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How much house can I afford?

It’s the question at the top of every first-time home buyers’ mind: how much can I afford to spend? But that’s only the tip of the iceberg. You’re also probably wondering about private mortgage insurance…just what is it, exactly? And will I need it? You may have heard about automated underwriting, but maybe you’re not sure how it will affect you. And of course, you’re probably wondering how much you’ll need for a down payment and closing costs.

Obviously, there are numerous questions to be answered when starting the process of buying your first home–and it can feel a little overwhelming! That’s OK: we’re here to help.

While this article can’t answer all your questions, it can help you with the first and possibly most important question of all: How much house can I afford?

To answer this question, break it down into two questions:

  1. How much will your financial institution pre-approve you for?
  2. What can you afford, based on your personal situation?
  3. It’s important to answer both of these questions if you want to find a house that realistically fits your budget and lifestyle.

    Step One: Get Pre-Approved

    You’ll want to start the process by meeting with your financial institution (lender) to get pre-approved for a home loan. We can’t over-emphasize how important this step is–we wouldn’t want you to find your dream home, only to be disappointed if you learn you don’t qualify for a loan. So, even though it’s tempting to start with the fun part–looking at houses!–do the responsible thing and talk to your financial institution first. They can help you determine how much house you can afford, which will make your house hunt much more focused and realistic.

    What does getting pre-approved for a loan mean? Your financial institution will have you complete a loan application, after which they’ll send it through automatic underwriting. Automatic underwriting is a process where a computer algorithm determines how much you qualify for, based on the following (the 5 C’s):

    • Capacity (ability to repay the loan)
    • Character (willingness to repay the loan)
    • Capital
    • Collateral
    • Compliance

    In other words, the computer takes into account the relevant information from your application, like your income, how much debt you have, your credit, and other factors to determine a pre-approval amount.

    While the amount you’re pre-approved for is important, you should remember that this number was generated from a computer, and it doesn’t consider other important factors. That’s why the second question–how much can you afford based on your personal situation?–is also important.

    Step Two: Think “Big Picture”

    Think about what’s missing from the pre-approval algorithm, like your other monthly expenses. These could include your cell phone payments, medical expenses, childcare, and utilities like an electric bill and water bill. You should also consider your discretionary spending, like meals out, entertainment, and travel. And don’t forget to account for possible planned (or unplanned!) life changes.

    Planned Changes

    Some life changes are easy to predict. Always dreamed of being a mom or a dad? Having kids will change your financial situation, so you should accommodate for that when deciding how much you can spend on your new home. Daycare costs can be quite expensive; let alone all the other expenses you should consider. Per a report from the USDA, “Cost of Raising a Child,” the average cost of raising a child born in 2013 until age 18 is $245,340 for a middle-income family in the U.S. So, if you want to plan for kids in your future, make sure you include the extra expenses that choice will incur in your calculations.

    Unpredictable Changes

    There are also unpredictable changes that may happen in your life–and while it can be unpleasant, it’s wise to consider them. Brainstorm which life changes could influence your financial situation, such as losing your job, the death of a family member, separation from your significant other, or an injury. Perhaps you can’t predict whether any of these things will happen, but you can plan for them, by saving money to serve as a “safety net.” A good goal? Many experts suggest saving six months of wages to help mitigate the risk of emergencies.

    Lifestyle Choices

    Let’s not forget living your life–and realizing your dreams! Now is a great time to reflect on the type of life you want to live, and the goals you want to accomplish. If an annual vacation is important to you, or you’ve always wanted to take up a new hobby, plan for it! If you’ve always dreamed of owning a business, or you want to go back to school, plan for it!

    Purchasing a house can be a big financial decision, so it’s important you think about not just what type of house you want, but what type of house you can afford–and all the considerations that go into that decision.

    Use the Process

    Remember, pay a visit to your lender first to get pre-approved. Then, think about the type of lifestyle you want to live, and what planned or unplanned changes might impact that. Considering the answers to those questions will help you answer the BIG question about how much house you can afford.

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