How much house can I afford? If you are thinking about buying a home for the first time, there may be a million questions swirling around in your head. What is private mortgage insurance and why do I need it? What is automated underwriting and how does it affect me? How much do I need for a down payment and closing costs?
Whew! Unless you work at a financial institution or aced an economics course last week, it’s all a bit confusing.
This article can’t answer all of your questions, but it can help you with the first and possibly most important question of all: How much house can I afford?
You need to consider two factors:
- How much your bank will pre-approve you for, and
- What your personal circumstances dictate you can afford
After all, you want to end up in the house that is best for you, and not in the poor house.
Step One: Get Pre-Approved
First, go to a lender and get pre-approved. This is extremely important because there is nothing worse than finding your dream home only to find out you don’t qualify. No other house in your price range will ever compare after that. Do yourself a favor and figure out how much house you can afford BEFORE you start looking at houses!
At your lender’s office, you will fill out a loan application, and the lender will send it through automated underwriting. This is a computer-generated loan decision based on the 5 C’s: capacity to repay the loan, character or willingness to repay the loan, capital, collateral and compliance. Basically, the process will consider relevant data from your application such as your income, debt, credit, etc. to arrive at a logic-based loan decision.
Your pre-approval amount is a good starting point in telling you how much house you can afford, but it isn’t—or shouldn’t be—your final number.
Step Two: Consider Current and Future Financial Needs
The amount for which you are pre-approved doesn’t take into account some of your monthly expenses, like cell phones, medical bills, daycare, or utilities. Your monthly cell phone bill or your never-ending payments on Billy’s braces are things YOU need to consider when budgeting for a house.
Adding up current bills is easy, but what about future bills? Consider planned life changes, unpredictable events, and your lifestyle.
There are some life changes that you can predict. If you know you want to have kids in the future, you really need to consider that when determining your mortgage payment. Having children will impact your income, either because a parent may want to stay at home or you will be paying daycare. Daycare costs can equate to a house payment!
The U.S. Department of Agriculture “Cost of Raising a Child” report states the average cost of raising a child born in 2015 until the age of 18 is $233,610 for a middle income family in the U.S. If you are planning on having children, maybe the question “How Much House Can I Afford?” should really be “How Much House Can I Afford After Kids?”
There are life changes that will affect your ability to repay your loan or significantly change your financial status. Some life changes (such as loss of a job, death of a family member, injury, or separation) are unpredictable and can throw you for a financial loop. The best scenario is to have a safety net. Many experts say it is ideal to have six months of wages saved for emergencies.
Finally, you also know how you want to live. If you can’t live without that annual vacation to the Florida Keys or you have an expensive hobby you just can’t give up, you need to plan for that. Maybe you work in the women’s department at Macy’s now but have a dream of opening your own fashion consignment shop in a few years. Maybe at some point you want to go back to school to get your master’s degree. You need to evaluate the future, not just your current financial situation.
If your consignment store becomes a huge hit and you franchise across the Midwest, or your master’s degree lands you an executive job with an annual bonus that used to be your salary, or you win the lottery, you can always buy a bigger better house!
In the end, only you know your life plans, your saving habits, your spending habits, your dreams, and how much house you can afford.
Use the Process
So first get pre-approved by a lender, and then carefully analyze your life situation. This two-step process is how you will determine how much house you can afford!