Written By Jim Cook – Loan Officer in Plymouth
Home ownership is an important goal for many Americans. It offers the opportunity to build wealth, connect to community, and provide stable housing for one’s family. Yet a number of those who aspire to own a home can struggle to understand housing costs and how those costs will work with their incomes and budgets. It is important to understand how to budget for the funds needed at the time of your purchase, as well as property taxes and insurance.
Because most home buyers finance the purchase of their home, anticipate your monthly housing cost will include a principal and interest payment, mortgage insurance if required, property tax, homeowner’s insurance premiums, and any homeowner’s association fees if applicable your property. Use your real estate and mortgage professionals as a resource and take advantage of online tools to establish a working range for home prices, property taxes, insurance premiums, and rates for loan programs suited to your needs.
Other expenses to consider when budgeting include installment loan payments, credit card payments, and projected payments for any deferred credit such as education loans and any court-mandated obligations such as child support or alimony.
With these figures in mind, you’re able to establish your total projected monthly obligations, which can be compared to your monthly income and your other financial goals for savings, projects, and discretionary items like travel and entertainment. Your mortgage lender will apply a formula to establish the largest monthly payment you qualify for, but you may want to look in a lower limit based on your complete financial picture.
Mortgage lenders rely on a figure known as debt-to-income (DTI) ratio. This is the relationship between your gross monthly income and your projected total monthly obligations. While some programs may allow a higher limit, 45% is a useful, conservative limit to base your calculations on.
For example, a buyer with $8,000 monthly gross income monthly obligations would be limited to $3,600. If other existing credit obligations totaled $1,000, the maximum housing expense would be $2,600.
Many personal finance professionals endorse the use of the “50/30/20” Budgeting Rule. This rule suggests that your budget should be established based on your after-tax or “take-home” pay and should be applied as follows: 50% toward mandatory expenses, which includes housing, utilities, insurance, basic groceries, transportation, minimum debt repayments, and childcare costs; 30% toward “wants” and discretionary spending; 20% toward savings or additional debt repayment.
In the example above, where the buyer earning $8,000/month receives $6,000 after taxes, this formula allows $3,000 for housing and other mandatory expenses. If other mandatory items total $1,000, the maximum mortgage payment following this rule would be $2,000 monthly, a much more conservative housing budget.
Engage qualified professionals early in the process and begin doing the work of establishing your budget. Consider how important homeownership is to you when making all other financial decisions.
Ultimately what is most important is that you, the home buyer, have done the work to establish a budget that fits your goals and needs. Your lender can tell you what is possible, but you must establish a budget and purchase price range which not only allows you to become a homeowner, but also allows you to remain a successful homeowner for years to come.