How much house can I afford?

The topic of house affordability comes up often, this topic should be taken very seriously as this will decide your economical fate in the next few years.

First thing you should do is to set a price you are willing to pay for a property before you even start looking for a property.

That way you can narrow down your choices. But how do you do this? This few steps can help you navigate how much house can you afford.

The rule of thumb is to buy a house that is no more than 2 x your gross annual income.

Before we get started I want to tell you; Live within your means.

It is of no use to buy a very expensive house that leaves you without cash reserves (savings) to repair the A/C WHEN it breaks down, because it will breakdown or when the plumbing gets clogged etc.

You could want a million dollar estate, but could you afford it?

What is Debt to Income ratio and why you should know?

DTI metric will be used by banks to determine how much money they will lend you.

DTI is a comparison of Total Monthly Debts (mortgage/rent, student loan payment, car payment etc) to Pre-tax income.

Typically banks use 36% as the optimal number to lend you money.

You can calculate easily this by multiplying your pre-tax income by .36.

Your gross monthly pre-tax income x 0.36 = Target monthly mortgage payment.

For example $5000.00 monthly pre-tax income x 0.36 = $1,800.00 should be the target monthly mortgage payments you could afford.

36% is safe number, you could go higher understanding you could be stretching yourself thin and leaving little room to maneuver should the unexpected happen. However this number is decided by the bank, they usually set minimum requirements.

One way to alter these numbers is by keeping debt down to a minimum.

Knowing what your DTI is will pretty much narrow down what property is within your reach.

Credit score -

Credit score also plays an important role, usually banks require scores of more than 680 to qualify for a good mortgage interest rate.

Why is it important to have a good credit score?

Let's take a closer look;

Joe has a poor credit score of ~450, gets a 4% interest rate on a 30 year fixed mortgage; this means for a typical $200k property with a 20% down payment he will be paying $955.00 a month (not counting insurance/taxes etc.).

Jim has an excellent credit score of ~780, gets a 2.8% interest rate on a 30 year fixed mortgage; this means for a typical $200k property with a 20% down payment he will be paying $822.00 a month (not counting insurance/taxes etc.).

Jim pays $133.00 less per month, $1,596.00 less per year just because he has a good credit history.

Did I get your attention on why the credit score is important???

You do not have a credit score? - take out a credit card and pay it consistently every month.

Determine what will your monthly payment be.

Your monthly payment will not only be the mortgage, there is a little more to it (Taxes and Homeowners insurance).

You will have to factor in 2 important details when buying a house-

-Taxes - Taxes will be payed yearly, they will depend on which state you live, Miami-dade county tax ix ~1% of the property value (this will be determined by the state appraisal not by you). The more expensive the property the more taxes you will pay.

-Homeowners insurance - Bank will require you insurance to secure their investment, therefore they will require you to have homeowners insurance. Your insurance broker can give you a glimpse of how much you will be spending. The more expensive the house, waterfront and if it is in a flood zone are all factors that come into play, talk to your insurance broker.

-HOA's - (Home Owners Association fees) find out if there are any, typically a gated community or a condo WILL have one, factor this into the monthly payment.

The above information could be found easily in the internet nowadays, state websites will have this info, you just have to dig a little.

Final word of advice -

If you are serious enough to be looking at properties, my serious advice is to do your due diligence and get a realtor and a pre approval letter. They will give you a concrete idea as to how much you can spend on a property.

Let's say you found your dream property, at the price you want (and can pay), but you are not prepared, you will not be able to make an offer for the property. When you come back ready to make an offer on the property, it may be sold (yes it happens that fast).

Till next time.

Disclaimer - This blog is meant purely for educational discussion of finance. It contains only general information about financial matters. It is not financial advice, should not be treated as such.