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Understanding how much house you can realistically afford is a difficult process. With so many factors to consider, there are numerous ways you can mistake how much you can afford and end up in financial trouble. Before you begin the home-buying process, it’s imperative you sit down and really come up with a comprehensive list of what you can afford, how you can afford it, and where your money is going. You’ll consider your income, your expenses, and your lifestyle. It’s easy to assume you can afford so much house when you aren’t considering things like groceries and gas to get to and from work. This advice is designed to help you understand how much home you can afford so you go into the buying process confident in your finances.

Down Payment

One of the most important factors in your house budget is your down payment. It’s traditional to make a down payment of at least 20% of the asking price of your home. For example, if you’re looking for houses that cost $500,000, you’ll need to put $100,000 down to secure a mortgage. Most traditional lenders refuse to finance homes for more than 80% of the value. This means you’re not going to buy a home without a down payment.

There are down payment assistance and homebuyer assistance programs for buyers who cannot afford a down payment, and each one affects your budget. When you choose a mortgage such as this, you pay private mortgage insurance. This is an additional fee each month attached to your mortgage, and it can be several hundred dollars each month depending on the amount of your loan. Knowing if you can make a down payment or not helps you figure out how much home you can afford.

Income and Credit

Your credit score highly affects how much home you can afford. If your score is excellent, you have good income, and no debt, you can get a great interest rate. If your credit is blemished and your debt is a bit high, you might not qualify for a low rate. This means you’ll need to buy a less expensive house to make up for the higher interest rate. For example, if you are someone whose credit score is around 675, you might not qualify for a rate of less than 4.625% based on current interest rates. On a $200,000 mortgage fixed for 30-years, you’ll pay $1,028 per month for your mortgage.

If you have an excellent credit score of 740 or higher, you’ll see rates as low as 3.841% and a payment each month of $926. That’s $100 in savings per month. That’s with a 20% down payment on a $200,000 house. Your income matters, too. You’ll need to determine your take-home pay each month and subtract what you already pay for expenses from that to see what’s left over.

Debt

Your debt matters. If you have ample debt, you’ll receive a lower rate and a lower amount when applying for a mortgage. It’s best to keep your debt under 30% of the available balance, or you can pay it all off and live debt-free instead. Your debt-to-income ratio is used to determine how much you can afford to pay for a mortgage payment, and more debt means less house when lenders look at your credit.

Extras

You have excellent credit, and you end up buying a $200,000 with a $926 per month payment. If you bring home $6,000 per month after taxes and pay only $1,500 in expenses otherwise, you’re looking at paying a total of $4,500 left over. Your new mortgage payment makes that $2,426. You’re left with more than half your monthly income in your pocket, so you know you can afford that house.

You’re forgetting extras. As a homeowner, you now owe annual property taxes and homeowner’s insurance. You might have a homeowner’s association fee, lawn service, utilities, and more. If your property taxes are $4,000 per year and your insurance is $2,000 per year, you’re paying far more than $926 each month for your mortgage. Many lenders escrow taxes and insurance, which means you’ll pay an additional $500 per month to cover the cost of taxes and insurance. That’s a total of $1,426 each month. Now you have to add other fees such as HOA and utilities to your budget and you’re looking at a lot more each month. Can you really afford that?

Figuring what you can afford to spend on a home is difficult, and it’s highly personal. You must sit down and do the math to figure out how your new home and expenses fit into your current budget. Just because a bank tells you that you can afford a certain amount doesn’t mean you can, which is why you must do this work for yourself to see what you can actually afford.