How Much House Can You Actually Afford? No Really.

As I’ve said in earlier articles, I am a huge proponent of owning real estate. A lot of my financial success is attributed to real estate. It is no secret that it is by far the most common wealth building tool out there. It allows you to build wealth while providing the added utility of being able to live in it.

When it comes to home buying, one of the most important aspect is figuring out how much house you can afford. Most information you find online will tell you to get pre-approved through a bank or lender to figure out the price tag of the house you can afford. As always, I am going to give you slightly different advice.

Getting the bank preapproval is just one step. The more important step is to look at your financial health and budget to figure out what you think you can afford to swing every month in terms of a mortgage payment.

If you are a first time home buyer, home ownership will bring many changes beyond what you are used to. In addition to the principal and interest on your loan, you need to account for the below expenses.

1. Property Taxes (Usually added to your mortgage payment)
2. Homeowners Insurance (Also added to your mortgage payment)
3. Homeowners Association Dues
4. Water Bill
5. Garbage Bill
6. Sewer Bills
7. Sewer Capacity Bill (If you are buying a new construction house)
8. Any additional home purchasing costs you decide to roll in to you loan add to your payment
9. Private Mortgage Insurance (PMI) – If you do not put a 20% down payment

All of these expenses in addition to the bills that you are already paying in your apartment, like gas, electric and internet.

You also need to account for the fact that as your home appreciates in value every year, so do your property taxes. That means, your mortgage payment will most likely increase every year as your house appreciates in value so you need to plan for it.

My biggest problem with simply going by what your bank will preapprove for is quite simple. The bank doesn’t care about your savings. They look at your credit rating, evaluate the risk of giving you a loan, use that risk to calculate your mortgage rate, Look at how much money you have left over after you pay all your existing debts, and then calculate how much you can pay every month in mortgage. Extrapolate that into a total loan amount and give you a number.

If the bank approves you for a house up to $400,000 and you buy a $400,000 house, you are doing yourself a huge disservice. You need to remove what you want to save every month from the bank’s calculation equation and then determine what you can afford. I wrote in my last post that it is ok to stretch the envelope a little when it comes to buying your home, but that stretch is on top of YOUR affordability calculation. Not the bank’s. Below is the sample breakdown of real home ownership costs on a $425,000 house in a Seattle area suburb.

Notice I did not include electricity or natural gas because you are likely paying for those in your apartment too. However, those will go up when you move to a house also. So essentially, if you cannot spend $2645 for your home and still manage to save a decent amount of your take home paycheck, you need to lower your purchase price, or increase your down payment (save more before you buy).

PS. One of my biggest pet peeve expenses is paying for Home Owners Association Dues. I never feel like I get my money’s worth. I cannot believe there are buildings and condo complexes that charge over $1000 a month in HOA dues.

In my last post, I promised to share the two categories on my own monthly budget that command double digit percentages of our take home pay. Those categories are –

1. Home – Usually 40-45%. As I said in my last post, we splurge on our house and we can do this because we don’t really have any other debt. (Experts recommend this number to be between 30-35%). This was also a calculated strategy on my part because a more expensive house allows me to enjoy the appreciation on higher priced asset over time. The second category will tell you however, that I did not do it at the expense of my savings goals.
2. Savings – Usually about 30%. This keeps the investing and compounding wheel rolling to eventually give us the ability to retire early.

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