As a prospective home buyer, you should create a thorough budget before starting your search, to avoid overbuying and winding up house poor. To begin, start by tallying your total gross income. How much do you make now? Do you anticipate that number changing anytime soon? Your future earning potential can impact how much house you buy, especially if you’re taking on a 15- or 30-year mortgage.
Your budget should also include a down payment. How much money do you have available to put down? What percentage of the loan will you need? Requirements vary by loan type, from 3.5 percent for an FHA loan to 20 percent for a conventional loan. Your down payment can impact what kind of loan you receive, future monthly payments and how much you have left in savings for future use.
Explore financing options and find out how you can pre-qualify with your preferred lender. The initial phase of the lending process can be completed virtually, but with mortgage rates at historical lows and a tremendous demand for refinancing, lenders are overwhelmed, and the process may take longer than usual. Once you find your dream home, you should expect the closing process to take extra time. There are also likely to be more clauses in contracts stipulating certain exemptions because of the coronavirus pandemic.
If you pre-qualify with a higher amount than you initially planned, don’t start looking at higher-priced homes just yet. It may be tempting to push your borrowing to the limit; however, you must consider more than the mortgage payment when deciding how much house you can afford.
Particularly now, you should be more conservative in your budget and consider homes at lower price points. Home buyers should always stay within an appropriate range for their expenses, and the current economy only underscores the importance of budgeting for unforeseen circumstances.
The costs of owning a home
The standard rule of thumb is that homeowners should allocate no more than 30 percent of their gross income to monthly payments. To avoid stretching yourself too thin, that 30 percent should include expenses related to maintaining and running your home, including homeowner’s insurance, HOA fees, maintenance, utilities, and services such as trash and Internet.
Don’t overlook commuting costs, which can be significant if you’re moving farther away from work, school or other places you expect to frequent. And while many people are working from home right now, commuting costs will eventually impact your budget. Tolls, gas and other commuting expenses can push your budget over the 30 percent allocation and leave less disposable income.
Unforeseen expenses — like a dead appliance or a malfunctioning water heater — can also eat up available funds. Create an emergency fund with upward of eight to 12 months’ worth of household expenses designated for covering the cost of replacing or repairing essential items in your home without having to rely on credit cards to pay for them.
Sometimes your purchase will include a home warranty, which can be a budget-saver if something breaks within the warranty period. My home’s heating system went out two months after I purchased the home, and the quote to replace the system was $5,000. Luckily, the home had a warranty, and we got the system replaced for $75, the cost of the warranty’s deductible.
If you’re upsizing, you’ll gain not only more space but also additional costs, from mortgage and taxes to utilities and maintenance. A smart planning method is to apply the percentage of increase in space to your budget. For example, if the home you are buying is 15 percent larger than your current space, increase your anticipated costs in the new home by the same percentage.
Plan for the long-term
Whether you’re buying a starter house or forever home, always consider the long-term picture. If you have difficulty keeping up with the monthly payments, you may skimp on maintenance, which could create more issues or reduce your property’s value when it’s time to sell.
Shifting tax laws can be difficult to plan for but can affect your future costs. Tax law changes in 2018 lowered the interest deductibility threshold for new loans to $750,000. However, it’s shortsighted to use current tax laws as a judge for whether you buy a home today; laws are likely to change, especially if you plan to own the home for a long time.
If you’re not sure if buying a home fits into your plan, start by talking with some financial advisers. They can help you see the long-term picture and give you the confidence to make the right choice.
David Mount is a director with the Wise Investor Group at Robert W. Baird & Co. in Reston, Va. Baird does not provide tax, legal or real estate advice and does not provide or service mortgages.