How Much Home Should You Buy? Tips for Choosing an Affordable Mortgage
When you're buying a home, it's easy to get distracted by the fanciest house on the block. Designer kitchens, spa-like bathroom and spacious master suites have an undeniable appeal. And most of us would also like a home in a great neighborhood. But all that comes at a price. While it may be tempting to take on a large mortgage so you can get a home with all the amenities you want, that's not always a smart financial idea. Below, I've highlighted some issues to consider when buying a home, as well as tips to help you choose an affordable mortgage.
Strive to Be Mortgage Free
We believe everyone should strive to own their homes debt free. By living within your means, you can use your excess cash flow to pay down the mortgage. This requires that you don't take on a larger mortgage payment than you can afford.
How do you do this?
- Save up, buy a small home. (This may be a home that costs $100,000 rather than one that costs $300,000.)
- Save some more, sell your home, buy a bigger home.
Sticking to this plan means that you may not be able to buy your dream home right away. You might have to settle for living in a different area than you'd prefer or deal with having a longer commute until you're financially able to buy what (and where) you really want.
Your monthly mortgage payment shouldn't exceed 25% of your take-home pay. [Tweet This]
How Much Should I Spend on a Home?
If you must take on debt in order to buy a home, we suggest using the following approach to keep the home's value (and corresponding expenses) in a range that is manageable given your income.
Your monthly payment (including principal, interest, taxes and insurance) should not exceed 25% of your take-home pay. If your monthly take-home pay is $10,000, then your payment should be no more than $2,500. Once you have calculated the monthly mortgage payment you can afford, you can determine the total mortgage amount and the value of the home you can afford. For instance, if you can afford a mortgage payment of $2,000, then the annual mortgage payment is $24,000 ($2,000 X 12 months). This corresponds to an initial mortgage balance of $270,000. If you are making a 20% down payment, this corresponds to a home value of $337,500.
Another way to make sure you are buying more home than you can afford is to use the following guideline:
Your annual income $________ X 2 = $______________
Your annual income $________ X 2.5 = $______________
Generally, we recommend that people not buy a home with a value that exceeds two to two and a half times their annual income. Remember, this is the home's total value, not just your mortgage. So, let's say you and your spouse have an annual income of $125,000. How much home can you afford?
$125,000 X 2 = $250,000
$125,000 X 2.5 = $312,500
So, if you have an annual income of $125,000, we suggest looking at home in the $250,000 to $312,500 range. (Of course, you can always be extra cautious and buy a home that costs less than $250,000.)
Other Key Questions to Ask
How much of a loan/mortgage should you get? If you must take out a mortgage, we recommend that it be no more than 50% to 80% of the home's value. Always make a down payment of at least 20% (or more if you can afford it).
What length of mortgage should you get? Take out a 15-year fixed-rate mortgage. Then, pay down your debt as quickly as you can. The funny thing about 15-year mortgages—they're always paid off in 15 years.
Should I retire with a mortgage? No. If possible, do not retire before your mortgage is paid off. To do that, you may need to make extra payments so that you can be mortgage-free before you retire.
Is this home in the best possible location? Location is key when it comes to real estate. Some buyers will be looking for a home on the water or that has a nice view, and you property may sell faster if it has those qualities. Other buyers may be more concerned with having a good local school district, access to public transit, a safe, family-friendly neighborhood, or nearby amenities (such as shops, restaurants or parks within walking distance). On the flip side, it may be more difficult to sell homes that are located on busy streets, are in unsafe areas or have less-than-desirable neighbors.
Don't Buy More House Than You Can Afford
If you're in the market for a new home, you have many things to consider. As you consider your options, be sure to keep your budget in mind. Don't let your desire for certain features or amenities blind you to the reality of what you can actually afford. Instead, before you even start browsing lists of homes for sale online, make sure you've determined exactly how much house you can afford to buy. Remember, you can always make upgrades, or buy a bigger house in a better location, later, when you have the means to do so. For now, stick to a home (and a mortgage) that's within your budget.