Buying a home is one of the largest purchases you’ll ever make. To make matters even more complicated, the real cost of a home involves a lot more than just the sale price. So how do you know how much home you can afford?
One of the first things that homebuyers often do is get prequalified for mortgages, but financial adviser Sheryl Garrett, founder of The Garrett Planning Network, said that number can be misleading.
“What you can qualify for has zero to do with what you can afford,” Garrett says. “From the get-go, you can go online to the mortgage company, or ask the Realtor, who can tell you what they think you can qualify for. But I’ve never seen that to be a good fit for anyone.”
The 28/36 Rule
Garrett, who is based in Eureka Springs, Arkansas, says that using the “28/36 rule” is one way to know if you can afford a home. The idea is that a household should spend no more than 28% of its gross monthly income on total housing expenses, and no more than 36% on total debts, including housing, car, and student loans, etc.
“If you can hit one of those ratios, you can be in good shape,” Garrett says. “In lots of places, it’s very challenging to meet those ratios, but try to get as close as you can to them.”
It’s Not Just About the Price of the Home
Tony Garcia III, market manager for Wells Fargo in Los Angeles, also says it’s important for homebuyers to think ahead when it comes to expenses.
“We always tell them that they’ve got to think of things that they’ve never thought of before,” he says. “You don’t want to go in and spend every single last penny on your down payment and new furniture,” because unexpected repairs or updates may be lurking around the corner.
In addition, because mortgage interest rates can fluctuate, what an individual is preapproved for may be different than what your final interest rate is in a contract. Garcia says that homebuyers should be comfortable with a range of rates.
“If rates move up 0.5 percent, that can impact payments pretty significantly,” Garcia says.
For example, if a homebuyer was preapproved at 4% for a 30-year, $200,000 loan, then monthly payments including interest, but not insurance or taxes, would be $954.83. But if the rates rose before they locked in a contract to 4.5 percent, the monthly payments would be $1,013.37, which adds more than $700 a year.
On the topic of insurance, and taxes buyers must remember those will add to the monthly bill. The listing for any home you’re interested in should include taxes, so estimate how those will fit into your payment. However, taxes fluctuate as the home is assessed and re-assessed, so buyers should prepare for those changes as they continue to own the home. Insurance rates vary based on the size and location of the house, among other factors, but insurance companies may be able to give you a ballpark quote.
When the time comes to start looking for your dream home, Garrett recommends starting with houses that cost 10 to 20% less than the maximum amount budgeted.
“Don’t start at the high end, because it’s almost impossible to come down,” she says.
As long as you’re keeping all expenses in mind, doing a bit of educated estimating can be a good idea. Online mortgage calculators such as HSH can help buyers understand what monthly principal and interest payments might be. Also, when shopping for a mortgage, a loan comparison worksheet like one provided by the Federal Trade Commission can help keep numbers in mind.
After You Move In
Garrett says that first-time homebuyers, in particular, may not be aware of all the expenses involved in moving into a new home. Even with a brand-new home, it could cost several thousand dollars to set up the house with things like window treatments, shelf liners, shower curtains, and other odds and ends.
“Every time we move, we’re often purchasing certain items,” Garrett says. “You may need to buy a vacuum cleaner for the first time.”
Garrett says the first thing she does after purchasing a new home is to rekey all of the locks. While that can cost several hundred dollars, it gives her piece of mind that she is the only person with access to the home.
Buying a new home also can mean thinking about the costs associated with trash disposal, homeowner association fees, or repairs. Like a car, houses need regular maintenance to keep everything in tip-top shape.
“But if you defer maintenance it does not get cheaper,” Garrett says, and advises being prepared for the unexpected. “Sometimes we don’t know what we don’t know.”
Despite all of the challenges, both Garrett and Garcia say owning a home is worth it.
“The biggest thing is, owning a home gives people that feeling of community, that feeling of pride,” Garcia says. “You can truly create an amazing amount of memories.”
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