You can expect that your house payment should be no more than about 30% of your gross (before taxes) monthly income. A payment consists of the Payment and Interest on the Loan (PI) plus one month of the property Taxes and Insurance (TI). Take the 30% of your gross income and subtract an amount of the expected TI and then use the remaining amount to figure out how much loan you will have. Take that loan amount and add how much you have saved for a down payment and that will equal the amount you can afford for a home purchase.
Now if that all sounds a little too complicated, let’s break down the part some and point you to some resources to make this a little easier.
How to calculate things like property taxes and insurance? So much of this depends on where you live. If you live in Hawaii your property taxes may be low and insurance might be high due to volatility of weather.
- Reach out to your local agent and get quotes on approximately how much you might expect to pay for a homeowner’s policy with the types of coverages that you would want. These quotes are often specific to you as an individual and may vary depending on where you intend to live.
- Once you have an insurance quote for an estimate on the cost of a policy, take that number and divide it by 12 months – this will give you the monthly amount.
- On property taxes, look and see how much taxes are on properties that you have looked at. This too will vary by state.
- Ask your local real estate professional how taxes are calculated in the area that you want to live in. Be sure to include any city, county and state taxes that are applicable in the event that where you wish to live has more than one tax base.
- Note that in places like Oregon, every county does their millage rate a little differently and that taxes may change annually. Assessments might also be different from house to house making this a bit of a wildcard. If you are in California, the taxes will be based on your purchase price. States like Washington have payment twice a year, so be sure that you note what the full year of taxes might be. Once you have a ballpark estimate you can take that annual amount and divide by 12 months to come up with your monthly amount for taxes.
How to calculate your mortgage payment
- Use a ballpark of what interest rates are running at currently. Realize that the only guaranty is that they are going to move and that may be down or up and even several times in a given day. Best measure is to not be overly focused on the rate. Use a conservative number and calculate based on that.
- Once you have that you can go to the mortgage calculator and experiment with loan amounts until you get close to your monthly payment that you calculated you could afford.
Budget should always be your first priority
There’s a tension today in the homebuyer world. Some of it is unavoidable and some is unseen. It is important to live in the reality that you have.
- Just because the lender can qualify you for a whole lot of loan and house, doesn’t mean that you should. Homes come with responsibilities and needs just life any family member, they just aren’t alive to tell you. They will though, when you notice that the leaking gutter leads to that water in the basement or your kids are having a fun time picking the peels of paint off the garage door (hopefully not eating it)!
- If you avoid using all of your cash assets on the down payment, will you have enough funds to move, buy window coverings, shelf paper, rugs and all of the other things that come with a move?
- If you feel you need a large or expensive home, consider your reasons for this. Is it out of practical reasons or are you trying to impress someone? If it is just to impress, will this purchase make you house poor? I’m not advocating aestheticism here, just asking you to think carefully about the largest purchase you have probably made in your life thus far.
- Do you have a budget? If so, what feels comfortable to you for a payment? Do you have the ability after you purchase to still put away funds for a rainy day or other big purchases? Are you able to set aside funds for that roof that will need replacing in the next ten years?
- There is the bigger problem right now though of the price of housing being exorbitant and there may be no choice but the squeeze of that maximum loan that the lender is offering you in order to squeeze your way into a home. You may recognize the discomfort and are taking some comfort in the fact that the deductibility of the mortgage interest and taxes will provide some relief. The other relief is that you won’t have to worry with a landlord raising rents every year. Yes, a home is one of the best hedges against inflation, making it still a winning deal.
Conclusion
Bottom line with all of this budget chat is that you are going in with your eyes wide open. You recognize the risks and are thinking about how to mitigate them should you get in a challenging position. By and large most people have done well with home purchases over the years.
One last question for you – can you think ahead to possibly owning your home free and clear someday, even if it is when your mortgage is mostly paid off and you downsize into paying cash? A Financial Planner can assist you as you lay out that goal and help you keep to that path as you walk into homeownership, whether it’s the first time or the fifth. The idea of owning a home free and clear has been lost in years past, but it’s an important value to own something, care for it and enjoy the freedom of no debt. It’s worth some consideration.
Go shopping. See what is out there. You don’t need to engage a realtor right away, you can do open houses just like you kick tires looking for cars. Drive the neighborhoods that you like, research the options. If you are open minded you might find a jewel that you didn’t expect. Calculate your house payment options and live with the idea for awhile and see how it sits. If you are in a tough price range engage a Real Estate Professional to assist you in your search. Share with them your goals, aspirations and limitations. The best professionals will be more interested in serving your needs and desires than trying to sell you something. If they aren’t then move onto someone who will. You are the one who will live there, make the payment and have your home there.
Have helped buyers of all types and financial levels and worked on 1000's of loans.
There is always something new!
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