Question: My husband and I are in the early stages of planning our first home purchase and currently trying to set a budget. What advice do you give clients to help them decide how much of a mortgage they can afford?
Answer: Spend too much and you’ll have a half-empty home for a few years. Don’t spend enough and you may be moving sooner than you hoped. This week we’ll break down some of the conversations I have early on with clients as they’re deciding how much mortgage they can afford.
How Much Are You Allowed to Spend?
I often find that professionals employed in the DC Metro are allowed to spend more than they actually want to spend. That’s a good thing! It means we have a lot of highly qualified buyers who have enough fiscal sense not to spend to their limits (ahem…US Government…ahem). Even so, the first thing you’ll want to do is determine how much you’re allowed to spend by talking with a lender who will provide an honest, detailed review of your finances to let you know what your maximum loan and monthly payment amount is. A good lender will also serve as a valuable advisor as you plan your budget.
Here’s a link to a column I wrote last year with my favorite loan programs including low down payment options, 10% no PMI loans, and doctor loans.
Length of Ownership
I’ve said it before and I’m saying it again – the amount of time you expect to own your home is extremely important in your home-buying strategy and often glossed over.
If you are buying a 3-5 year home (accurate for many first-time buyers) your focus should be on value and keeping your cost down so that you give yourself room to save for your next purchase, which is likely a longer-term home. Your income and inflation are less likely to increase significantly in that time, so an expensive monthly payment now will still feel expensive in 3-5 years.
If you are buying a 10-15+ year home, the greatest value you’ll generate is choosing a home that suits you and your family long-term. The cost of buying something too small or too far from work that leads to a sale halfway through your intended ownership period is often much higher (taxes, commissions, closing costs, moving costs, etc) than the cost of moving into a slightly uncomfortable range of your budget. Your mortgage payment hopefully won’t feel expensive forever if you’re in the first half of your professional career because you’ll likely have significant increases in income and, over time, the effects of inflation will minimize the stress of your mortgage (if it’s a fixed rate mortgage).
Monthly vs Down Payment
I find that most people based their budget on their savings and thus, the amount they have to put down towards a max purchase price. For some reason, monthly expenses often go overlooked so don’t forget to consider how much you’re comfortable spending each month which includes your mortgage, taxes (assume annual increases), applicable condo or HOA fees, and homeowner’s insurance. This doesn’t include a budget for maintenance and repairs, which should be estimated at an annual expense of 1-2% of your home’s value. Your purchase price budget is like the glamour muscles that everybody pays attention to, but the monthly payments are like your core muscles that support the whole thing…does that make sense to anybody else?
Savings is clearly an important factor in what you can afford. Your savings determines the amount you can put down; although with solid loan products available with as little as 3% down, many buyers qualify for a lot of house with little savings. In addition to your down payment, you’ll pay 2-3% of the purchase price in closing costs like taxes, fees, insurance, and escrows (closing costs can be paid by the seller). Finally, don’t forget about what you’ll need after you close – moving and furniture add up quickly and you should always have 3-6 months of fixed/living expenses in savings in case of emergency.
Don’t Tempt Yourself
Once you decide on your budget, don’t allow yourself to visit properties that are highly unlikely to drop within your budget. One of the easiest ways to derail your progress is visiting homes 10-20% over budget, leading you to desire features that only exist together in homes you can’t afford. Save the window shopping for another time if you’re serious about buying a home now.
Ultimately, the best way to decide how much mortgage you can afford is to plan ahead by establishing a relationship with a lender and taking enough time to explore your options with an agent who understands the market and your needs. With enough planning and work, you’ll be able to decide for yourself if the mortgage you can afford gets you the home you want, or if paying rent for another year is better than paying a mortgage.