Making the decision to purchase a home is a big and exciting step. The next most important step is to determine how much you can and should realistically spend. The amount is dependent on several factors including your income, credit score, and lifestyle. Because housing is expensive and the biggest line item in the monthly budget for a majority of households, it is not a decision to be made lightly.
Start with Your Take-Home Pay
Many financial guidelines use gross income as the benchmark, but it’s also worth running your numbers based on take-home pay. After taxes, retirement contributions, and other payroll deductions, determine what your actual monthly budget looks like. Make sure a mortgage payment leaves you with sufficient funds for food, transportation, healthcare, savings, and discretionary spending.
The Pre-Approval Process
Getting pre-approved by a mortgage lender is the most accurate way to determine your buying power. The lender will review your income, credit, assets, and debts to determine how much they are willing to lend. Keep in mind: lenders may pre-qualify you for a loan amount higher than you should use. Just because you can borrow a certain amount doesn’t mean you should.
Don’t Forget the Hidden Costs
Your monthly housing costs include more than the mortgage principal and interest. Factor in property taxes (in California, typically 1.1% to 1.25% of assessed value annually), homeowner’s insurance, any HOA fees, and maintenance reserves. Add these to your monthly mortgage payment to get your true total housing cost.
Build in a Cushion
Avoid stretching your budget to the absolute maximum just to buy a slightly larger or nicer home. Life happens — unexpected medical bills, job changes, car repairs — and having a financial cushion allows you to weather these without jeopardizing your home. A good rule of thumb is to maintain 3 to 6 months of living expenses in liquid savings even after purchasing.
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