So, how much home can you afford? The answer may not be as simple as you think.
They say the American Dream is a beautiful house, 2.5 kids, a dog names Max, and a home to call your own. However, the dark side of that American Dream is also massive debt, overspending, and poor financial planning.
I’m not going to try and justify either image, explain why “Max” is a terrible dog name, nor am I going to explain how to make 2.5 kids (gross.) However, the one aspect I can speak on is your home and how much you should spend – or not spend.
As a real estate entrepreneur, I know a thing-or-two about homes. In fact, over the past five years, I’ve purchased and moved into five different homes – each time collecting more junk to add to the mix, making “moving day” (or “moving week,” in my case) more and more difficult and expensive.
Yes, I realize this is insane. However, in my quest for real estate mogul-hood, I’ve made both smart and dumb decisions when buying these homes and learned a lot along the way. Perhaps the most important thing I’ve learned is to always buy within your means. In other words: don’t spend too much.
But how much is too much? This article is going to explore that question and hopefully help you discover how much you should spend on your next house and still live the frugal life.
How Much You Spend vs. How Much You Make
Bear with me a moment. Yes, this first point is obvious, but you’d be amazed at how quickly common sense flies out the window. It happens when you lay eyes on that sexy front porch, large backyard, man-cave in the basement, or granite kitchen island. Far too many homebuyers quickly lose focus of their financial limitations when emotion enters the picture.
To determine the amount of money you should spend on your house, it’s helpful to simplify it down to how much you can afford to pay each month. When you obtain a mortgage, your monthly payment depends on the size of the loan, so obviously a more expensive house is going to cost you more each month. It’s much easier to think of a house cost as “$1,000 per month” than $154,997.”
To determine how much you should actually pay each month, it is important that you look at it from a perspective of how much you currently make, right now. Not in six months, not in two years; now.
Many people buy a home based on the belief that they will be getting a raise soon or some other financial windfall will come their way. Don’t be that person. Buy with what you can afford today, and if that windfall comes, you can pay off your mortgage even faster.
A good rule of thumb is the 30% rule.
Your house payment should be no more than 30% of your take-home pay. If you bring home $3,000 per month, your mortgage should not be more than $1,000 per month. This number also includes the taxes and insurance that go with that house payment.
To figure out your monthly payment, simply use a free online mortgage calculator along with current mortgage rates and work backwards. For example, the following photo was taken from my recent favorite mortgage calculator, www.financial-calculator.appspot.com/.
Notice I plugged in a loan amount of $150,000, with a 3.75% interest rate, a 30 year repayment, and $2500 for taxes and insurance. The total payment ends up being just over $900 per month. From this calculator you can tweak the numbers to find out what the maximum you can afford is.
How to Buy a Home In Your Budget
When you begin shopping for a home, follow the following three easy steps to avoid overspending:
- Figure out how much you want to spend (see above.)
- Write down that amount.
- Don’t look at properties more expensive than that.
Your real estate agent will want to show you more expensive properties. Don’t do it. Stick to your guns, know what you can afford, and don’t go over that number. By writing down your maximum amount, you’ll be able to
Additionally, for the true frugal-minded folks out there, I offer this important piece of advice: Just because you can afford a certain payment, doesn’t mean you should. Aim for the the lowest price home that still fits your needs and desires, not the best home you can potentially qualify for. Your future self will thank you.
Read more: How to create a budget that works
Don’t Listen to the Bank
The bank will lie to you.
They will tell you that you can afford more than you really should. “Go ahead, you can qualify for up to 35% of your gross income! Heck, we can even push that to 50% if you join our super special elite checking program!” they’ll say.Just because the bank says you can afford it, doesn't mean you really can!Click To Tweet
The problem with this approach, however, is by borrowing up to 35% (or more) of your gross pay (before taxes) you are left with less than half your paycheck to pay all the other bills in your life. The appeal of frugality is not that you are required to live frugal – but that you choose to. Taking out a mortgage that covers more than 50% of your take home pay leaves you no option but to live cheap – for the next thirty or fifteen years.
Should You Go 15 Years or 30 Years?
Ah, the classic debate. Should your mortgage be for 15 years or for 30 years? I wish I could simply tell you one is the right way, and one is the wrong way – but I can’t; each situation is different. However, I can tell you that a 15 year mortgage might not be as expensive as you think. Typically, a 15-year mortgage will carry a slightly lower interest rate which makes the payment a bit more bearable.
For example, let’s say you find a house you want to buy that will require a $150,000 loan. At 3.75% for 30 years, your payment would be $694.67. That same loan amount, for just 15 years and at a 3.25% rate would be $1090.83 – a difference of just under $400 per month.
Is $400 per month extra worth saving 15 years on your payment? Again – the choice is up to you, but I’ve never heard anyone say “Boy, I’ve been paying on this loan for 15 years and now it’s done. I sure wish I could pay for another 15 years!”
Make Your Home Payment Work With Your Frugal Lifestyle – Not Against
Bills are irritating, and payments are the enemy to your financial freedom. However, for most people – a home loan is a necessity in order to live in a house that you own. Therefore, it is important that you take control of you home shopping experience and make it work for you – not the other way around. By doing so, you can save money, live a more free life, and continue living a frugal lifestyle.
Do you have any tips or tricks on purchasing a home? Leave me a message in the comments below!
Brandon Turner is an active real estate investor and the Community Manager at BiggerPockets.com, an online community with vibrant real estate forums. Brandon writes on topics including tenant screening, landlording tips, and how to get started investing.