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How Much Can I Afford to Buy a Home?

While the journey to homeownership is an exciting and significant milestone in one’s life, that blissful feeling can easily be taken away when you are presented with all the out-of-pocket costs it takes to move forward. Since it’s one of the biggest purchases in your life, it’s important to know how expensive the process to buy a home is. Of course, the overall cost depends on your financial situation and if you considered options to reduce these costs.

Whether you’re a first-time or repeat homebuyer, purchasing a home requires careful financial planning and consideration. One of the crucial questions you’ll need to answer is, “How much can I afford to buy a home?” We’ll explore the essential factors that determine your home affordability and provide practical tips to help you make informed decisions on your path to homeownership.

Assess Your Financial Situation

The first step in determining how much home you can afford is to take a close look at your financial situation. Calculate your total monthly income and analyze your monthly expenses, including debt payments, utilities, groceries, and discretionary spending. Do you have additional money to spend after all things considered? Knowing your current financial standing will give you a clear picture of how much you can allocate toward housing costs.

Remember to take your savings into account! Having substantial savings can be incredibly beneficial when covering the expenses associated with purchasing a house. However, if your savings are limited, there’s no need to worry. We have strategies to help ensure that you find yourself in the optimal position to afford your ideal home.

The 28/36 Rule

Did you know there’s a common rule on how much of your income you should put toward your monthly mortgage payment? The 28/36 rule is a guideline for potential home buyers to determine their affordability and financial stability when considering a mortgage. This rule suggests that your monthly housing expenses, including mortgage payments, property taxes, and insurance, should not exceed 28% of your gross monthly income. Additionally, your total debt, which includes student loans, car loans, and credit card payments, should not exceed 36% of your gross monthly income.

This rule serves as a practical tool to ensure you’re not going over your budget and can comfortably manage your financial commitments. It’s crucial to remember that while the 28/36 rule is a general recommendation, individual circumstances, and financial goals vary, so we recommend consulting with your lender and/or financial advisor to see if this rule should apply to you.

Consider Down Payment and Closing Costs

The down payment is a significant upfront cost when buying a home. There is a common misconception that you must put down at least 20% of the home’s purchase price, mainly to avoid private mortgage insurance (PMI). In reality, a 20% down payment is not necessary to buy a home. In fact, about 44% of homebuyers put less than 20% down, according to a recent confidence index survey from the National Association of Realtors (NAR), putting into perspective that putting down less than 20% is more common than you may think.

Additionally, don’t forget to factor in closing costs, which typically amount to 2-5% of the home’s price. Being prepared for these expenses will help you create a realistic budget for your home purchase.

Determine Your Credit Score

Understanding your credit score is a fundamental step in gauging how much home you can afford. Your credit score reflects your creditworthiness and can directly impact the interest rate you’ll receive on your mortgage. Lenders will use your credit score to assess the risk of lending to you.

A higher credit score typically leads to lower interest rates, which can affect your monthly mortgage payment. Ultimately, your credit score plays a pivotal role in determining not only the amount of money you can borrow but also the interest rate, affecting your overall affordability. We recommend regularly reviewing your credit report, addressing any red flags, and most of all, making regular timely monthly payments on your accounts to keep your score as high as possible to secure your ideal home financing option.

Keep in mind that everyone is entitled to one free annual credit report from the three major credit bureaus! If you are planning to buy a home soon, you can run a free credit report if you haven’t already in the last 12 months to determine if it needs to be improved.

Determine Your Debt-to-Income Ratio

Lenders use the debt-to-income ratio (DTI) to assess your ability to make mortgage payments. DTI is calculated by dividing your total monthly debt payments by your gross monthly income. Most lenders prefer a DTI of 43% or lower, but the lower your DTI, the more financially secure you’ll be when taking on a mortgage. A DTI above 43% does not mean that you cannot qualify for your purchase or refinance, since there are multiple loan options that will allow for a higher ratio.

By calculating your DTI ratio, you can gain valuable insight into your financial situation and ensure that you’re taking on a mortgage that doesn’t increase your debt in a harmful way. If you would like to calculate your DTI ratio before home shopping, you may do so however we recommend reaching out to one of our mortgage advisors to evaluate your DTI. We may calculate a more favorable DTI depending on the target loan program, which can increase your chances of getting pre-approved and help you avoid financial strain in the long run.

Account for Future Financial Goals

While purchasing a home is a significant financial commitment, it may not be the only financial commitment you have planned for the future. Are you thinking about buying a new car in the next few years or maybe want to start a family? If you have other long-term financial plans, take a second to prioritize these into order of most importance to you and figure out a reasonable timeline for each. As it’s not recommended to take out more than one loan at a time, a reasonable timeline is crucial to determine how you can fulfill all your goals successfully, without getting overwhelmed or struggling to maintain your finances.

Choose the Right Loan Program

Do you find yourself unable to afford to buy a home without assistance? Luckily, several alternative loan programs may better suit your financial situation, such as first-time home buyers, low-income individuals, or those with credit challenges.

Federal programs, like FHA loans, can offer more lenient credit requirements and lower down payment options. VA loans are available for eligible veterans providing competitive terms and sometimes requiring no down payment. State and local governments even offer down payment assistance and grants for qualified buyers, making homeownership more attainable. Research these alternative loan programs to see what’s available and seek guidance from lenders who may have more options that fit your needs, such as RWM Home Loans.

Use a Calculator or Talk to a Loan Officer

When determining how much home you can afford, two valuable resources come into play: using a mortgage calculator and talking to a loan officer. Mortgage calculators are online tools that allow you to input variables such as loan amount, interest rate, and loan term to estimate your potential monthly payments. This helps you quickly assess various scenarios to get a rough idea of your estimated mortgage payment.

On the other hand, consulting with a loan officer adds a personalized touch that allows you to raise questions if you are ever unsure about how affordability is calculated. Loan officers are home financing experts who can provide detailed insights that align with your financial situation. For example, loan officers at RWM Home Loans can efficiently run a total cost analysis for you by taking into account your financial situation and goals to determine the amount you can comfortably borrow. Overall, loan officers provide more value and consider factors that might not be reflected in a generic mortgage calculator.

You’re Closer to Homeownership Than You Think!

Knowing how much you can afford to buy a home is a critical aspect of the homebuying process, especially if you’re in the beginning stages. It’s better to be proactive now by analyzing how much you can afford than assuming you can’t afford a home and missing out on the chance to start building equity now. Remember to consider all mortgage costs, choose an ideal loan program, and talk to a loan officer to obtain an estimate for how much you can afford. With careful planning and informed decision-making, you’ll be well on your way to finding the home that suits both your lifestyle and your financial well-being.

Another way to overcome affordability challenges when it comes homebuying may be to buy it with a friend! While this may seem like an exciting opportunity, try not to call your friend immediately and start completing the paperwork. Instead, read over our pros and cons to make sure it is an ideal financial decision for both of you.

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