Buying a Home

How Much Home Can You Afford?

Let’s admit it- renting an apartment just isn’t fun.

Dealing with a property manager. Making (overpriced) rent payments month after month without seeing any return on your money.  There are a lot of traditional appeals of owning a home.  It’s the American Dream!  It’s a great investment! (Side bar:  it’s not always a great investment). It’s a place that’s truly your own!  Among the newlyweds I talk to, all of these emotional factors play a role in deciding to buy a home. That being said, the primary motivator often is a financial one- they’re just sick and tired of writing rent checks every month.

But does it always make sense to buy a home?  There are lots of reasons for me to say “no”, but one I want to focus on today is cost.  How much does it truly cost to buy a home?  And, relatedly, how much home can you actually afford?

Shocking Fact: Not Everything You Read on the Internet Is True

If you type, “How Much House Can I Afford” into Google, the first links that pop up take you to calculators where you can plug in a few numbers and it will tell you how expensive of a house you can buy and have your mortgage payment be the same as your rent payment.  Problem solved, right?

Wrong.  Wrong, wrong, wrong.

The most common mistake I see newlyweds looking to buy a house make is that they use these calculators to back into a house value they think they can afford just by looking at how much the mortgage payment is compared to their current rent.  There are a LOT of other costs, which we will break down later, that add up quickly when buying a home.

Let’s take utilities as an example.  If you’re buying house that’s four times as large as the apartment you’re renting right now, it wouldn’t be unheard of for your utility bill to be four times as high for your house as it is for your current apartment.  Even if it’s not quite that extreme, you can still expect utilities on a full family home to be much higher than on a single bedroom apartment.  These online calculators leave things like this out.

Long story short, your monthly mortgage payment should be significantly less than your monthly rent payment.  To look at it another way- your mortgage payment should be no more than 30% of your gross (before tax) monthly income, and 25% is even better.

Before You Buy, You Need an Emergency Fund

It’s no secret that it costs a lot to buy a house.  Even though you’re taking out a mortgage, you’re still going to need to make a down payment upfront. And a big one, at that.

But, you should never equate “make a large down payment” with “have just enough in my savings to make a large down payment”.

Simply put, you need additional savings in an emergency fund before you even think about saving to buy a house.  Typically, I recommend having enough in an emergency fund to cover six months of living expenses if you were to lose your job.  I know that’s a tough mountain to climb for many people.  Don’t focus on the total, but rather the small steps you can take, starting today, to get there over time.  So, start by focusing on saving enough to cover one month of expenses, then two, and so on until you build up to six.

Emergency funds are a topic for another day. The important point here is that you should never use your emergency fund to pay for your down payment.  As tempting as it can be to grab that pile of cash when you’re trying to save for a big down payment, leave it be.  If you happen to lose your job a month or two after you buy your house, you’ll be glad that you did!

Speaking of the Down Payment… How Much Do I Need to Save?

Before you can make serious decisions about whether you are ready to buy a home, you need to have enough saved to make a down payment.  This is the biggest upfront cost, by far, that will help dictate how much home you can afford to buy.

Generally speaking, 20% is the golden number for a down payment.  In other words, take the listing price of the property you’re looking at, and take 20% of that value.  That’s how much you should try to save, up front, to buy the home.

There are mortgage payment options out there that will let you get away with having less than 20% saved.  But the more you put down up front, the better your mortgage terms will be, which is a goal worth striving for.

Other Upfront Costs

Unfortunately, the down payment is just the beginning.  There can be many more “hidden” upfront costs to buying a home that you should be prepared for.

The biggest items here typically are the closing costs.  Closing costs can run anywhere from 2%-7% of the home’s value, depending on where you are buying and what is included.  Closing costs include a number of charges, including attorney’s fees, inspection costs, title costs, mortgage application fees, and others.

Sometimes, you can have these costs be added to the value of the mortgage rather than pay up front.  You may even be able to negotiate with the seller to have them cover a portion of the costs.  But, you should be aware of them, and plan accordingly.

Other costs up front that many people overlook include moving expenses and, perhaps more importantly, furnishing a home.  Houses can be quite a bit bigger than a one bedroom apartment!  You don’t have to do it all up front, but keep in mind how much it will cost you to fill all of those extra rooms.

Ongoing Costs

This is where it can really add up.  First and foremost, one of the biggest advantages to renting rather than buying, which you’ll give up the second you move into a home, have to do with property taxes.  While you can be entitled to some tax deductions when you buy a home, your tax bill will likely rise as you will owe property taxes to your state and local governments every year. These vary drastically from town to town, state to state.  Do some homework ahead of time so you know what you’re getting yourself into.

Of course, landlords can be a blessing and a curse when you rent.  As a homeowner, you’re now responsible for all the maintenance to the property that they handled for you before.  And of course, first time homes for a family typically are relatively cheap, which means there are more likely than not a good number of maintenance issues to be addressed.  I usually recommend that couples looking to buy a home set aside 1-1.5% of the total property value  every year for home maintenance.

Those are the two big ones, but depending on where you live and the type of property you buy, there can be many other “hidden” costs to keep in mind, such as Homeowners’ Association Fees.

The Bottom Line…

I’m not trying to talk you out of buying a home.  Really, I’m not.  I think owning a home is a great goal to shoot for and can be a great investment for your future (but, like any investment, its not a sure thing).

My point is that you need to be aware of the costs of buying a home up front.  It’s not just as simple as comparing your rent payment to your projected mortgage payment- you need to go deeper and get a good, honest feel for the “unexpected” costs of owning a home.  That way, when you buy a home and sign the mortgage, you can be sure that you’re really ready.