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Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about real estate; specifically, how to figure out how much house you can afford to buy.
Watch the following video and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.
You also can learn how to send in a question of your own below.
For more information, check out “Stop and Think: How Much House Can You Really Afford?” and “10 Ways to Pull Together the Down Payment for a Home.” You can also go to the search at the top of this page, put in the words “real estate” and find plenty of information on just about everything relating to this topic.
If you’re looking for the best deal on a mortgage, shop various lenders at this page of our Solutions Center. There, you can also find anything you need to improve your finances, from help with debt to a better credit card.
Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by MoneyTalksNews.com, serving up the best in personal finance news and advice since 1991.
Today’s question comes to us from Carla:
“My husband and I are considering buying our first house. How do we know how much we can afford?”
Carla, I’ve got three things for you:
Thing No. 1: Rules of thumb
There are several simple rules of thumb that can give you an idea of the maximum you can spend on a home. For example, one suggests you shouldn’t spend more than 30 percent of your monthly income on housing costs. Another says you can buy a house that is three to five times your annual income.
The problem with these simple rules is they ignore things like how much other debt you have, your income history and your credit score. The more other debt you have, the less stable your income. The lower your credit score, the less house you can afford.
To get a little better idea, try an online calculator. Zillow has one. But these aren’t much more accurate than the rules of thumb, since they don’t address the things I just talked about.
If you really want the most accurate idea of how much you can afford, go to a mortgage broker and fill out an application. They’ll tell you exactly what you can afford.
Thing No. 2: Forget thing No. 1
When you find out how much house you can afford based on an online calculator, talking to a mortgage broker or using rules of thumb, you learn the maximum amount you can borrow. Guess what? When you tell a Realtor the maximum amount you can borrow, you’re going to be shown houses that are at or above that maximum amount.
What you really should do is buy a house you can afford that adequately serves your needs. You’ll be tempted to buy as much house as you can possibly afford because you want to impress your friends and you want to have a nice house. Ignore that temptation.
Granted, it can make sense to buy an expensive house if real estate values are rising: The more you own, the more you make. But be careful. Take it from someone who has owned lots of houses. When you buy a house, you will be heating, cooling, cleaning, insuring, maintaining and paying property taxes on every room in that house. Every square foot you’re buying that you don’t need is costing you money you wouldn’t have to be spending.
That’s why my advice is always to buy what you need — not what you want, what your friends want, what your parents want or what that Realtor wants.
Thing No. 3: The right path
Properly buying property doesn’t start with driving around looking at houses. It starts with good credit, because the quality of your credit directly impacts the amount of house you can afford, as well as your ability to buy it.
To illustrate, say you’re borrowing $300,000 on 30-year mortgage. If you get a 4 percent interest rate because your credit is awesome, you’re going to pay about $215,000 in interest over the life of that loan. If you get a 5 percent rate because your credit’s not so awesome, you’re going to pay $280,000 in interest over that same 30-year period.
In other words, guys, you’ll spend $65,000 more on the same home simply because you had crappy credit. That $65,000 could help put your kids through college. It could help you retire early. It could help you establish your own business.
Bottom line? Have good credit before you start this process. Since improving your credit takes time, start as soon as you can. Then, when your credit is good and you’ve saved up a healthy down payment, get preapproved for a loan. That means going to a lender, applying and having them agree in writing to lend you “X” amount.
Not getting preapproved is like going to the mall without your wallet: You can’t buy anything. So, first good credit and a down payment, then preapproval, then shopping.
Hope that answers your question, Carla.
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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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