Buying A First Home: How Much Can You Afford?

Benefits of Home Ownership

The purchase of a home gives you several important financial benefits.

First, there is an opportunity to build equity. With every mortgage payment, some of the money that was borrowed (principal) is repaid. This, along with generally increasing home values, increases your equity (the difference between the market value of a home and the amount that is owed on the mortgage). A second financial benefit is potential tax deductions. If you itemize tax deductions on your federal tax return, your mortgage interest and property taxes on a principal residence are deductible.  A third financial benefit is leverage, which is the use of other people’s money to magnify potential financial gains.  Finally, you can "lock-in" the price of housing, unlike the cost of renting, which will increase with inflation.

However, despite the advantages, you should not rush into this decision.  There are some very important financial considerations in determining how much you can afford to pay for a home.
How Much House Can You Afford?
Prospective homeowners need to determine how much house they can afford before beginning to search for a home. One frequently cited guideline is that an individual or family should spend no more than 2 to 2.5 times their annual income for a home. Another is that monthly costs for principal, interest, taxes, and insurance (PITI), plus consumer debts (car loans and credit card payments, for example) should equal no more than 40 percent of take-home pay.  These are general guidelines and need to be applied with caution because geographic locations, ages, size, and other financial obligations (child support, for example) of families vary. You can also use the link to the "How Much House Can You Afford" link at the bottom of this article.

You'll also want to make sure that you can afford all of the additional costs associated with  home ownership, including property taxes, homeowners’ insurance, condo or community fees, utilities, maintenance and repairs, and home improvements.

You’ll also need to save for closing costs and a down payment.  Due to the recent consumer loan melt down, most lender’s now require a minimum down payment of 10% of the purchase price of the home, or 20% to avoid PMI (Private Mortgage Insurance).

Another thing that you should do before shopping for a home, is to get pre-approved by a lender, not just pre-qualified. Pre-qualified simply means that your income fits the lender’s debt-to-income ratios. Pre-approved means that a lender has verified your income, checked your credit, and agreed in writing to provide a mortgage up to a certain amount.

Saving on the Costs of Financing Your Home

Borrowing the least amount possible and repaying a mortgage as quickly as possible will reduce borrowing costs.

You can check mortgage rates with your local banks, but you may be able to find a better rate online.  Bankrate.com has a helpful mortgage comparison tool. Shopping for the best terms on a mortgage can save tens of thousands of dollars over time.

Another strategy that can save on home financing costs is making extra payments on the principal to reduce the loan balance faster, thereby reducing the total interest paid. You can either include the extra amount with your monthly payment, if you have a regular source of increased income, or make a once a year or one time extra payment. 

Try our Calculator:  How Much House Can You Afford?