Becoming a homeowner is not a move to take lightly. It's important to know how it can affect your finances in the long run. Start by asking yourself these questions.
Are you on top of your current spending?
Before imagining your financial future, it's important to have a clear understanding of your financial present.
That doesn't necessarily mean you have to go on a rigid budget. But it's important that you know how much money is coming in and where it's going every month. You may have a good handle on your biggest expenses — rent, car payments and insurance — but some cash drains can fall into the "where did it go" category.
For the next two months, track where every dollar goes. Given a clear understanding of where your money is going, you'll be able to make smart cuts where needed. This helps you know how big of a house payment you can afford comfortably and confidently.
How much house can you afford?
Keeping in mind what you learned from evaluating your current monthly cash flow, decide just how big of a house payment you can swing. Realize it will include not just principal and interest, but also property taxes and insurance.
One rule of thumb suggests that your housing expense should stay between 25% to 36% of your take-home pay. So, if your family brings home $5,000 per month after taxes, your mortgage payment, including taxes and insurance, should be between $1,250 and $1,800. Keep in mind, just because you can theoretically afford a higher house payment doesn't mean you should.
Consider that the size of your house will impact your bottom line well beyond your payment. For example, more rooms mean more furniture, more upkeep, and higher heating and cooling costs.
How long will you be in this house?
The less time you plan to spend in a home, the less sense it makes to buy it.
The biggest reason is closing costs, which are some of the heftiest upfront expenses of buying a home. They cover appraisal fees, document preparation, loan origination and discount fees, flood-zone evaluation and title insurance, and more. Closing costs can range from about 2% to 5% of the purchase price and, unlike your down payment and principal payments, these expenses are a pure drain on your cash.
When you own the home for a short amount of time, you're far less likely to recover these costs through an increase in the property-market value. Bottom line: If you think you'll move in three years or less, renting may be the smarter move.
How stable is your income?
Your commitment to a certain house payment should reflect your confidence in your job and income. For example, if you're in an industry that's experiencing layoffs or you're compensated on sales commissions, you should only take on a payment you're confident you can sustain during leaner times.
You should also consider the possibility that someone who's currently working may stop doing so — such as a parent who opts to stay at home with children or a breadwinner who's eagerly eyeing retirement. This potential income loss could impact your ability to cover a high house payment.
It also makes sense to evaluate the likelihood that you may be moving to a new area to take advantage of a new job opportunity. Owning a home makes moving more complicated, and a potential future move should be considered in your decision.
How much cash do you have?
In addition to being ready for closing costs, you'll also need money for move-in expenses, such as furniture, drapes, lawn mowers, snowblowers and other things you'll need to be comfortable in your new home.
Beyond that, you'll want to have a cash cushion to pay for repairs and other unexpected expenses — and not just ones related to your home. You should set aside enough cash to cover your living expenses for three to six months.
What are your other financial goals?
Sometimes homeownership is equated with the American dream. But there's much more to a rich and fulfilling life than where we live. Rather than blindly maxing out on the most expensive house you can afford, consider the other things that will make you happy now and in the future.
In addition to leaving room in your finances for things such as travel, dining out, new cars, children and personal interests, you should also have ample cash to regularly save at least 10% to 15% of your income. That money could help you reach other important goals such as retirement and college expenses.
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