Home ownership has long been considered a major component of the American Dream and a significant milestone in adulting. But this expense can also eat up a huge portion of your budget, so it’s important to keep the costs in check.
That means setting realistic expectations based on your budget, and not HGTV and Pinterest-inspired home fantasies. Before hitting the open house scene, figure out exactly how much you can afford to spend on monthly housing costs, including your mortgage payment, insurance, property taxes and maintenance. Considering how much you currently spend on rent and other housing-related costs is a good place to start.
Generally, lenders want your monthly housing payments to add up to less than 28 percent of your income. They also look at what other debts you carry and prefer that your overall debt-to-income ratio be 36 percent or less. In other words, if you make $5,000 a month, the bank would likely allow you a home loan that would make your payments $1,400 a month or less and your total debt payments $1,800 a month or less.
Of course, banks have some wiggle room on what loans to approve. But even if you find a lender willing to give you more, that doesn’t mean you should do it. You’re better off trying to keep your monthly payments well below these suggested limits to give your budget room to breathe. After all, you’re probably going to be locked into these payments for decades.
One way to lower your housing costs is to pay more upfront. At the minimum, aim for a down payment of 20 percent. While you can qualify for a mortgage with less, you’ll have to pay private mortgage insurance (PMI, on top of having to borrow more, which means you’ll have higher monthly costs).
Just remember not to use all your savings for a down payment. You should have another 2 percent to 5 percent of the sale price set aside to cover closing costs for your home purchase. And you still need an emergency fund—which you probably need to beef up to cover the added costs of homeownership—as well as money for other savings goals.