For most people, a house is the largest expense they’ll ever have. An exception might be a business, but relatively few of us ever make that kind of investment. A car, a college education for the kids, an elaborate vacation — rarely does any of them add up to the cost of a home.
Does that mean prospective buyers should be intimidated by the thought of actually going through with the purchase? Absolutely not. In fact, in many ways, it makes more sense to own a home than to rent one.
For one thing, rents inevitably go up. For another, when you make house payments, you are edging ever closer to actually enjoying full ownership and, meantime, building equity that will serve you well in many ways. But every buyer should make sure the house is affordable. That means not only which house is finally selected, but where. A house in New York City or San Francisco, for example, will almost surely cost five or six times as much as a similar home in a small city or village in a less-populated area, less-affluent area.
On the other hand, buying a home also buys you responsibilities for upkeep that renters don’t have. Small repairs and yard upkeep are the homeowner’s problem, as is hiring experts for the big repairs. And buying is not the best answer in every situation. For example, renting is certainly preferable if you’re not planning to stay where you are for long. In that case, buying would prove more costly, as the costs associated with purchasing a home, such as escrow fees, taxes and closing costs, take time to amortize.
But, once you’ve decided that buying is the best strategy for you, there is a lot to consider in figuring out exactly how much you can — or should — spend. The U.S. government has defined an affordable home as one costing less than 30 percent of your pretax monthly income. About 19 million people — nearly 37 percent of homeowners — spend more than 30 percent of their income on housing. And that 30 percent is actually considerably more than many experts advise. Some insist that no more than 25 percent of gross income should be committed to a home purchase. Many put the figure at 28 percent.
But consider all that goes into the term “home purchase.” That amount is more than just what you will devote to monthly mortgage payments. It also includes taxes, insurance and maybe condo or association fees. Upon buying the house, remember, there are also legal fees and closing costs, which typically amount to 2 to 3 percent of the price of the house.
If you made $60,000 a year and used the 30-percent standard for home purchase, you could afford to spend about $1,500 a month on principal, interest, taxes and insurance without exceeding your limit. Using the 25-percent standard, your limit would drop to $1,250.
All of this does not take into account other debt. If you are carrying debt from credit cards, student loans, auto loans, alimony, child support or other bills, figure on spending no more than 36 percent of your income on total monthly debt payments, including your mortgage. If that $60,000 earner were spending $300 a month on a car payment, $200 on a student loan and $125 on credit-card bills, the monthly mortgage limit would be reduced to $1,175.
Some experts strongly recommend keeping mortgage payments even below 25 percent. That’s because, in the event of one of those rainy days when a sudden expense arises, paying too close to the limit will impose new urgencies. You want to avoid having to withdraw or borrow against an IRA or 401(k) or taking out another loan that will imperil your regular mortgage payment, which has such a profound influence on your overall credit standing.
Those same experts go a step further and state that, in houses with two incomes, the 25-percent rule should be applied to only one income. Relying on the income of two people doubles the chance of calamity, they say. What if one of you loses a job or has a debilitating illness?
Furthermore, if children are in the future, keeping the mortgage payment well below the maximum affordable is crucial. Children are expensive. Their needs must not conflict with housing needs.
And a fund should be set aside for emergencies. Some authorities recommend keeping available 1 to 3 percent of the cost of the home for repairs and upkeep.
Taking into account the best findings of the most informed and perceptive experts, the best thing you can do for yourself when considering buying a house is to try to be as conservative as possible when evaluating what you can afford. If you have enough income and enough available cash to support the payment of less than 25 percent of your monthly income toward your mortgage and related expenses, look at the numbers again and see whether you can move up. If so, you could set your sights on a better house or better neighborhood or take on a higher mortgage payment to retire your debt earlier.
If not, be prepared to either settle for a more modest house or wait a while longer until your financial situation improves.
Meanwhile, though, be prudent and frugal in all buying, keeping in mind the goal of eventually owning the home you truly want. Keep your debt under control and try to get yourself into a situation in which you can easily rely on having available 25, 28 or even perhaps 30 percent of your monthly income for your housing expenses.