Category: Personal Finance

How much home can you afford?

Often times, people make the mistake of buying as expensive a home as how much a financial institution is willing to lend. This is a terrible mistake to make.

When buying a home, there are two costs involved – (a) closing costs and (b) ongoing reoccurring costs. There are several one-time costs that get rolled up into closing costs when buying a home.

Then there are reoccurring fixed costs to consider when buying a home – mortgage, maintenance, utilities, home owners insurance, HOA, taxes etc. These are reoccurring expenses that need to be paid for as long as you live in the home.

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Switching gears, I would like to provide some historical perspective on home size. Average home size in the (US Census Data) 1980’s was around 1700 sq. ft. It has been on an increasing trend ever since and the average home size in ~2013-2014 was around 2600 sq. ft.

The home size has been on a continuous ramp upwards. This is a very important thing to keep in mind when buying a home. The bigger the home – the more it is going to cost you on maintenance, utilities, home owners insurance, taxes etc.

The bottom line is “Bigger the home, bigger is the reoccurring cost of owning the home”.

 

The simple truth is that just because you qualify and get approved for a home loan doesn’t mean that you can actually afford it. This brings up a great question – how much home can you really afford?

In Old French, Mortgage means “dead pledge”.

When signing up for a 15 or 30 year home mortgage loan, one needs to be extremely cautious. That is a very long period of time.

 

One approach to determining how much home you can afford is based on the gross annual income. Assuming income stability and a reasonably good credit score, guidance from financial institutions on home affordability range from 2.5 times gross annual pay up to 5 times gross annual pay.

The higher end of the scale does not make any sense. Some financial institutions got into a lot of trouble due to giving loans to people who couldn’t afford the homes they were buying –i.e. loaning for homes close to 5 times one’s gross annual pay .

The guidance from financial institutions must always be taken with a grain of salt. They always have their best interest before the consumer.

It would be a wise choice to stay at slightly lower than the lower end of the guidance – 2 times gross annual pay.

 

This article is written to educate and drive awareness of things to consider when buying a home.

Home buying is an exciting event in life. If done with wisdom, one gets to enjoy the home and keep a fat wallet as well.

Trimming down on the home sq. ft. requirement would go a long way in keeping the home cost near two times the gross annual pay.

 

 

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