How Much House Can We (Really) Afford?

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One of the first questions that pop up when prospective home buyers begin their search is “how much can we afford?” Sure, you may get pre-approved for $400,000 but can you (or would you really want to) afford that payment each month? Once you throw in taxes, insurance, and utilities you may find yourself not being able to spend as much money on the things you enjoyed doing before you bought your dream home.  What’s even worse is that you could become the definition of house poor.

In today’s technology driven age you can find plenty of resources that will help you figure out how much home you should be looking for. Pretty much every real estate website has their own mortgage calculator that gives you rates and may even let you plug in taxes and insurance. But what if you just want to skip their advertisements and just leave it up to the person you trust most…..YOU?

You can essentially cut out the middleman and go into your home search more informed with a few simple tools and a little research.

Your mortgage is essentially made up of four separate pieces. Principal, interest, taxes, and insurance or PITI. (You can remember this by how much of a “PITI” it is that you have to pay so much in interest)

P= Principal

I= Interest

T= Taxes

I= Insurance

Normally we could figure out what your monthly payment is by taking the price of your home, your interest rate, and the length of your loan then plugging them into a TVM calculator (explained later) and adding that to your monthly taxes and insurance rates. However, today we aren’t looking for your monthly payment, we are looking for how much of a house you can look for when searching based on what you can afford monthly.

So, to do this, first we can identify our variables. Interest fluctuates based on the market, unless you have a locked in rate from a pre-approval you can not be sure what your interest rate will be. I always err on the side of caution when estimating and would recommend adding .5 to 1 percent to whatever you believe your credit score will get you.

Our other variables are taxes and insurance. Taxes can usually be found pretty easily by visiting the public records website for your area.  For my county in Delaware the local government has a parcel search which allows me to get the taxes and sewer information for any parcel of land in the county.  For insurance you may need to ask friends who own a home in your area or receive a quote from a few providers in order to get yourself in the ballpark.

Once you have those numbers, or a good estimate of them, you can write them down and they can become pretty easy plug in for your calculation.  

Your constant will be what you can afford monthly. To find this you will need to develop a good budget for your household expenses before deciding on how much you can afford. You want to make sure that you will have enough after all of your bills each month to still enjoy life and put food on the table.  Every financial advisor seems to vary slightly in how much this needs to be because it is a highly personal and emotional decision.

Some people can be completely content hiking for little to no money each weekend while others need to go to the movies or other costly adventures.  Know which one you are and be completely honest with yourself when setting up this budget. You’ll thank yourself later.

Ok, so you’ve picked your number. “I cannot spend more than (blank) each month on my mortgage.” Well, now what? Now you just plug the numbers in. You can plug them into a how much can I afford calculator or choose to do it on your own.  I prefer using a time value of money calculator to figure out my principal and interest then add my estimated monthly insurance and tax payments.  Most people allow the bank to hold an escrow account for them that they can pay their insurance and taxes from. It is free and ensures that you don’t forget to pay these highly important fees. (The government can foreclose on you for not paying your real estate taxes)

 

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