Home ownership is a cornerstone of the American Dream. But if you don’t do your financial homework before that house warming party, it can become a nightmare.
Buying too much house can cripple your finances in both the short and long term.
So, how much house can you really afford? Let’s run the numbers.
Your mortgage payment consists of principal and interest (P&I). Real estate companies and lenders typically say you can spend up to 28% of your gross household income on your P&I. We think that’s too much, and recommend that you try to stay closer to 20% of your gross. That means if you and your spouse make a combined $100,000, you should limit yourselves to $20,000 of annual P&I, or $1,666 per month. The bank may well pre-approve you to borrow more than 20%, but you don’t have to use every dollar they wave in your face.
If you commit 28% of your gross to P&I on that same income, you’d paying $2,333 per month. That’s a difference of $667 per month that could be going to other things like savings, consumer debt reduction, or simply a little more wiggle room in the family budget.
OK, not all of that $667 is available for other spending. You’re now a homeowner. That means property taxes, home insurance and maintenance costs both small (painting, lawn care) and large (roof replacement, foundation cracks). You need to set aside money every month for those never-ending expenses.
It’s easy to get carried away during house hunting. Don’t do it! Think long and hard about what you truly want and need in a house before you start looking. Must you be in that trendy neighborhood? Can you be happy in a more affordable nearby area? Will you use that huge, costly-to-maintain yard? If you aren’t planning on kids, why pay a premium for a great school district? Two guest bedrooms? Really?
The nice-to-haves in a home are exactly that. But their value pales in comparison to the peace of mind you get from living below your mortgage means.