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Homework: How to Calculate How Much House You Can Afford

Blog icon for Calculating Home AffordabilityCrashing open houses and daydreaming about your future home? The spring and summer months often bring out a slew of looky-loos and serious house shoppers. If you’re ready to consider a new place to throw out the welcome mat and move in to a new neighborhood, one of the most important initial steps is to consider your budget, whether that takes the form of a bigger space for your growing family, or perhaps downsizing to make life simpler.

You’ve heard this before. A Couple decides they are ready to buy a home. They start looking at houses and fall in love with a home. They are already decorating the place in their minds—imagining holiday dinners, birthday bashes and cozy evenings—when suddenly they discover they cannot afford it. Sigh. Not a great way to start the home-buying journey.

So how should a person–or couple–determine how much house they can afford?

A great place to start is with an affordability calculator. Many sites offer this service, and it’s free. Plug in a few numbers about your income, projected down payment and other monthly debts, and you can start to get an estimate for what you can afford as a monthly mortgage payment.

A standard rule is that your monthly housing payment (principal, interest, taxes and insurance) should not take up more than 28% of your income before taxes. This debt-to-income ratio is called the "housing ratio" or "front-end ratio."

You’ll also want to check out the interest-rate environment. Are rates running high or low, and what is the state of your credit score? A higher credit score will translate into a lower interest rate, allowing you to afford more house with your funds.

As you start to zero in on your desired location and home, you need to also consider how much property taxes will be every year. Some people bundle this cost into their monthly mortgage payment, impounding the expense so it is saved and ready to be paid twice a year by their lender. Others save these funds outside of their mortgage and make the payments on their own.

Yep, there’s more. On top of your mortgage and property taxes, you must pay homeowner’s insurance, and set aside funds for repair. There is always something to fix when you own a home­—the unexpected leak, broken appliance or faulty heater.

Having these insights from the start will keep you from shopping for homes outside of your budget. So, do your homework, and contact a lender to get a preapproval letter so that perfect open house doesn’t break your heart.  The letter also tells real estate agents and home sellers that you are serious and prepared, and it puts you in a good place to snag the home of your dreams…within budget of course.

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