Dear Carrie, I'm ready to buy my first house but my friends think I'm crazy to take on that financial commitment. Can you help me figure out how much house I can afford? —A Reader
Dear Reader, This is a question that more and more young homebuyers are asking. Interestingly, there has been the perception that young people would much prefer to rent than take on the financial challenges of buying. Some of this was fueled by the economic downturn. But with an improving economy, a 2014 survey by Fannie Mae found that 76 percent of Millennials aspire to own a home. So while your friends may be skeptical, it seems that you have a lot of company in your desire to buy your first house.
Of course, it is a big financial commitment, often the biggest investment any of us will make. It's also a big personal commitment. So before we get into dollars, let's take a step back.
The first thing to understand is that like any other investment, you can't 'time' the real estate market. Historically home prices continue to rise, but they also go through downturns. This is the reason you'll often hear the advice not to buy a home unless you're confident you'll be able to stay put for at least a few years, and ride out a potential drop in value.
I agree with this — to a degree. But on the other side of the coin, a "starter" home can be your entry into the real estate market, allowing you to move to a more expensive home in the future. If you delay too long and prices rise, it will be that much more difficult to take this first step.
In other words, there isn't one 'right' time to buy. You simply have to weigh all the variables and determine the best time for your own circumstances.
Also think about whether you have the time and inclination to maintain the property. When the roof leaks or the plumbing fails, it will be up to you to fix it. Are you willing to make that commitment of time and energy — as well as money — that maintaining a home demands?
Some lenders say you could afford a house that's 2-2.5 times your annual income. Others will go up as high as 5 times your income, assuming you don't have a lot of other debts.
It's good to know how much someone might be willing to lend you but, to me, what you can afford to pay long-term is even more important. So the rule I still harken back to is the 28/36 rule. As a general guideline, this rule suggests that your total housing costs shouldn't exceed 28 percent of your gross monthly income. All of your debt combined shouldn't exceed 36 percent of your gross monthly income. So do the math. If you make $80,000 a year, your total housing cost shouldn't be more than $22,400, or $1,866 a month. On the other hand, if you have no other debt, you can consider pushing this a bit higher. But if you do have a student loan or a car payment, don't go beyond 36 percent total.
While figuring out how much you can handle in monthly mortgage payments is important, probably the number one cost in purchasing a home is the down payment. Ideally, you want to aim for at least 20 percent down. And that can be a big chunk of money.
If you have the down payment taken care of, great. If not, you probably need to up your savings. One way to do this might be to look at your current housing costs, and if they're lower than a potential house payment, put the difference in your savings each month. That way you'll not only build your down payment, you'll get used to budgeting for the mortgage.
Upfront costs are only part of the picture. Homeownership is an ongoing financial responsibility that includes insurance, property taxes, periodic maintenance and repair, and possible homeowner's association fees. Be sure to also factor these costs into your monthly budget.
We've been talking about costs but there are definite tax advantages to ownership that can help ease the financial burden. Currently you can deduct the interest expense on up to $1 million of home-secured debt used to purchase or make capital improvements on your principal residence. Mortgage points are also deductible on an original mortgage the year you pay them. Plus, property taxes are currently income tax-deductible. That said, don't be seduced by salespeople touting tax deductibility. The ability to deduct unavoidable expenses is great, but always try to keep your interest expense and payments to a minimum.
If you're ready to get going, I strongly advise you to first check your credit score. Many credit card companies now offer this free. Then get pre-approved by a lender. It's also a good idea to check with a site like Zillow or Trulia so you can be realistic about which neighborhoods match your budget. The more prepared you are, the better deal you can make — hopefully for a house you'll both love and be able to afford.
Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER(tm), is president of Charles Schwab Foundation and author of The Charles Schwab Guide to Finances After Fifty, available in bookstores nationwide. Read more at http://schwab.com/book. You can e-mail Carrie at [email protected] This column is no substitute for an individualized recommendation, tax, legal or personalized investment advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.
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