How Much House Can You Really Afford?

2010 December 15
by Kyle Bumpus
from → Personal Finance, Real Estate

Buying a house is a complex process, often fraught setbacks, delays, and disappointments. We all have a dream about the kind of home that will be our lifelong sanctuary, a retreat from the crazy world that will shelter and protect our loved ones for the foreseeable future. Unfortunately, most of us can’t afford to purchase the house in the Hamptons that resides in our imagination. Many homeowners have to face the fact that what they want and what they can actually afford are two different things, which generally means settling for a house that is far less appealing. However, some people (a lot of people) try to get the dream home anyway, often with disastrous results. So if you think you may be trying to live beyond your means, here are a few tips to give you a wakeup call and snap you back to reality.

  1. Check your credit. A low credit score is a problem for many adults. Most of us never learn how to manage money (or learn too late) and because of that we spend on credit to an alarming degree, often getting in way over our heads. And a low credit score can spell disaster for those who wish to buy a home. High-risk borrowers will be approved for less money, face higher interest rates, or even be denied outright. So if you want to shoot for the dream home, learn how to manage your money and raise your credit score. Somewhere along the line, you may discover that spending within your limits is a better plan than shooting for the moon.
  2. Calculate monthly payments. Remember a little equation from algebra called the principal-interest formula? If you thought math would never come in handy, you’re about to eat your words. You can use this formula (found online in detailed description) to determine how much your monthly payments will be for a certain loan amount at a certain interest rate over a certain amount of time. Or you could just ask the bank to figure it out for you. The point is, you don’t want your payments to exceed one fourth of your monthly income; otherwise you will have to cut back in other areas (or face the consequences).
  3. Assess your savings. Saving for a rainy day is important, especially in these tough economic times. The general rule of thumb when it comes to liquid assets is to have at least three months’ worth of salary tucked away so that you can continue to pay your bills if you lose your job. However, if you’ve bitten off more than you can chew with your mortgage payment, you’re not going to be able to save a penny. In fact, you will likely be living paycheck to paycheck or digging yourself a pretty big hole of debt. If you find that you can’t save money despite an ironclad budget, you’re probably spending too much on your mortgage.
  4. Look to the future. Consider your prospects for the future. Are you going to get that raise you’re counting on, or magically make more money at some point? Maybe you’ll win the lottery or a rich relative you never heard of will leave you everything. You’re beginning to get the point. You can’t live on a pipe-dream; you can only depend on what you have right now (and maybe not even that). So be conservative and plan for a future in which you are making the same amount of money (or even less). This way you won’t be too disappointed when that promotion doesn’t come through (and you’ll still have a house to come home to).
  5. Expect the worst, hope for the best. Facing the reality of one’s financial situation isn’t always easy, but plans can change. Even if all you can afford right now is a shoebox-sized condo, future successes could allow you to trade up (while failures will come as less of a blow if you don’t have to lose your overpriced Malibu dream house in the process). So plan for the absolute worst possible outcome, but keep working towards your dream. If you’re smart about choosing a house you can actually afford right now, the one you covet may soon be within your reach.

Sarah Danielson writes for AdvanceMe, the nation’s leading merchant cash advance provider and credit card factoring company.

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2 Responses
  1. 2010 December 20

    This is good advice. Often when I talked with prospective homebuyers about mortgage financing, they always want to know the maximum home they can qualify for and then proceed to shop for homes near their maximum or even more. I don’t think this is a good approach at all. Yes, it is good to know how much of a home one can qualify for, but homebuyers should never buy at the top of their price range. Taking less house than one can afford means more restful nights and more financial flexibility to deal with the unexpected when it inevitably comes up.

  2. 2010 December 27
    Matt permalink

    re #2: There are any number of mortgage calculators online that will calculate your payments and generate an amortization table for you so you can see how much goes to interest and how much to principal with each payment. There is also a Loan Amortization template built into Excel that does this as well and it is even easier to see what happens when you change the loan amount/interest rate/term. I think it’s a good idea to run some of these numbers before you go into the process so you have a good idea of what you can afford under different circumstances.

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