House Affordability: What Can You Afford?

When people start looking for a home, house affordability is their biggest concern, especially if most homes in their region aren’t affordable for first time buyers. Before my husband and I started our search, we sat down together to figure out what we can afford on our current budget. Once we had a target budget, we contacted a mortgage broker to get a feel for how that translated into a home price. If you plan on buying a home this year, you need to know what you can really afford. Here’s a more specific look at how we figured out what “affordability” meant to us.

Review Your Budget
First, we looked at our average monthly budget, which we pulled out of Quicken. In this case, we worried less about our monthly cash flow, and more about what we truly spend each month on various expenses. We averaged out things like auto insurance that don’t occur monthly.

We didn’t plan on cutting any expenses in order to afford the mortgage, because that may not be realistic, and because even if we do end up cutting expenses, other expenses will come up.

We did consider the additional tax savings we’ll see as a result of itemizing our mortgage interest. Home prices in our region are high enough that our interest will greatly exceed the standard deduction. Rather than receive a refund, we’ll adjust our withholding to recapture that money on a monthly basis. We included that extra money in our budget.

In addition to the monthly mortgage payment, you also need to consider the cost of property tax and insurance. Most calculators use about 1.85% to 2% for a combined total, or ask you to input a fixed number. Ask around to find out what property tax and insurance typically cost in your area and divide by 12 to come up with an estimate. In most cases, you pay insurance annually and tax bi-annually, but you need to save up for that monthly so it doesn’t come as a surprise.

Review Your Goals
We want a house, but we don’t want to be “house poor.” For us, affordability means we can also meet our other goals, such as retirement, personal savings, and buying a new car for me this year, and him in the next four years. If we want to meet those goals, we can’t spend all of our money on the house. We guesstimated our car loan payments and monthly retirement contributions will be, and included them in the budget as placeholders.

We’re not currently meeting those goals because we’re funneling all of our excess income into a savings account to bulk up our down payment/closing costs/moving costs fund.

Contact a Mortgage Broker
You could use an online calculator to try to guesstimate the home price you can afford based on your targeted monthly mortgage payment, but factors like your credit score and interest rate will affect that. It’s much faster to call a mortgage broker. We used a referral from a friend to find a local broker. I told him our incomes, down payment amount, other loan or debt payments, and targeted monthly payment with property tax and insurance.

As it happens, our targeted monthly payment was exactly at the limit for our maximum debt-to-income ratio (DTI). He then checked our credit and used our DTI to figure out a maximum home price. We used that to guide our open house tour and then conveyed it to our agent so she could guide us to appropriate houses.

When considering affordability, it doesn’t matter what your friends could afford. You may have more or less debt than them, or more or less income, or a higher or lower credit score. Focus on what you can realistically afford and you should be fine.

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