You've made the decision to purchase a new home. The next step is figuring out how much you can afford...
1. Find your mortgage 'comfort zone': There are lots of free online mortgage calculators to give you an idea of the sales prices you can afford. This is a great place to start even before actively looking for homes. Keeping your 'magic' number in the back of your mind will make your home search more satisfying. There is nothing worse than getting your heart set on something that you can't quite afford.
2. Speak With a Lender (or two, or three): Make an appointment to sit down with a loan officer to discuss your current financial situation and your lending potential. A professional will be able to give you a pretty good idea of how much the bank will be willing to lend you based on the amount you can afford to put down, your debt, credit and income. Once you have found a home you are really excited about, you will want to be pre-approved for the amount of the house less your down payment. A pre-approval letter tells the current homeowner that you are serious about buying their home, and have the resources to do so.
3. Calculate Monthly Expenses: Now that you have a good idea of what your monthly mortgage payments will be, it's time to sit down and think about the other expenses that will come with this new home. Include the mortgage payments, taxes and insurance in your calculations. Keep in mind that your monthly home costs should be 28% or less of your gross monthly income. For example, if you make $5,000 each month before taxes, you should be spending no more than $1,400 on home expenses. To give yourself some breathing room, you can calculate 28% of your take home pay.
4. Consider Your Debt: Unfortunately most of us carry some debt, whether it be student loans, car payments or credit cards. Your debt to income ratio (including your mortgage payment) should be 36% or less of your gross income. If you're making $5,000 per month, your debt should be $1,800 or less.
5. Factor In All Other Expenses: Now it's time to make a list of everything else you spend money on monthly. These will include groceries, heat, maintenance, fuel, car expenses, entertainment and phone bills. Add this number to your debt and monthly expenses and subtract from your take home pay. Do you have enough to feel comfortable month to month? If not you will need to make adjustments to your spending patterns.
6. Don't Forget Closing Costs: Typically closing costs are between 2-5% of the total purchase price of a home. You will need to bring this amount with you at closing to cover legal fees, inspections etc. When you find a home you can afford and decide to place an offer, remember to calculate this percentage and deduct it from the amount you can afford to put down initially.
7. Leave Money For Upgrades: Remember not to leave yourself so strapped for cash that you won't be able to afford the upgrades you were initially excited about making to the new home. Maybe you want to plant a garden, paint or buy new furniture. These are important and you should factor those costs in to your decision.
When you have your affordability calculated you will be much more prepared to place an offer on your dream home. Let the search begin!