Buying a new home is a particularly exciting time. It’s easy to get caught up in the emotion of it all and lose sight of the pragmatic aspects of buying a house. Before all else you should ask “can I afford a house?” Many house-hunters will step into the market with no clear understanding of what they can actually afford. Knowing what you can afford to spend on a house will mean that you can more effectively target potential properties which will ultimately lead to a greater chance of finding your ideal house.
As a rough guide to the question “can I afford a house?” and what you can spend, multiply your yearly gross revenue by 2.5. For example, if your yearly household income is $75,000, you might be in a position to qualify for a $187,500 home. Of course these numbers will change based on many different factors such as current interest rates and your credit and debt history. Also different lending institutions will apply different formulas based on different financial situations. Other things to consider are your present financial commitments, spending patterns and overall debt, your present life-style and future plans (for example are you planning a family, or to go back to study).
How do I know whether I can afford a house?
Mortgage providers frequently use two lending formulas to calculate more reliably what you might be able to afford to spend on a mortgage:
- Housing Expense Ratio – the general recommendation is that your monthly mortgage payment, including principal, interest, insurance and taxes, be less than 30 percent of your gross monthly income.
- Debt to Income Ratio – the lender will determine whether you are likely to be able to service a loan when taking into consideration all of your other debts. These other debts might include other loans, credit cards, child support and general household expenses. As a general rule-of-thumb your total debt commitment should be less than 30-40 percent of your gross monthly income.
(Of course these are general ratios and you would be advised to get individualized advice regarding your particular situation)
To be able to get a more accurate big-picture overview of your financial situation you must draw out a budget detailing all your outgoing financial commitments and payments and all of your incoming wages, salaries and payments. This will not only give YOU a better understanding of the question “can I afford a house?” but will also be a requirement by the lending institution you approach. Whatever calculations you do, remember that you also need to save for the down-payment, closing costs, inspection costs, moving, and other similar outgoings.
Keep in mind that it’s in your self-interest to be as complete and as accurate as you can when working on your budget. Any inaccuracies or under-estimates here will only hurt you in the long-run (as we have seen only too well in recent times). You want to make sure that you can comfortably service any mortgage you take out. When you ask yourself the question “can I afford a house?” you not only want to be able to answer “yes”, but also how much you can afford to spend, and to clearly demonstrate to yourself and to the lenders you ability to pay it back.
