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The largest purchase most people will make in their lifetime is their home. It’s also the longest-lasting purchase most people will make. With that in mind, it is important that you buy a home that brings you joy instead of grief.
Too many people stretch their finances beyond the breaking point, buying a home they can’t afford and paying the price via financial strain, a decreased quality of life and even family strife. Following these basic rules of thumb can help ensure that you don't overextend yourself in your search for the right home.
1. Avoid PMI
The first rule when buying a house is to make sure that you have enough saved for a down payment; 20% should suffice. A 20% down payment will allow a borrower with good credit to qualify for the best mortgage interest rates while avoiding private mortgage insurance (PMI).
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PMI is required for some mortgages when a lender is afraid you might default on payments. In essence, PMI is a lender's insurance policy that the borrower pays for. You get nothing out of it, and it costs you money. So, assuming you have good credit, having enough for a 20% down payment lets you avoid that losing game.
2. Control your PITI
The second rule is that your PITI (mortgage principal, mortgage interest, property taxes and homeowner's insurance) should be about one-fourth of your total living expenses. For example, if your total expenses are $4,000 per month, then your PITI should be about $1,000. (And, of course, your expenses should be covered by your income, after you’ve made sure to put away money for retirement savings, emergency funds and other safeguards.)
Mortgage lenders use a so-called 28% rule when considering your application; that is, no more than 28% of your total income should go toward housing. Budgeting around one-fourth of your total expenses toward PITI should assure you're in good shape.
3. Remember maintenance costs
It's smart to budget approximately 1% of your house's total cost for annual maintenance. This is just the cost of maintaining the house and grounds; it doesn't include upgrades or planned repairs. For a $300,000 house, this comes out to $3,000 per year, or $250 per month. Although that might sound like a lot of money to put aside, you'll be thankful it’s there when you need to fix your air conditioning or a hole in your roof.
The bottom line
Following these rules might seem difficult, particularly saving 20% for a down payment. However, if you can do that, you'll likely be able to afford mortgage payments, especially since they'll be taking the place of rent and adding equity to your home. Also, if you're able to save 20% for a house, you should have no problem maintaining an emergency fund, which it's smart to have anyway.
Many people find that with consistent effort and a little planning, they can afford a home of their own. If you're not sure whether you can, talk to a fee-only financial planner.
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