Marc A. Hebert's Money $ense: Factors to consider when deciding how much house to buyBy MARK A. HEBERT
May 27. 2017 10:09PM
Buying a home is an exciting, but scary, undertaking. It is usually one of the largest investments an individual will make. There are a lot of factors to consider. In order to know how much home you can truly afford, you will need to take a look at your lifestyle and your income and how you spend it.
Most people will need to take out a mortgage to pay for their home. In these cases, how much home you can afford really is a function of how much of a mortgage payment you can handle. In the simplest terms, take your monthly income and subtract all your nonhousing-related expenses. This is the gross amount you will have available to spend on housing before other adjustments.
You also will need to take into account other housing-related costs. These depend on what kind of a house you buy and its location. A house in the southern part of the country will need to be heated less and air conditioned more. Another home might need more in repair costs down the road. If you own a condo, there are the fees and assessments to consider.
Other examples of housing costs include rubbish removal, gas heating, water, lawn care, homeowner's insurance, property taxes and sewer charges. Check whether you need to have flood or earthquake insurance as well.
Make a list of these expenses and research the costs involved. Once you have done this, take the total of the expenses and subtract it from the amount you had available to spend on housing. This will give you some idea of the mortgage payment you can afford.
The next step you might consider is to prequalify or obtain preapproval for your mortgage. Shop various lenders. Compare their mortgage rates and terms. That will give you an idea of the purchase price of the home you can afford.
A question that usually comes up is what is the difference between preapproval and prequalifying for a mortgage?
To prequalify, the lender will calculate certain ratios they deem appropriate. This will provide the lender an estimate of just how much you are able to borrow.
When you are seeking preapproval, the lender will actually go through the underwriting process and verify the items that you have included on the application. Upon preapproval, you will get a letter stating that you will have a mortgage of a certain amount. There are still conditions, for example, the property must appraise at a certain level. Getting preapproval gives a buyer more credibility because the preapproval letter lets the seller know you will qualify for the mortgage.
One important point here is that the lender is telling you how much home you can get a mortgage for. This isn't the same as telling you what you can afford. Go back to your calculation of what you can spend and see how it compares. Remember your actual mortgage will depend on your interest rate and the length of the mortgage term.
One final step before marking the purchase is to review your budget and future plans. Can you reduce your other expense? This could free up money for housing. Do you have a rainy day fund because you never know when something unexpected could happen, like a furnace in need of repair. Do you have to buy a new car soon? Do you have a child on the way? Are you saving enough for retirement and potential children's education? The goal is to not have a mortgage payment that is beyond your means and allows you to accomplish all of your lifetime financial goals.
Marc A. Hebert, M.S., CFP, is a senior member and president of the wealth management and financial planning firm The Harbor Group of Bedford. Email questions to Marc at firstname.lastname@example.org. Your question and his response might appear in a future column.