Find yourself daydreaming of buying the perfect home? According to Bank of America’s 2018 Homebuyer Insights Report, 72% of millennials say homeownership is a top priority, coming in second to retirement. It’s all part of the life plan: go to school, get a good job, save up and buy the dream house.
While it can be an exciting time, buying a home is one of the biggest financial decisions you’ll ever make. At Abacus, we want to help clients buy their dream home without it becoming a future financial burden.
So how do you know how much house you can afford? Let’s explore a few factors that can help ensure a positive home buying experience.
The 28/36 Rule
The 28/36 rule is used by lenders to determine how much house an individual can afford. Understanding how this rule works before starting your search for the perfect home can be beneficial so you don’t fall in love with a house outside your price range.
The first part of the rule states a family shouldn’t spend more than 28% of their gross monthly income on total housing costs. Total housing costs include monthly principal and interest payments, property taxes, homeowner association or condo fees, and insurance payments. The 28% does not include other expenses such as utilities or maintenance.
The second part of the rule states a family shouldn’t spend more than 36% of their gross monthly income on all recurring monthly debt payments. Recurring monthly debt payments include total housing costs listed above, and also any payments for car loans, student loans, other personal loans, and credit card payments.
Just because lenders allow you to spend up to 28% of your gross monthly income on a home purchase doesn’t mean you should. Most people understand mortgage payments also mean paying property taxes, homeowners insurance, possibly even homeowners association fees. But there are even more expenses to consider before making an offer on a home.
When thinking about up-front costs to buy a new home, people often think of how much they’ll need to save for a down payment. However, a down payment isn’t the only cost to be aware of. There is usually a significant closing cost ranging from 2%-5% of the purchase price of the home. Closing costs cover application fees, appraisals to determine the fair market value of the home, home inspections, attorney fees, and a variety of other fees that might apply.
For example, if you bought a home for $500,000, you would want to multiply that amount by 2%-5% to find the approximate closing costs (which in this case would be $10,000 – $25,000. Assuming a 20% down payment of $100,000, you would need to save between $110,000 – $125,000 to purchase the home.
Maintenance & Repairs
Whether buying a fixer-upper or a brand new house, at some point repairs and maintenance will be required.
Initial repairs can be planned for by hiring a home inspector who will assess potential replacement items and costs. But what about unplanned repairs? Consider these replacement costs:
- Roofs – every 15-30 years depending on type of material
- Gutters – every 20 years
- HVAC systems – every 10-15 years depending on how often its been used and maintained
- Water heater – every 8-15 years depending on model
- Kitchen appliances – every 10-15 years
In addition to larger repairs, homeowners can expect to spend money on smaller costs to maintain their home each year. These include buying tools such as lawnmowers and gutter cleaners, and paying professionals to change air filters, apply pest control, and fix plumbing issues. While every home is different, on average homeowners can expect to spend 1% – 2% of their home’s value on maintenance each year.
Whether transitioning from renting to owning or upgrading to a larger place, you can likely expect your utility costs to rise. Expect to pay for gas, electricity, water, sewage, trash, and recycling, but don’t forget about cable, internet, and home security expenses that may also be desired.
While some expenses like cable, internet, and trash removal will be a fixed amount determined by the provider or city, some costs like electric, gas, and water will be determined by usage, which can add up.
Buying a home should be a fun and rewarding experience, but not one that negatively impacts your financial future. Even if you’re not looking to buy a house right away, it’s never too late to start thinking about how to make a smart purchase.
Schedule a call with an Abacus advisor today to get more in-depth support so you can begin your house-hunting journey with confidence.