Deciding how much you can afford to spend on your dream home can be a major challenge. For many, buying a home is the largest investment we make in our lives, and we typically borrow through a mortgage to pay for it. If you do not correctly calculate how much home you can afford, you may end up struggling to make the payments, and the financial strain could lead you to sell the home. There is also such a thing as underspending on the home. You may find yourself desiring upgrades down the road that are hard to make on the home you purchased. While the latter scenario is probably less worrisome than the former, having to sell your home and move elsewhere is quite costly. So how do you size the home just right?
FIGURE OUT WHAT YOU VALUE IN A HOME
A lot of people start with a percentage of their gross income to determine the size of monthly payments that they can afford. This is unlikely to lead to an ideal choice. Start instead by making a list of all the things you care about in a house. The first is location, but not in a traditional real-estate-agent sense. What’s important in your daily life? Commuting distance, schools, proximity to friends and family, dining and entertainment, etc. Don’t just think about driving to work. If you drive two or three times a day to take your kids to different places, you probably want to be close to those places. Next, think about the size and features of the home you would like. Make a list of all the things you think are important.
You can then narrow down your search by location and get a sense of the range of prices for the houses that fit your needs. Use this information in your financial planning to maximize the qualities you can afford.
MAKE A BUDGET
Once you have a sense of what you would like, the next step is to make a budget. If you have never done one, it is definitely worth it when buying a house. Start with a simple budget, and then continue to refine it. A budget will allow you to understand how much free cash you can have at the end of each month to make a mortgage payment. The second reason is to create awareness of where your money is going. After you spend on basic necessities, you can probably reduce spending on certain items to increase spending on some of the features of your future home.
For example, you can probably lower your car expenses if you buy a new car less often and if you settle for a less expensive model. It’s all a matter of priorities. The best way to increase the potential of your budget is to align your spending to what you really care about. That’s what budgeting helps you do.
Home ownership has a lot of value in itself, including a sense of security and community. That’s why finding out what is important in a home to you should be the starting point of the decision-making process.
Once you have a range of what you would like and a budget with some flexibility, you should be able to narrow down your search. You may have to revise your list of desirable home features and your budget until you reach a comfortable range.
You may find yourself struggling to stay within your budget after considering competing needs like retirement savings. This can be the case if you live in a high cost area, for example, where you may have to get used to a high housing cost ratio. And it may be OK to have a higher investment in your home if you can plan to use some of that value, later on, to fund your retirement.
As in all investment decisions, your time horizon matters too. A long time horizon allows you to spread the costs of buying and selling a home while you accumulate equity. If you think you may stay in a home less than five years, a smaller, easier to sell home would be a better choice. If you plan to live in the house longer, think about features that you are likely to appreciate over time.
Making a budget is the most useful thing you can do in this process. No financial ratio, real estate agent, or mortgage broker can help you figure out what you may be able to pay every month on your house, but a good budget can. It will also provide peace of mind that you are not taking an unnecessary risk to your overall financial health when buying your dream home. After that, happy home buying!