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The decision to buy a home is huge, but many buyers make a major mistake in their excitement: They buy a property they can't actually afford.
Taking on too much house is problematic in several regards.
First, if you buy a home with mortgage payments you can't keep up with, you risk falling dangerously behind to the point where you lose the property to foreclosure. In a less extreme but almost equally troubling scenario, you might scrounge up enough money to pay your mortgage but fall behind on your remaining bills, racking up unhealthy debt and ruining your credit in the process.
Want a better bet? Know how much of your income you can comfortably afford to spend on housing and use that number to guide your buying decisions.
The 30% rule
As a general rule, your housing costs shouldn't exceed 30% of your take-home income.
Now, there are several interpretations of the words "housing costs." At a minimum, they should include your mortgage payment (including private mortgage insurance, if you're liable for it), property taxes, and homeowners insurance. If you bring home $4,000 a month, the most you can afford to spend on all of those items combined is $1,200.
Therefore, you'll need to research property taxes in the area you're looking to buy in and get some quotes on a homeowner's policy. You should also use an online mortgage calculator to see what mortgage you can afford based on your down payment and estimated taxes and insurance. Having that information on hand before you get too deep into your home search will not only be useful, but could prevent you from making a major mistake.
But there's another school of thought on that 30% rule. Some financial experts feel the 30% threshold should include not only your mortgage payment, property taxes, and insurance, but also predictable maintenance.
There's no easy way to determine what upkeep will cost you, but most homeowners spend 1%–4% of their property's value on maintenance every year. If you're looking at newer homes, you can veer toward the lower end of that range. If you're looking at older properties, stick to the higher end.
If you're looking to buy a $200,000 home and expect to spend 3% of its value on maintenance, that's $6,000 a year, or $500 a month. Going back to our example where your take-home pay is $4,000 a month, that would mean you'd need to subtract $500 from your $1,200 monthly limit, leaving you with a more limited budget for buying a home.
To be clear, the first interpretation of "housing costs" is more common than the second. But if you're able to keep your housing costs, including projected maintenance, to 30% of your income or less, you'll get yourself more financial wiggle room.
You don't want to be house poor
By spending more than 30% of your income on housing, you risk falling behind on costs related to the home or on other essential bills. But even if you can, in theory, spend 40% or 50% of your earnings on housing and still keep up with your bills, think about what that will do to your lifestyle.
Chances are you'll have to give up luxuries you've come to enjoy, like dining out, entertainment, and traveling. And there's a good chance that spending that much on housing will cause you to fall behind on other goals, like saving for retirement or establishing a college fund for your kids.
The takeaway: Don't let your housing costs eat up too much of your income. If you can stick to that 30% threshold or lower, there's a good chance you'll manage to pay your loan without having to stress about other bills or give up things that make you happy.
11% of the mega-wealthy swear by this investment…
The richest in the world have made their fortunes in many ways, but there is one common thread for many of them: They made real estate a core part of their investment strategy. Of all the ways the ultra-rich made their fortunes, real estate outpaced every other method 3 to 1.
If you, too, want to invest like the wealthiest in the world, we have a complete guide on what you need to take your first steps. Take the first step toward building real wealth by getting your free copy today. Simply click here to receive your free guide.