Buying a Home: How much home can I afford?

21 Min.
  1. 2:38Welcome
  1. 2:34What do I need to save for?
    • Introduction
    • Down Payment
    • Closing Costs
    • Escrow
  2. 3:46I'm pre-approved - now what?
  3. 2:25How much will I pay Monthly
  4. 5:42How much can I afford
  5. 3:01Reflection & Taking Action

Congrats! You've made the Grownup decision to buy your own home. What’s next? Before diving into online searches and attending open houses, you’ll need to determine how much you can afford to put down and how much mortgage you can really handle. We’ll discuss getting your finances in order so you can become a homeowner, whether you’re considering a luxury condo or charming fixer-upper.

Before beginning this course, it's helpful (though not necessary) to have some relevant financial information handy, like how much you’ve already saved toward a downpayment, if any. Pull together any research you’ve already done on the price range of houses that interest you. (Don’t panic; we’ll help you do this!). Also, we’ll be using our home affordability calculator, so feel free to open it in another tab to peruse when we get to that activity.

What you'll learn

  • Learn the true costs of home ownership.
  • Determine how much house you can afford with our home affordability calculator.
  • Discover tips and resources to help you reach your homebuying goal.

Society of Grownups Resources

Trusted Resources

  • Check out the US Department of Housing and Urban Development to research state and local housing programs throughout the country.
  • Learn more about FHA loans which are insured mortgages offered by the U.S. Department of Housing and Urban Development.
  • Determine if you qualify for a USDA loan, available to people with low to moderate incomes who want to purchase a home in a rural area.
  • If you’re a veteran, on active duty, or in the reserves, you may qualify for a government-guaranteed Veterans Administration loan.
  • Use CreditKarma to check your credit score and simulate different scenarios that could affect your credit score.
  • Annual Credit Report offers free credit reports from all three credit reporting bureaus on a yearly basis.

Welcome to Society of Grownups and the class-- Buying a Home: How Much Can I Afford? My name is Rachel Rabinovich and I'm a certified financial planner professional, one of the team

This class assumes you've already made the decision to buy a home. That's really exciting, but it can be a little scary too. And you may be thinking, now what? How do you get started, and how do you decide what's right for you?

My goal is to help you answer those questions. We'll do that by talking about the true costs of homeownership, how to figure out for yourself how much house you can afford by walking you through our home affordability calculator, and some tips and resources to help you reach your goal of buying a home.

I would love for you to stick with me for the whole class, but please feel free to explore the chapters that you feel are most applicable to your situation.

You probably have priorities that you would like to have in a home, such as a backyard for the dog to run around in, a front porch to drink coffee in the morning, or a great neighborhood in which to bring up children. For me, a house with a fenced in backyard and walking distance to stores, schools, and the train were my priorities.As you begin the process of buying a home, enjoy taking some time to think about what's important to you. This can be one of the more fulfilling parts of the home buying journey.

People also buy a home for many different reasons, and we've heard some great ones, such as the ability to customize your home, to have a stable monthly housing payment that you can budget for, and the pride of ownership.

While it's really important to think about your priorities for a home, it's equally important to be aware of the financial aspects to know where you're starting from. Let's take a moment to think about this. The screen will pause, and I'd like you to write down how much you have saved so far-- if you've already started saving. If you haven't started yet, write down how much you're planning to save or how much you think you need to save for a down payment. Being able to articulate where you are will help you figure out how much you still need to save. Once you've taken as much time as you need, feel free to jump back in and unpause the screen.

OK, now that you've had a chance to jot down your numbers, let's get started. We're going to talk about the number you wrote down later in class as we think about how much you should plan to have for a down payment and other upfront costs. Having a sense of where you're starting from and thinking about what your priorities are will help guide you to making decisions about your future home while keeping your values in mind.

We'll be talking a lot about the ongoing costs of home ownership and how to think about the right amount for you, but everyone knows there will be a large initial investment, too. This tends to be the first step in thinking about how much house you want to buy, and relates to the numbers you were just thinking about.

Just about every home purchase normally requires some sort of down payment, but how much are you comfortable paying upfront? Remember, you probably don't want to drain your bank account for a down payment, because there are a lot of other unforeseen expenses that can pop up along the way. Typically, buyers will put down anywhere from 3.5% to 20%. Conventional loans require at least 5% down, but there are programs that may be available if you have trouble reaching that amount. Keep in mind, anything less than 20% of the purchase price will mean that your mortgage payment will be higher, and you will likely need to pay private mortgage insurance for a period of time. We'll talk more about this in a few minutes when we discuss ongoing payments.

But a down payment isn't the only thing you need to save for. You will also need to pay closing costs before you can move into your new home. Closing costs are the fees included in the final steps of the home buying process and can run between 2% and 5% of the price of your home, so it's important to keep this in mind as you are setting your savings goals. They can include costs associated with such things as pulling your credit report, attorney's fees, and the home inspection. Closing costs can also include points, which is a fee you can pay in exchange for lower interest rate.

Finally, you'll need to make sure that you have saved some money for escrow. You might be wondering what that is. Escrow is a fancy word for a security deposit. When you get a mortgage, your lender is typically going to need the first year of homeowner's insurance to be paid, which averages around $1,000 a year, but can vary greatly depending on where you live and the cost of the home, plus three to five months of property taxes, which also fluctuate depending on where you live. The bank will hold this money in escrow for you. An escrow account can be structured in different ways, depending on the lender and your down payment, but is often included in the closing costs.

Fortunately, paying some of your upfront costs, like prepaid interest, real estate taxes, and points, may save you money on your taxes. I would recommend that you speak to a tax professional about this.

Before you start looking for a home, it's common practice to get a pre-approval from a mortgage lender that will approve you for a specific amount. Your actual pre-approval amount is based on some standard calculations used by a mortgage lender, which typically factors in your credit report, employment, and financial information. But let's be honest here. They don't actually know you and your financial situation. Just because you're pre-approved for a certain mortgage amount doesn't mean you actually have to use it. It's like getting a credit card with a high credit limit. Just because it's there doesn't mean it's a good idea to max it out. When I bought my home it was very tempting to go for the house at the top of our pre-approved amount. We didn't, though, and I was really glad because it would have left our budget with no wiggle room.

So why would you want to avoid buying at the top of your budget or pre-approval amount?

Well, the main reason we didn't was to avoid feeling house poor. Having a big beautiful home is great, but if you are stretched too thin you're not going to have the cash in your budget for the other things you love or the other goals you're working towards. In my case, that meant saving for my daughter's education, for my retirement, and being able to still enjoy things like eating out and updating our house.

Often going from an apartment to a house means that you may find yourself suddenly needing more furniture and supplies. You may want to buy a new dining room set, or curtains and blinds. Having a backyard and a deck are great, but now you'll need a lawnmower, and you may want a grill and patio furniture, too. If your new home is older like mine was, walls may need painting and rugs may need to be pulled up. Consider how important these things are for you and how they fit into your budget.

Another reason not to buy at the top of your budget is that unlike a fixed mortgage payment, your homeowner's insurance and property taxes are likely to go up for a number of reasons. Mostly, insurance and tax rates are based on your home's value which could increase over time. It's a good problem to have, I suppose, but you may want to leave yourself some wiggle room.

Not only do you need to consider your budget and increasing taxes and insurance, but you are also bound to run into some unpredictable expenses. There is no landlord to call when the furnace breaks or the roof leaks. You're on the hook. Maintenance and repairs are unpredictable, so you want to have cash on hand in case something comes up.

These are the wildcards of home ownership costs. They will vary greatly depending on the property, and you can plan to spend 1% to 4% of the value of your home each year on this.

If you can't necessarily rely on the pre-approval amount to guide you in figuring out how much house you can afford, then what? Well, get intimate with your budget. What are you comfortable spending towards your housing expense on a monthly basis? If you aren't sure, take your current rent payment-- if you rent-- and add any monthly amount you are currently saving towards owning a home. This will give you a better idea of what you can afford for a mortgage payment. Also, would you be willing to re-evaluate your spending plan to make it work? Maybe you'll find that hosting a movie night rather than going out for drinks every weekend would be a fun trade off so you can save more money. Sit down and take a look at how you've been spending and think about your own priorities. Check out some budgeting apps like Mint or Level Money, or create a spreadsheet to track your expenses and find places to save.

So in summary, think carefully before you dive into a mortgage at the top of your pre-approval amount. Remember to still allow for some cushion in case an unexpected expense or repair pops up. Also think about what lifestyle changes you aren't willing to make, and the other goals you may want to save for. By not taking on a mortgage at the top of my range, I was still able to focus on my other priorities.

Part of figuring out how much house you can afford is understanding what goes into your monthly payment. I know for me it was eye opening to learn what else I would be responsible for besides the principal and interest payments, and that I would have to work these into my budget.

When you make mortgage payments to the lender to pay back your debt, you will be paying a portion of principal, which is the original loan amount, and a portion of interest. This is the rate the lender charges you to borrow their money. While you may have known that already, you might not know that when you itemize your taxes, you can deduct the interest payment from your gross income, which could help save you money on your taxes. You can also deduct your property taxes from your income for the year.

Private mortgage insurance, often called PMI, will also need to be considered if your down payment is less than 20% of the purchase price. This is to protect the mortgage lender in the event that you are unable to make your mortgage payments. PMI typically costs between half to 1% of the entire loan amount on a yearly basis, but it depends on your credit and the amount you have financed. You will generally be paying for this until you reach 20% equity in the home and will be included in your mortgage payment.

You could also pay property taxes and homeowner's insurance in your monthly mortgage bill. The lender will then pay these on your behalf from the escrow account that we talked about earlier. Not all lenders follow this practice, however, and you may be required to pay taxes and insurance directly, so be sure you understand your lender's policies. Remember, insurance is usually less than half a percent of your home's value. Similar to mortgage interest, your property taxes are deductible as well.

If you're buying a condo, you will most likely be responsible for Homeowners Association or HOA fees. Depending on the size of your condo association, it will generally go towards covering some expenses such as common area electric, master insurance, and sewer and water. In some bigger associations, it could also be used to cover maintenance, like landscaping and snow removal. HOA fees are usually paid directly to your association.

Let's talk more about how you can estimate how much house you can afford while taking all these factors into consideration.

As I mentioned earlier, we're going to take a look at Society of Grownup's Home Affordability Calculator. In this exercise, I will walk you through a sample scenario, but I encourage you to pull up the calculator on your computer and use your own information. That way you can start to see how much home you could potentially afford. And you can find it on our website at societyofgrownups.com. Please feel free to pause the class at any time during the activity to enter your own information. When we're done, we'll also look at how a different down payment amount will affect how much house you can afford.

First, let's look at monthly housing expenses. Think about what you're currently paying for housing costs and how much you're saving each month. As we talked about earlier, think about how much you're comfortable spending each month. For example, your rent is $1,000 and you're saving 500 each month toward your down payment. This means that you're accustomed to $1,500 going towards housing already. For this exercise, we're looking specifically at the total amount, including principal and interest, insurance, property taxes, PMI, and HOA fees. This figure will not include maintenance or repair costs.

What is your gross annual income? In other words, what do you and your partner-- if buying together-- make before taxes? In this scenario, let's assume your household income is $60,000.

What are the minimum monthly payments on all your debts? Tally up your credit cards, student loans, auto loans, mortgage, and HOA fees if you already own another property, plus any child support and alimony you may be paying. Here, let's assume you don't have any outstanding debts. This, along with your income, determines your debt to income ratio. I know, I said ratio, but basically how much your monthly debt payments compare to your monthly pretax income. Lenders like to see all debts, including housing debt, to equal less than 36% of your income.

Remember when I asked you to jot down how much you've saved or are planning to save? Use that number now to gauge how much you would like to have for a down payment. While I don't want you to forget about those closing costs and upfront escrow expenses that we talked about, this entry on the tool only accounts for your down payment. In this example, let's say that you have saved $10,000 for the down payment.

Your interest rate will depend on outside factors such as your credit, the terms of the loan, and the interest rate environment when you buy, and the type of mortgage you're getting. Currently, standard rates for those with good credit, a credit score above 700, could be around 4%, which is what we will use in our example. A score of 760 and above will usually secure the best or lowest rate.

Next, let's look at the terms of your loan. How long will your mortgage last? Most loans are for 30 years, which is what we are using in this example.

Property tax rates vary depending on what city or town you're buying in, and it can change year over year based on the city or town's budget. In our case, we will use the example of 1.2% of the assessed value, which is the current rate in Boston, Massachusetts, where we are located.

The cost of your homeowner's insurance will vary based on the type of property and the particular elements of your policy. Remember, the national average usually runs less than half a percent, depending on different factors like where you live, crime, storms, and other risks. For a property valued at 225,000, that would be about $800, which is the example we're using.

Homeowners association or condo fees will likely be required if you are buying a condo. In this case, let's assume you're buying a single family home so HOA fees don't apply.

According to the calculator, it looks like you might afford a home costing almost $225,000. On the right side of the screen, you can see a pie chart with a breakdown of your monthly housing payments, which total $1,491, which is close to what we indicated as your monthly housing expense. Notice that since the down payment is less than 20% you would be responsible for paying PMI insurance.

Let's see what happens if we increase the down payment to $60,000. Not only can you now possibly afford a house valued at nearly 300,000, you've also increased your down payment to 20%. This means you won't be responsible for private mortgage insurance.

If you followed along using your own numbers, how did you do with your affordability estimate? Was it higher or lower than you expected? You can see that a couple of the factors we talked about act as large levers in determining affordability. Mostly, the monthly housing expense and the down payment amount.

Remember, this exercise was just a simple estimation. Your actual pre-approval amount could vary based on your credit report, employment, and financial information.

Now that we've looked at the Home Buying Calculator and helped you to understand your personal situation a little, let's talk about some ways to get to that all-important down payment and being ready to buy your home.

Everyone is different, and a conventional loan may not be the best fit for you. For those who can't save 5% to 20% for a down payment, there are a few different options for borrowers, including local and state resources through the Department of Housing and Urban Development. HUD also offers FHA loans, which have a popular first time buyer's program. In addition, there are programs available for people in rural areas and for veterans. Check out the resources section for more information and helpful links.

There are a few things you can do to get yourself ready to buy that house or condo while you're continuing to save. You want to be able to put yourself in the strongest financial position possible when it's time to apply for a mortgage.

Set a monthly savings goal. This will help you to do two things. It will build your down payment and help you practice living with potentially higher housing costs. Remember when we talked about looking at your current budget and deciding what monthly housing costs would be right for you? Now would be a great time to track your expenses to see where you can find some extra savings. Maybe you're currently paying 1,500 in rent, but think you'd like to buy a home whose ongoing cost will be more like 2,000 each month. So try starting now and see if you can save that extra 500 each month. Doing this will help you get used to having less spending money, and you'll be building that down payment along the way.

Check your credit report. Is all the information accurate? Do you have any unpaid bills or errors you can take care of? A strong credit report and credit score will help you get the best possible financing when the time comes. Check your credit score at creditkarma.com, or you can get a full credit report from all three major credit bureaus at annualcreditreport.com for free once a year. Start monitoring your credit as early as you can.

Avoid opening new lines of credit, including credit cards or taking out an auto loan, for about a year before applying for a mortgage. Too much activity can negatively impact your credit score and may give the appearance of financial distress to lenders.

Get your documents together. I know it's daunting, but you'll want to be organized. Think pay stubs, bank account statements, W2's, tax returns for the last two years, statements from current loans and credit lines, and the names and addresses of your landlords for the past couple of years. Woo, I know that's a lot, but you'll need to reference this information when you apply for a loan.

And finally, crunch the numbers. Continue to use Society of Grownups Home Affordability Calculator to start thinking about how much house you can afford. If you haven't started looking yet, check out sites like Zillow or Trulia to get a better sense of home prices in the neighborhoods you're interested in.

I hope this class has been useful in helping you learn about the true cost of home ownership, figuring out for yourself how much house you can afford, and some tips and resources for getting you into your new home.

Please visit our blog on Society Of Grownups Website, and for more information about creating a spending plan or strengthening your credit score, check out our other online classes, Spending Plans, and Can I Have Your Number? Additionally, check out the resources section for some helpful links, which we talked about. I want to thank you all for taking the time to participate in our class.

Rachel Rabinovich
Rachel Rabinovich
CERTIFIED FINANCIAL PLANNER™

Financial planning can be a positive and powerful tool for changing lives.