According to Maslow’s Hierarchy of Needs, shelter is at the core of our basic human needs. Finances play a major role in the decision to either rent or own property. Before you consider homeownership you should ask yourself, “Am I financially ready to buy a home?”
If you are considering purchasing a home and want to see if you are financially ready, try the following:
- Find out the monthly cost of the house you desire, including insurance and taxes. If you want to be really accurate, factor in a few other homeownership-related costs that you aren’t currently paying as a renter such as maintenance, fees, and added utility costs. Be sure to factor in the current interest rate of a mortgage loan at your financial institution.
- Next, subtract the rent you’re already paying from the total monthly cost. Write down the difference.
- Lastly, when you pay rent, automatically place the rest of your “would-be” mortgage payment (factored in step #2) into your savings account.
For example: Your goal mortgage payment including expenses is $1,200 per month. You pay $700 per month in rent. Each month when you pay rent, you will place $500 into your savings account.
Try This Method for 6 Months
If you stick with this method, by the end of six months, you will not only have a pretty decent savings account, but you will have given your finances a “mortgage trial run.” If you were able to make stress free mortgage payments for six months, you’re probably ready to purchase a home.
It you experienced difficulty making payments, or if a minor emergency required you to withdraw money from your savings, then you might want to rethink purchasing a home for now. Or at least until you build up your savings and free up more money in your budget.
You should also ask yourself, “How much home can I afford?”
Housing affordability is dependent on location. As a tiny house movement emerges across the United States, there still remains the widespread belief that bigger is better. Unfortunately this belief also encourages people to purchase more house than they can actually afford.
Pre-housing crisis, traditional models estimated that 35 to 45 percent of your annual pre-tax income was a fair budget allocation for housing expenses. In the aftermath of the housing crisis lending requirements have grown stricter and guidelines have been adjusted. Most lenders are still willing to pre-approve creditworthy homeowners for 30-35 percent of their pre-tax income. Their ultimate goal is for the borrower to undertake the largest mortgage possible. That being said, it is in the homebuyer’s best interest to search out a mortgage and a payment that they can comfortably afford rather than searching for a home at the top of their budget.
How Much of Your Income Should You Spend on Housing?You should spend no more than 25%-30% of your TAKE HOME income on housing. Click To Tweet
Not pre-tax income, but take home income. Some experts suggest that the mortgage payment not exceed one-half of the homebuyer’s monthly income.
This is not the only factor to contemplate. Consideration should be given to the additional expenses of homeownership. Other costs such as property taxes, homeowners insurance, maintenance/repairs, HOA or condo fees, and increased utilities can quickly drive an affordable mortgage into the unaffordable range. Additional costs will vary by location but homeowners can expect to pay anywhere between $7,000 – $14,000 in additional expenses per year. And if you live in a flood zone or along a fault line take careful notice because flood and earthquake damages aren’t routinely covered by homeowners insurance. An additional policy for coverage in the event of a natural disaster will be needed…and add to your monthly payments.
Use this home affordability calculator to view the amount of mortgage you can afford.
It’s easy to become absorbed in the excitement of buying a home. Shop wisely and remember, a bank approval doesn’t equate affordability.