How Much House Can I Afford

How much house can I afford? Determining how much you can afford is one of the first steps in the home buying process. So how is it done? In this video, I break down an in-depth strategy for determining just how much you can afford to spend on a home. It all begins with determining what costs you’ll need to pay for. Then comes calculating your monthly housing budget, using your income as a starting point. And finally, we’ll put it all together to determine how much house you can truly afford.

If you spend too much on a house you could end up having to cut back on vacations college funds and retirement savings hello and welcome to practical personal finance where you get the information you need to understand and succeed with money i’m andrew scheer and one of the first steps to purchasing a home is determining what you can afford there are three

Steps to determining how much you can comfortably spend on a home and likewise this video will be divided into three parts that are roughly five minutes each in part one we’ll look at the five different areas your monthly housing budget will cover in part two will determine what your monthly housing budget is using your income as a starting point and finally in

Part three we’ll plug in some numbers and put it all together to get our final answer remember to give this video a thumbs up and if you’re new here then hit that subscribe button you’re about to learn something new about money before we do any calculations or plug in any numbers it’s important to define what your housing budget will cover many people believe

That your monthly housing budget should equal your mortgage payment but if you’re only looking at your mortgage payment i feel like you could be setting yourself up for failure there are a lot of other factors that could impact your housing costs on a monthly basis so in this video i’m going to account for five different expenses you’re likely to encounter they

Are your mortgage payment which includes both principal and interest property taxes homeowners insurance private mortgage insurance and homeowners association fees let’s take a look at what each of these different expenses cover and why it’s important to factor them into your housing costs we’ll start with your mortgage payment this is the amount of money you

Pay your mortgage lender every month it includes both principal and interest payments and it will most likely be the lion’s share of your monthly housing budget your mortgage payment hinges on the term you select and the interest rate you are given the most common term lengths are 15 and 30 years a longer term can mean lower monthly payments making expensive

Properties more affordable on a monthly basis but it can also mean a higher interest rate and a substantially higher amount of total interest paid over the course of the loan the interest rate you’re given will depend on your credit score your total monthly debt payments and the loan term you select a high credit score low monthly debt obligations and a shorter

Loan term will help you secure the lowest possible interest rate and a low interest rate will save you thousands of dollars in interest fees next is property taxes this is the money you’re going to have to pay your local government as a homeowner it goes to pay for local services like public schools parks and police and fire departments property taxes will vary

Based on the location and the assessed value of your home assessed value is the valuation that the local government has decided on for your property typically the assessed value is lower than the market value which is the price you’ll pay for the property property taxes are calculated annually by multiplying your assessed value times your local property tax rate

Local property tax rates can range from 0.5 percent to more than 2 depending on where you live your property taxes might only amount to a couple hundred dollars per month but in certain areas it’s not uncommon to see monthly property tax bills of 500 or even 1 000 third is homeowners insurance this type of insurance will protect you from a wide range of financial

Risks it will pay to replace your stuff if it’s stolen or destroyed for reasons beyond your control it will cover medical expenses for guests who suffer injuries while visiting your home and most importantly it will cover the cost of fixing or rebuilding your home if a disaster strikes the cost for homeowners insurance varies just like property taxes based on

The value and location of your home but prices are relatively consistent across the board fourth is pmi or private mortgage insurance this is an insurance policy that you may need to purchase on behalf of your mortgage lender it covers your lender in case you default on your mortgage and they need to foreclose on your home whether or not you’ll be required to

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Purchase pmi depends on your down payment if your down payment is less than 20 percent of your home’s purchase price you can expect to pay for pmi if your down payment is 20 or more of your home’s purchase price you don’t need to worry about it the annual cost for pmi is calculated by multiplying your total mortgage amount by a certain percentage that percentage

Varies based on a number of factors including your credit score your total monthly debt payments and your actual down payment percentage last but not least is homeowners association or hoa fees if your home is located in an area that’s governed by a homeowners association you can expect to pay hoa fees every month these fees pay for a variety of different services

I’m talking about landscaping trash removal snow plowing and exterior building maintenance sometimes these fees also cover utilities like water gas electric and internet access and quite often they pay for a property management company to manage every aspect i just described and enforce any hoa rules hoa fees can range from 25 or 50 per month all the way up

To seven or eight hundred dollars per month and to be honest i wouldn’t be surprised if they went even higher than that it all depends on where you live and what’s included make sure you check to see if there are any hoa fees on the property you’re looking at so you can factor them into your monthly housing budget there’s an argument for including your monthly

Utilities like water electric gas and internet in your monthly housing budget i can’t argue that these utilities are essential to keeping your household running but i personally choose to omit them because unlike the five expenses i just discussed the money you pay for utilities is not paying for the home itself step two in determining how much you can afford

Is determining your monthly housing budget there’s no shortage of ways to think about how much you should spend on housing every month most methods involve reserving a specific percentage of your monthly income for your housing costs but does that mean your income before or after taxes and what percentage on the conservative end of the spectrum you’ve got people

Like dave ramsey dave will tell you to spend no more than 25 of your income after taxes on housing on the other end of the spectrum you’ve got mortgage companies who want you to spend as much money as possible on housing they might approve you for a monthly mortgage payment of 40 or even 50 percent of your income before taxes and that would definitely put you in a

Bind let’s settle the before tax versus after tax debate first income taxes can vary widely from state to state in the u.s depending on where you live you might be paying 10 state income tax or you might be paying no state income tax at all on top of that everyone’s tax situation is different if you’re single making 100 000 per year you’ll be paying a lot more in

Taxes than a married couple making 100 000 per year combined for those two reasons it’s best to use your after-tax income when determining your housing budget specifically we want to look at how much you take home every month on average after taxes but before any other deductions so before things like retirement contributions health insurance and anything else

Taken out of your paycheck besides taxes we’re going to ignore those other deductions when calculating your monthly housing budget determining your monthly income after taxes is pretty simple you can always calculate it the old-fashioned way by using your paycheck multiplying to get the total for the entire year and dividing by 12 but i prefer to use a paycheck

Calculator if you’re following along head on over to smart assets paycheck calculator i’ll leave a link in the description of this video start by selecting your marital status in the top left corner next enter your city and stay in the location box enter the number of dependents you’ll claim in the dependence box and set the pay frequency to monthly since we

Want to know how much on average you’ll take home every month to be conservative leave the allowances set at 1 for federal state and local now it’s time to enter your salary if you’re paid hourly this will take just a little bit of math all you need to do is multiply your hourly wage times the average number of hours per week that you work times 52 since there

Are 52 weeks in a year as an example let’s say i make 24 dollars per hour and i work 40 hours per week i multiply 24 per hour times 40 hours per week times 52 weeks per year and i get 49 920 per year that’s the amount i’ll use for my salary if you’re married it’s important to add both your salary and your spouse’s salary together to get an accurate estimate of


Your household income for example let’s say i make forty five thousand dollars per year and my wife makes fifty seven thousand dollars per year add those two together and i get one hundred two thousand dollars per year combined that’s the amount i’m going to put in the salary field up at the top and as you can see my estimated monthly take-home pay is 6544.

This should be a good estimate of my income after taxes but before any other deductions next i need to determine what percentage of my income i can comfortably dedicate to my housing costs this is where things get subjective and i want to do a little thought experiment earlier i mentioned how dave ramsey says you should limit your housing budget to just 25 of

Your take-home pay the reason dave suggests 25 is so that you’ll have enough flexibility in your budget to save for retirement and put money in your kids college fund and get your mortgage paid off early i believe dave is in the right ballpark but i’m also cognizant of the fact that 25 is just not realistic in certain areas if you live in an area where housing

Costs are above average there’s a good chance you have an above average income as well in an area like that things like child care and entertainment might cost a little bit more but a majority of other mainstay budget line items like insurance utilities and groceries probably cost about the same as they would anywhere else if you have that higher income those

Monthly expenses represent a smaller percentage of your monthly spending and so if you live in an area where housing costs are above average and you have an above average income i think you’re free to spend a little bit more on housing all that being said i believe most people are safe spending 30 of their income after taxes on housing if i had a lower household

Income especially less than sixty thousand dollars per year i think it’s prudent to stick to that twenty five percent recommendation but if i had a high household income say over one hundred eighty thousand dollars per year and a conservative lifestyle i’d be comfortable spending as much as 35 percent of my monthly income after taxes on housing your income and

Your lifestyle choices are unique to you and therefore the percentage you elect to spend on housing is a personal decision in my earlier example my annual household income was 102 000 my income isn’t that low nor is it extraordinarily high so i’ll go with 30 percent when i multiply my monthly take-home pay by thirty percent i get one thousand nine hundred sixty

Three dollars and twenty cents that’s my monthly housing budget now that i know my monthly housing budget and what it’s going to be paying for it’s time to put it all together and determine how much house i can afford this is going to involve some educated guesswork i may need to go back and adjust my estimates as i go let’s start off with my mortgage payment

Since this will be the most expensive part of my housing budget a good place to start is to assume that my mortgage payment will account for 80 percent of my monthly housing expenses this leaves some room for property taxes homeowners insurance pmi and hoa fees so i’ll start by multiplying my total monthly housing budget of one thousand nine hundred sixty three

Dollars and twenty cents by eighty percent and i get one thousand five hundred seventy dollars and fifty six cents next i’ll head on over to the google mortgage calculator link is in the description i select the maximum loan tab at the top and enter that number i just calculated 1570.56 once i’ve done that i need to determine what the market looks like for mortgage

Interest rates right now the website is a great resource for this purpose link is in the description remember that the interest rate you’re given is determined by your unique financial situation as well as the term you select so i like to add a little bit of a cushion to the current interest rates by adding 0.3 percent to the advertised rate this

Helps account for the fact that i might not be given the lowest rate available i prefer a 15-year term and for that term it looks like the interest rates are right around 2.5 percent as of this recording if i add that 0.3 cushion i get an interest rate of 2.8 back in the mortgage calculator i enter the interest rate 2.8 percent the 15-year term and i get a maximum

Loan of about 230 000. let’s say i have a down payment of forty thousand dollars saved up if i add my maximum loan amount to that down payment i’ll get a ballpark estimate of how much house i can afford so i’ll add forty thousand dollars to 230 thousand dollars and the result is 270 000 this means that i should generally be looking at homes that are at most

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Around 270 000 but before i make any offers i need to make sure that all of my other expenses still fit into my overall monthly housing budget if i were purchasing a two hundred seventy thousand dollar home the forty thousand dollars i have saved only gives me about fifteen percent for a down payment because my down payment is less than 20 percent i’ll need to

Pay for pmi if you recall from earlier pmi is calculated annually by multiplying the amount of my mortgage by a certain percentage that percentage will depend on your credit score your total monthly debt payments and your down payment amount a conservative estimate for what this percentage might be is zero point nine percent so if i multiply two hundred thirty

Thousand dollars by zero point nine percent i get two thousand seventy dollars for my annual pmi amount divide that by twelve and i wind up with one hundred seventy two dollars and fifty cents per month for pmi next are hoa fees let’s say the property i’m looking at has a homeowner’s association and the fee is 80 per month add that to the bill then there’s

Homeowners insurance it’s difficult to know what homeowner’s insurance will cost without getting a quote from an insurance agent about a specific property but a safe conservative estimate is 100 per month so for the purposes of this video that’s the amount i’ll set aside for homeowners insurance and last but not least i need to determine what my property taxes

Will cost to do this i’ll head back to this time to their property tax calculator link is in the description once i’m there i just need to enter my zip code and an estimate of the assessed value of the home as an example let’s say i’m looking at a property in the zip code 22032 and the assessed value is 250 000 the calculator gives me a result

Of two thousand four hundred ninety eight dollars to find out what that will cost me monthly i divide by twelve and i get two hundred eight dollars and seventeen cents per month the assessed value of a home is generally a little bit less than the market value and you should be able to find the assessed value in the listing but if you aren’t sure what it will be

Just go with the purchase price of the home for a conservative estimate of your property tax bill so i’ve got my monthly mortgage payment which is one thousand five hundred seventy dollars and fifty six cents my property tax bill of two hundred eight dollars and seventeen cents my homeowner’s insurance for one hundred dollars my hoa fees for eighty dollars and one

Hundred seventy two dollars and fifty cents for pmi add all those up and i get two thousand one hundred thirty one dollars and twenty three cents that puts me over budget by about 168 dollars i’d be at about 32.5 percent of my monthly take-home pay i’m not over by that much so if i really like the property i’d probably just go for it after all once i’ve got 20

Percent equity and pmi goes away i’ll be right on target but if i really want to stick to my budget and keep it under 30 percent i’d have to make some changes to the formula i could look for a less expensive home to cut down on my property taxes i could try for a longer term on my mortgage maybe 20 years instead of 15 to lower my mortgage payment or i could save

Up a little bit more of a down payment to avoid having to pay pmi all of these are possible options for making my budget work but it will definitely take some trial and error to make that happen if you’d like to do some of the calculations i did in this video i created a spreadsheet that you can download that does all the heavy lifting for you it’ll take care of

Calculating your salary if you’re an hourly worker your monthly housing budget your property tax and more you can access the spreadsheet by clicking on the link in the description once you’ve got it open in google sheets go to the file menu and select make a copy this will save a copy to your google drive that you can edit so how much house can you afford would

You change any of my recommendations let me know in the comments if you enjoyed this video you’ll love my video on how to calculate compound interest you can watch that one by clicking right here and if you’re not already a ppf subscriber then what are you waiting for click right here thanks so much for watching i’m andrew scheer and i’ll see you next time

Transcribed from video
How Much House Can I Afford By Practical Personal Finance