt expenses, including your mortgage, should be limited to 36 percent of your income.

For instance, if you earn $100,000 per year, or $8,333 per month, your housing costs should not exceed $2,333 per month, and your total debt costs should not exceed $3,000.

Estimating Your Future House Payment:

Your monthly payment depends on the house’s cost, your down payment, and your mortgage interest rate. A higher down payment and a lower interest rate lead to lower monthly payments.

For example, using Bankrate’s mortgage calculator, if you’re looking at a $400,000 house and put down 20 percent ($80,000) with a 30-year mortgage at 7.5 percent interest, your monthly payment would be $2,237. With a 20 percent down payment and a 6.5 percent interest rate, it drops to $2,022.

Cost of Homeownership:

Don’t forget about the ongoing costs of homeownership, including maintenance and, if applicable, homeowner’s association (HOA) dues. Healthy cash reserves are vital for unforeseen expenses.

Conclusion:

Before you start your home search, crunch the numbers to determine your budget and get preapproved for a mortgage. Working with a knowledgeable local real estate agent can also be invaluable in finding the right property and negotiating a favorable deal. Remember, a home is a long-term commitment, so ensuring financial flexibility is crucial. Happy home hunting!