Homeownership is the dream of most people and it should be a blessing when you move into your new house. But don’t bite off more than you can chew (to use an old expression) by purchasing a home that is beyond your means to pay for. The question to ask is, how can I decide if I can afford a given home or not?
The Terrible Mistakes Of The Run-up To The 2008 Housing Bubble
In the early days of this century interest rates were very low and new homeowners commonly purchased homes that would otherwise have been beyond their means. They got by with this, for a short time, because their monthly payments were very low. But too many had balloon mortgages which meant that after a few years the bank could raise their interest rate and therefore their monthly payment. There were more than 800,000 home foreclosures in 2008 and the number of homeowners who were in default on their mortgages in 2009 was 20% higher. In retrospect, these poor people bought more home than they could afford. How can you avoid this mistake today?
Get Out The Paper And Pencil
How you can decide if you can afford a home or not is by using simple arithmetic. But first here is a caution. No matter how much you make you might be laid off from work through no fault of your own. The first thing to think of before buying a home is putting aside a rainy day fund. Pay off those credit cards and start putting money in the bank every payday. Ideally, you will have three to six months worth of expenses, including mortgage payments and utilities, in your account before you buy a home. And then there is the down payment for your home. You are more likely to get a mortgage, will have less to pay off, and will get a better interest rate if you put down 10% or better yet 20% of the value of your home.
Once you have credit cards paid off and money in the bank now it is time to do the basic calculation to help you decide if you can afford a home or not. And do not forget to add a little extra to your savings for moving expenses and unexpected home repairs.
Add your take-home pay and that of your spouse. Then take 25% of that (pay x .25) and that is what you can afford to pay monthly on the mortgage and taxes for your new home.
Go to your lender and get pre-approved for a loan. Shop around for the best terms and rates. Then ask your real estate agent to show you homes that fit into your price range.
This way you will not fall in love with a home that you cannot afford. And you will avoid the terrible problems that way too many homeowners experienced a decade ago when they found themselves in the Great Recession with more home than they could afford in the first place.