Whether you are a first-time home buyer or have experience owning real estate, buying a new house is an exciting endeavor.
However, a home is more than just a place to live — it is also an investment and a major financial commitment. So, before you buy, make sure that you know exactly how much you can afford.
It’s a good idea to take a close look at your finances and establish your housing budget before you start looking for homes. In fact, you shouldn’t even apply for pre-approval until you have a solid understanding of home affordability. Otherwise, you may be tempted to borrow as much as the bank will allow, putting a strain on your finances for decades to come.
This guide will help you ensure you’re making smart choices when it comes to the size of your mortgage loan.
Upfront Costs to Consider
When trying to decide how much home you can afford to buy, the first thing to consider is the up-front costs you’ll need to pay.
Your Home Down Payment
The first — and largest — of these costs is your home down payment. Traditionally, mortgage lenders require a 20% down payment in order to grant you a mortgage loan.
So, to buy a $300,000 home, you’d need to pay $60,000 up front. Obviously, saving a substantial sum of money for a down payment can be a challenge, so the amount of money you have available for a down payment will impact how much house you can afford to purchase.
You May be Able to Pay Less Than 20%
While 20% is the recommended down payment, you don’t have to make a down payment this large. Many conventional mortgage lenders allow you to buy a home with as little as 10% down, and some mortgage lenders even permit you to make a down payment as low as 3%.
If you get a loan insured by the government, such as a VA or FHA loan, your down payment can also be very low. With an FHA loan, for example, you could make a down payment as low as 3.5%.
But Should You?
Just because you can buy a home with a low down payment doesn’t mean you should. If you buy a home with a low down payment, your interest rate on the loan will often be higher — and you’ll have to pay extra costs such as fees for private mortgage insurance to protect the lender in case you default.
If the value of your home fluctuates, you could also end up owing more than your home is worth, which is a precarious position to be in because you would not be able to sell your home for enough to pay off the loan if you need to move.
If you want to avoid these added costs and risks, then the amount of money you have saved will directly determine how much money you can afford to spend. For example, if you have only $20,000 saved, don’t try to buy more than a $100,000 home.
See the full guide here: How Much House Can I Afford?