How much home can you afford? The answer is a combination of many factors, but properly dialing in a budget is a good first step that can be easier than you think.
Setting a proper budget prior to beginning a home search is an important early step in the process that can make your search more efficient and help you balance priorities. The good news is that arriving at a ballpark number need not involve tedious expense accounting or a deep dive.
By factoring in a few key data points you can establish a range that can help you vet properties and better understand their potential impact to your lifestyle and your bottom line.
Tip One: Reject the Rule of Thumb
Many may be familiar with conventional wisdom that states that you should spend no more than 25%-30% of your income on a mortgage payment. While this passes as decent advice, there are several inherent issues with this math. First, depending on your additional debt service, credit history and other factors, lenders may simply choose not to lend you that much. Second, approaching any purchase with the “what’s the most I can spend?” mindset can prove foolhardy. While the 25% limit is a good disqualifier of any payment that exceeds it, it isn’t a great way to set a budget.
Tip Two: Understand your Cash Flow
So how can you begin to set a budget? A good starting place is via some high level cash flow analysis using your online banking app. Today nearly every major bank has built-in tools that automatically categorize your expenses and can help you understand your take home pay and other important metrics. These can be invaluable in budgeting for a new house payment.
With only a few clicks on a bank app, you can approximate your average monthly income and expenses over time. Digging even slightly into these numbers can be eye-opening and identify how much money you are devoting to rent or housing today, how much is available and most importantly, where to find more. By investing a little time to understand your budget, you can reverse engineer an acceptable payment.
Tip Three: Know your Buying Power
Now that you understand what type of payment you can afford, you need to see what type of home that may support. While any mortgage lender would be happy to put your finances through their paces, dissect your tax returns and tell you exactly how much home you qualify for, the very outset of a home search may not be the time for such a detailed discussion. This doesn’t mean your mortgage pro is of no use to you. While they prefer to speak in absolutes, nearly all of them will help you spitball numbers to understand a theoretical bottom line.
To arrive at yours, simply present the amount you are comfortable spending per month, share your expected down payment and ask them to run the numbers based on prevailing rates. Make sure they include estimates for insurance and taxes in your payment.
To find tax rates and other details, it may help to preview some active listings and use real numbers-- even if they are for a home you have no intention of purchasing. Ask your mortgage lender to share the impact that changes to term of loan and other factors may present.
Tip Four: Begin your Search (but watch your step)
Armed with an idea of your payment and budget you are now ready to begin your search. Keep in mind that making an apples to apples comparison of homes requires you to keep a few additional things in mind. While rate, term and purchase price amount are obviously huge factors in determining a monthly mortgage payment, other factors can play in as well:
Property Tax- Annual property tax can make two strikingly similar listings deliver markedly different mortgage payments. Taxes should be considered early in the process, and you should make sure to include 1/12th of the annual property tax amount in any projection.
HOA Fees- Depending on your search area, some homes may include an HOA fee for community services. These will be disclosed with every listing and their impact should also be carefully considered.
Insurance- You may want to ask your insurance agent to estimate homeowner insurance rates based on the value of home you are targeting. This can help project a payment with even greater detail. You should also understand that if you are planning to put less than 20% down on a home you may also be subject to Private Mortgage Insurance.
Experienced Agent with Local Expertise
Defining a budget is an important early step in the home buying process but one that need not be taken alone. While the tips above can help you approximate a simple budget, to truly understand your options, it may make sense to meet with a real estate agent. He or she can help you understand mortgage options, connect with finance resources, refine your wish list, understand your target area, build a custom search and much more.
Zach Adams has extensive experience in the west metro of Minneapolis helping families like yours with issues like these. He is laser-focused on Eden Prairie, Plymouth, Maple Grove, Minnetonka and the surrounding communities. His wisdom is built upon 100s of local transactions and can help you to understand the often complex world of residential real estate in this area.
A free consultation with Zach is a value-add no matter where you are in this process. He’d love to help you define next steps, create a custom timeline and align the resources you’ll need to find the home of your dreams.