For most, buying a home is the largest purchase they’ll ever make, and it will most likely become the largest portion of their monthly budget as well. There are many programs that have been put into place to make it easier for you to buy a home, but the question you must ask yourself is whether or not you’re truly ready to buy.
I love when I have the opportunity to teach a client about real estate while finding them their first home, but many times, I have felt like telling my client that they’re not ready to purchase a home.
Perhaps that is because I’m rather conservative with finances. I am a tried and true believer of old school finances, which you may be familiar with if you’re a fan of the Dave Ramsey show. Dave Ramsey is a financial expert above all financial experts, who applies common sense and real math to financial equations with the premise that you can become wealthy, self-insured, and be able to live the life you’ve always dreamed about if you simply exercise some patience and hard work.
Those of us who “have to have it now” are part of the majority of people who believe the only way they’ll ever have $500,000.00 in the bank is if they win the lottery. It simply isn’t true.
The simple rule that I follow when I advise clients who are looking to buy a home is to keep their total housing expenses, which include their mortgage payment, taxes, and insurance to about 25% of their take-home pay. This allows you to make room in your monthly budget to do those things that most people say they’ll do, but never get around to doing, like investing for their future, and their family’s future.
If you’re not investing, you’re losing, and there’s no reason in today’s day and age to believe that your payments to “social insecurity” will come back to you by the time you retire. You’re on your own, and you better be doing all you can do to make sure you have taken care of yourself and your family through retirement.
So How Much Home Can You Afford?
Based on the 2009 IRS tax tables, an individual making $40,000.00 per year will owe $6200.00 in taxes. With a smart plan, you’ll be saving that money in an interest bearing money market account rather than withholding it from your paycheck. Why let the government earn interest on your earnings? That leaves you with $33,800 in take home pay. This is your budget. Divide that by 12 and you have an idea of what you have to live on every month. In this scenario, it’s $2816.00. If you follow the 25% rule, your house payment, including taxes and insurance, should be no greater than $704.00 per month.
Another point to note is that you want your mortgage to be no longer than 15 years, and when interest rates are low, you want to fix that rate for the entire loan. So how much home can you afford?
Assuming you’ll be going with an FHA loan with only 3.5% down on a 15-year fixed rate mortgage at approximately 5.3%, the sales price of your home should be in the $90,000 – $95,000.00 range, and no higher. (click here for a list of currently available homes in this price range)
By sticking to the basic rule of 25% of your take-home pay going towards your housing, you should be in great shape to help build your future. Compromise your savings, and you’ll be throwing away your future. If you aren’t able to live by a strong, well-planned budget, and you’re attempting to devote too much of your monthly payment towards your home, you will become house-poor, and you won’t have much to show for it. If this is you, perhaps it’s not the right time for you to buy a house.