How Much House Can You Afford?
Understanding the Related Costs of Buying a House
You'll need to think about more than a mortgage payment to determine if you can afford a house. To assure you are purchasing a residence within the confines of your budget, you must consider closing costs, taxes, carrying charges, and yearly maintenance requirements as well. How much can you afford?
First calculate the estimated mortgage payment
Several formulas exist to help determine how much a lender will allow a consumer to borrow. One of the more accurate formulas is a front- and back-end ratio. It states that the buyer can afford as much as 28 percent of his or her gross-monthly income toward the monthly mortgage payment, assuming that the consumer's other debt payments (credit cards, car loans, student loans, etc...) are less than or equal to 8 percent of his or her gross-monthly income.
To better understand this formula, assume a gross-family income of $7,000 a month. The front-end ratio or maximum monthly mortgage payment is (28 percent of $7,000) $1,960. The back-end ratio is (8 percent of $7,000) $560. Therefore, the buyer can afford a $1,960 monthly mortgage payment as long as monthly debt payments are less than or equal to $560. If debt payments exceed the back-end ratio, it will reduce the monthly mortgage payment dollar for dollar. For example, if debt payments are $760, the maximum monthly mortgage payment a person could afford would be reduced to $1,760.
Down Payment and Closing Costs
These terms refer to how much money the buyer will have to pay out of pocket and up-front to purchase a home. Down payment is simple; it refers to the amount of money the buyers need to invest at closing toward the price of the home. Many lenders request a down payment of at least 20 percent of the cost. For first-time homebuyers, this may be difficult to achieve. Several programs are available and relatively easy to qualify for that allow buyers to make down payments of as little as 3 percent of the price of the home.
Closing costs can include attorney fees, home inspection costs, title search fees, bank fees, transfer fees, to name a few. For the sake of estimating, closing costs can range from 1 to 5 percent or more of the value of the home.
Monthly carrying costs
Both a co-op and a condo unit are going to have monthly maintenance or monthly condo fees. These will vary, but this type of owner must expect to add onto their monthly condo or maintenance fees the taxes for the unit divided by 12.
Home ownership comes with the burdens of maintaining your property. While in most residential condos or co-ops this is embedded in the cost of your monthly maintenance or condo fee, there are still additional costs for when you want to replace a bathroom or kitchen, re-do the floors, add more closets, change light fixtures or add carpeting, etc. Likewise when owning your own house and plan to make regular capital improvements. Make sure you allow something in your budget for these items.