Dave Ramsey's 5 Steps for Figuring Out How Much Home You Should Buy

Don't buy a home before reading this advice. 

When you buy a house, you are making a major financial commitment. You want to make sure your mortgage payment and other housing costs aren't so high that you end up house poor and can't afford to cover other costs. And you don't want to struggle continually to make your mortgage payments, as this will just create a ton of stress.

The good news is, you can avoid all that by making smart decisions about how much house you can afford to buy. Finance expert Dave Ramsey has a process for estimating how much you can -- and should -- pay for a property and it includes taking these five key steps. 

1. Determine how much you can spend

According to the Ramsey Solutions blog, the first step you should take when determining how much house you can afford is to calculate 25% of your take-home pay. So, for example, if your after-tax earnings are $4,000 per month, 25% of that amount would be $1,000.

Doing this calculation is important because you do not want to devote more than this percentage of your income to paying for housing expenses. "Stick to that number and you’ll have plenty of room in your budget to tackle other financial goals like home maintenance and investing for retirement," Ramsey says. 

2. Calculate how large of a mortgage you can take out

After you've determined how much money you can devote to housing, Ramsey suggests you can then use a mortgage calculator to see how much you can afford to borrow so your payments stay within this threshold. This will guide you in determining how much you can pay for a house. 

When you use the calculator to see what your mortgage payments will be, don't forget to factor in your down payment. If you discover you can afford to make payments on a $250,000 mortgage and you have a $50,000 down payment, then you could theoretically afford a $300,000 house. But, if you are putting less than 20% down, you also need to add in the monthly costs of private mortgage insurance as well. 

Plus, Ramsey warns that you also need to take other costs into account when doing your calculations. "Don’t forget that grown-up stuff like property taxes and home insurance will top off your monthly payment with another few hundred dollars or so (icing on the cake)," the Ramsey Solutions blog reads. 

Your mortgage payments, including PMI, property taxes, insurance, and HOA fees should all be below that 25% of your income calculated in step one. 

3. Budget for closing costs

Closing costs also need to be considered when deciding how much house you should buy. These can add up to several thousand dollars and include appraisal fees, as well as the cost of home inspections, attorney's fees, and insurance. 

Ramsey urges factoring these costs into your budget and making sure you have enough saved to pay cash for them before moving forward. "You’ll either need to hold off on your home purchase until you’ve saved up the extra cash or you’ll have to shoot a little lower on your home price range," Ramsey warns those who find they don't have the money set aside to cover closing fees.  

4. Consider other household expenses

Closing costs aren't the only thing you'll have to pay for as a homeowner, and Ramsey urges you to make sure you can cover all the other expenses as well. These could include higher utility bills, home repairs and maintenance, and any upgrades and additions you might want to do to your space. 

5. Look at the size of your down payment

Finally, the last key thing to consider when deciding how much house to afford is your down payment. 

According to Ramsey, the ideal down payment is 20% or higher to avoid PMI -- but he says first-time buyers may be OK with putting down as little as 5% to 10%. You will need to be prepared to cover this mortgage insurance cost, though, and make sure that doing so won't put you above 25% of your income for housing costs. 

By considering all of these factors, you can make an informed choice on how much to spend on a home. Ramsey is spot-on with all of these tips, and you shouldn't buy a home without doing these calculations and making sure the costs fit comfortably in your budget.