First-Time Homebuyer’s Guide: Part 4
How much can you afford? 3 financial tips
You based the decision to buy your first home on sound logic and reasoning. Then you assessed your status as a borrower to see if you could actually do it. The next step is to determine the living expenses you can afford per month, which will give you an idea of your home’s price range. Like the last steps, this one requires you stay honest with yourself. It’s even useful to think in terms of worst case scenarios to give you an idea of what you can handle financially if you suddenly get unlucky.
Consider the following tips to help determine what you can afford as a homeowner on a monthly basis.
1. Budgeting 101
You’ve probably done this exercise before but it’s never a bad idea to do it again. Take your after-tax earnings (called disposable income), add up your payments and outgoing costs (living expenses), subtract the latter from the former, and viola! One shiny new dollar figure (discretionary income) you can slice up into savings and spending according to your goals and lifestyle. When you’re about to buy your first home, it’s important to write out a fresh budget because some things may have changed since the last time you did it. Maybe you got a little (or big) promotion. Maybe you enrolled in a new yoga class and co-ed sports league. Maybe the price of gas, milk and meat has gone up. Whatever the case, putting your budget on paper provides a good place to start when figuring out what you can afford.
2. Homeownership Extras
Owning a home comes with expenses that don’t affect you as a renter. This means you need to think about what kind of hit you can take to your discretionary income, the surplus money you save, invest and use to buy non-essential items. If you want to maintain the discretionary income you have as a renter—essentially keeping your rent payment and future mortgage payment the same—you’ll need to figure in a number of costs apart from the mortgage. Two major costs are property taxes and homeowner’s insurance. Typically, they’re managed through an escrow account and segmented into monthly bills along with the mortgage. Four elements, abbreviated as PITI (mortgage premium and interest, taxes and insurance), make up your monthly payment as a homeowner. One silver lining: the ‘ITI’ segment—mortgage interest, property taxes and insurance premiums—are deductible from federal income taxes. Other additional homeowner expenses include closing costs, landscaping and pool maintenance, and HOA fees if applicable.
3. Murphy’s Law
As a renter, it’s a pain when water pipes burst, the A/C goes out or the roof starts leaking, but it’s a temporary pain. Your landlord is obligated to spend money on fixing these problems, not you. But when you’re the one responsible for keeping the lights on and water running, Murphy’s Law is seemingly always at work: What can go wrong, will go wrong. As a homeowner, it’s important you maintain emergency funds to account for unexpected problems. You can stay liquid by either moving more of your discretionary income to savings and checking accounts instead of stocks and mutual funds, or putting less money down during the home purchase. Remember, the bigger your down payment, the lower your mortgage interest rate and monthly payment. This means you’ll need to find a balance between maximizing your discretionary income and lessening the financial shock of Murphy’s Law. A good way to calculate projected maintenance and repair costs is to list the major working components inside your home, like the stove, fridge, HVAC, dishwasher and washing machine, among others, and determine their age and estimated life spans (go to www.nachi.org/life-expectancy.htm for a good breakdown). This way, you’ll have a general idea of future expenses and the approximate timing of when they’ll dent your budget.
In next week’s First-Time Homebuyer’s Guide…
Part 5: Shop and compare with the Intuitive Loan Finder