How much home can you afford? In my initial consultation with a new client I ask , “what’s a comfortable housing payment for you?” Affordability is a relative question to someone’s personal opinion. I believe this is one of the most important questions to ask a new client rather than simply telling the new client how much they qualify to purchase. This is important, especially with first time home buyers, because they are new and may bite of more than they can chew.
I can tell you how much you qualify for to purchase assuming estimations for property taxes and homeowners insurance based on guidelines but does that mean you can afford that home?
Lending standards qualify debts as monthly obligations that appear on one’s credit report as well as those that may not but the borrower is otherwise obligated to. For instance, a person could have a loan with a promissory note with a monthly payment for a certain period of time with an uncle, friend, or maybe an investor that wouldn’t report to the credit agencies. Those must be included but lending doesn’t take into consideration a buyer’s other monthly expenses for groceries, gas, entertainment, etc… As so, it’s really up to you to know how much you’re comfortable spending for a total housing payment. Even if I knew all the expenses I still can’t dictate how much you can afford; it’s truly up to you.
Now, in regards to affordability relative to financing that’s based on income, assets, and liabilities (monthly debts). Generally speaking I can use 50% (in some cases more) of a buyer’s gross monthly income. From their monthly obligations, as previously mentioned, are deducted and whatever remains thereafter can be used for a total housing payment. That housing payment must cover the principal & interest, property taxes, homeowners insurance, mortgage insurance, and homeowners association fees – as applicable. Does that answer your question, “how much home can I afford?” For most people the answer is no.
Let’s dig a bit further. Supposing one’s personal housing budget is less than that of which I’ve qualified a client to purchase. For instance, Jaxson says he’s comfortable paying $1,800 per month and I’ve qualified him for $2,000 per month. Now we’re getting somewhere with an $1,800 monthly budget which – again – has to include principal & interest, taxes, homeowners insurance, mortgage insurance, and homeowners association fees – as applicable. But this still makes the question a difficult one to answer because it depends on how much Jaxson puts down, the type of home, interest rate, loan term, property taxes, and homeowners insurance. In Jaxson’s case, he’s putting down 20% to avoid paying mortgage insurance, he has fantastic credit, is buying a single family home, there is no association fee, and he qualifies for a great interest rate. But again, we’re still not done. Jaxson needs to know the price range that he should be shopping in and that’s where the rubber meets the road. His purchasing power is greatly going to be determined by the property taxes. Homeowners insurance can be estimated however property taxes in some markets – like Chicago – can fluctuate greatly for a home priced exactly the same. In other words, his $1,800 per month could qualify him a $400,000 home that has annual property taxes of $1,200 per year but only a $200,000 home with $10,000 in property taxes per year.
In summary, how much you can afford is determined based on your personal budget – assuming you meet qualifications – and thereafter is relative to property taxes in the area for which you’re looking to purchase. It’s important that you understand that a pre-approval letter for a specific amount must also include an estimation of property taxes, homeowners insurance, and – if applicable – homeowners association fees.
Once that’s all determined we share our mortgage calculator and educate our clients on how to use it to determine if the home they’re interested in fits within their budget. After we’ve given specifics such as an estimated interest rate and a homeowner insurance payment our borrowers simply enter in the purchase price, down payment, property taxes, and association fees – as applicable – to calculate a payment. If that payment is less than their monthly budget we suggest to our clients that they move forward with a purchase offer.
But be smart, know your budget, and don’t bite off more than you’re comfortable chewing. Homeownership can at times come with a slew unexpected expenses.
Call us – we’re here to help!