Buying a house is one of the biggest purchases that you’ll ever make (and most likely the biggest). After you already come to the decision that you want to buy a house instead of rent a home, the next question is how much will you spend on your new home?
With the housing and economic crisis that is happening all around us, knowing how much you can afford on a house is very important. No one wants to spend too much and then just a couple of years later to be foreclosed on or to be extremely struggling in a place that they have found to love.
Determining how much you can afford depends on your personality (because of differences in what a person likes in a house and how much individuals believe they can spend) and especially how much money you make and spend.
Below are some tips to keep in mind when you are trying to determine how much to spend on your future home:
1. You Can Spend Less Than Your Pre-Approval Amount
We were pre-approved for a lot more than what we could realistically afford. We knew for a fact that we did not want a house for the price that we were approved for. We ended up happily buying a house that was around 20% less than what we were approved for.
I’ve had friends who were pre-approved for homes that were $300,000, when the couple only made $40,000 altogether (still in college). The bank told them they could afford this, and believed they could as well. That was of course until they told me that and I sat them down and told them that their monthly after-tax income BARELY paid for their mortgage payment, and didn’t include any property taxes, etc.
There are a lot of housing costs to be thought of, so even if you are approved, you should keep all housing costs in mind. These include: property taxes, maintenance, possible increased electricity and gas bills, repairs, etc.
2. The 34% Rule
I’ve heard different amounts from different people. Sometimes it’s 34%, sometimes it’s 33% and sometimes 28%. This rule is that you shouldn’t spend more than this percent of your income. Of course it all depends on where you live, but generally try to have your housing costs be less than a third of your monthly pre-tax income.
Of course this rule all depends on where you live, as some areas have much higher housing costs than others. However, with your housing costs being less than a certain percentage of your income, it allows for comfortability.
If your housing costs are 50% of your pre-tax income, this can be a dangerous place to be in. If anything happened, such as a job loss, an event medical-related, etc., you would be in a tough place in your financial life.
We currently spend around 10% of our monthly AFTER-tax income on our house. However, when we first bought our house, this number was at around 35%. We have significantly increased our income and this has helped us greatly. We were not comfortable with dedicating so much money to our house when it was at 35%.
3. Think About Your Debts
The third of your income rule also depends on how much your other debts total to as well. If you currently have $50,000 in student loans, $25,000 in car loans, and even more in credit card debt, then a house that equals one-third of your income may be too much for you and your family.
How did you determine what to spend on your home? What percent is your housing cost?