Owning a home is as American as apple pie or the Fourth of July. It’s the first step in obtaining what most people dream of: a white picket fence, 2.5 kids, and black lab. Unfortunately, conspicuous consumption and debt are also just as American. Sometimes our ambition gets ahead of our wallet and we buy things we shouldn’t. With that being said, there’s nothing wrong with buying nice things; you just have to make sure you can afford them and they fit within the context of your overall financial plan.
So just exactly how much house can you afford? The answer is anything but straight forward. There are many variables to consider, and hiring a good real estate agent can help you clarify some of them. But to get you started, I have outlined three major financial considerations:
Create a Budget
You cannot purchase a house, or make any other financial decision for that matter, in a silo. You have to consider how that goal fits within the context of your greater financial plan, which is anchored by a budget. So if you have never created one before, buying a house is a good reason to give it a try.
Fortunately, most people who want to buy a house currently rent or pay a mortgage on their current home, so historical spending can give you a general baseline for what you can afford. But it’s a zero sum game; if you increase the amount you spend each month on a mortgage, you will have less to save or spend on other monthly expenses. So identify what will change: are there monthly expenses you will cut or can you save less and remain on track for retirement saving?
Estimate Monthly Mortgage Payment
It is easy to calculate how much your mortgage payment will be each month. There plenty of payment calculators on the internet that can compute principal and interest payments. However, there are other monthly payments to consider in addition to these two basic items.
Property taxes and insurance, which are generally escrowed and included with your monthly mortgage payment, can be a significant expense. You can look up current property taxes by street address using the county landroll query tool online. So if you are looking at a particular house or neighborhood, you can get a general idea of how much you can expect to pay each year. Insurance costs will be in the same range as property taxes but vary depending on a number of factors, but your insurance agent can quickly deliver a quote estimate to help guide you in the purchasing process.
In addition to these fixed monthly costs, you must also consider utilities, maintenance, repairs, and creating a reserve for the inevitable A/C and roof replacement. These costs are more difficult to estimate but can quickly add up. If you are purchasing a much bigger or older house, you must assume that the utilities will be higher.
Maintenance of a larger home can also add up, especially if the yard is no longer a manageable size and you end up hiring a professional. The same goes for cleaning. Owning a bigger house doesn’t create more hours in the day, so if you have more rooms to clean, you may also feel the need to hire a maid. These expenses also tend to create the greatest sense of guilt. But if they fall within your budget and allow you to spend more time with your family and keep your sanity, then there is no reason why you should feel guilty about them.
If you are currently a renter, you are unfamiliar with the stress of repairs. Even a quick trip from a plumber can set you back a couple of hundred dollars, and replacing the A/C will be several thousand. In order to be financially prepared for these “life costs,” you have to budget for small repairs and set aside a reserve for that unfortunate day in August when the unit goes out and you come home to a 90 degree wave of heat and humidity.
Calculate Down Payment and Emergency Savings
Finally, you need to decide how much of a down payment you can afford. This amount will greatly affect the monthly payments discussed earlier and determine whether or not you will also have the added cost of primary mortgage insurance (PMI). Obviously, a bigger down payment is better; ideally, you would have 20% of the purchase price. But many lenders will take much less, depending on your personal situation. So you have to decide if you want to stay in your current situation longer and save for a bigger down payment or pull the trigger on a new house and settle for a lower down payment.
You should also not underestimate the costs of moving and getting a house ready to move in. As compared to the overall purchase, these costs are relatively inconsequential, but they can add up. You may have to pay movers and rent a truck. Also, you may be thinking about repainting a few rooms and adding some new furniture to take advantage of all the space your new home may offer. You want it to feel like home, but all these things cost money.
As a part of your overall financial plan, you should build an emergency reserve, and buying a house doesn’t give you a legitimate excuse to cash it out. The emergency reserve has a purpose of its own, so do not re-characterize it as a house down payment fund because it’s convenience. Bad luck has a way of waiting for exposure, so if you deplete your emergency fund, don’t be surprised if life hits you with some unexpected expense that derails your plan.
Purchasing a home can be a scary process. For most individuals, it is the biggest purchase they will ever make. But if you give these areas proper consideration, you should be well prepared for making this decision.
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.