Estimating How Much Home You Can Afford

It's the question you need to ask yourself before you even BEGIN your new home search. It's the most important factor in determining what kind of home you can secure, and where you can begin to look. It's a crucial consideration for first-timers and veteran home buyers alike.

How much can you afford to spend on your next – or first – home?

Primary Rule – Annual Income
Most experts would advise you to follow a basic rule to determine your "home buying power" – multiply your annual gross income by two and one-half. Several factors may raise or lower this number, but it is a good baseline to use as an estimate when beginning your home search. Using this rule, you can predict the amount for which you will qualify when seeking a pre-approval document from a lender - a "must-have" before beginning your home search in earnest.

Secondary Rule – Housing Expense Ratio
A second rule to consider, and another that lenders will contemplate in determining your loan amount, is your ability to make a monthly mortgage payment that falls between 25% and 33% of your gross monthly income. This "housing expense ratio" can fall outside of this range to some degree (depending on a number of factors), but lenders are more likely to approve loans that deduct a smaller percentage of your monthly income.

Debt-to-income Ratio
Your debt and credit history are also import considerations in this decision. Lenders will obviously look more favorably on candidates who have a history of paying their credit card bills, vehicle loans, and student loans in a timely manner, and whose debt does not exceed more than 30% to 40% of their income.

Other Factors
While the mortgage payment is certainly the major element of a homeowner's monthly housing expense, there are a number of other factors prospective buyers should keep in mind when predicting and estimating these costs:

• Type of Mortgage – Today's buyers have a host of mortgage options from which to choose, and can select the package that best suits their situation. These include interest–only loans, ARMs (adjustable rate mortgages), and the traditional 15 or 30-year fixed-rate loans. Talk to your lender to find out what type of mortgage is best for you.


• Interest Rates – At the time of this writing, interest rates remain historically low. It really is a "buyer's market" out there, so don't be afraid to negotiate hard with your lender to secure a more desirable rate.


• Utilities – How much electricity and water will the house demand? What kind of cable or satellite service will you use?


• Maintenance – Will you need to join a homeowner's or condominium association with the purchase of this home? There are application and monthly maintenance fees to consider.


• Closing Costs – There are a number of fees that must be paid when completing a real estate transaction. These "closing costs" include points, taxes, title insurance, financing costs, and the services of a professional, and usually range between 2% and 7% of the purchase price.


• Repairs/Decorations – Does the house need any repairs or renovations? Typically, the seller will bear the costs of any major repairs or improvements prior to the sale, but not always. Be ready to find a few things you'll need to repair, and consider how much decorating you'll want to do to make the house your own.


• Property Taxes – Property taxes are levied by the various municipalities in which your property is located. This is a tricky element to predict with a home purchase, especially with housing costs going up so dramatically in recent years.

Down Payments – The First Hurdle
For most home buyers, the first hurdle to overcome in any home purchase is making the initial down payment. This is often the largest single payment you will ever make in your life, and it is usually the determining factor in whether a seller accepts your bid.

Fortunately, there are a number of sources into which you can tap to satisfy a down payment requirement. As always, speak to a tax professional for advice on using these options:

• Personal savings, bonuses, and commissions


• Gifts from relatives


• Mutual Funds, securities, bonds


• IRAs, Roth IRAs, 401(k) plans

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