Some thoughts on buying a responsibly priced home that might make you sleep better at night for years to come…
If the idea of owning a home is exciting and empowering to you, that's great! The more education you have before you take the leap, the less stressful it will be once you actually own a home.
How much home can I afford?
Do you know what you can afford per month for PITI, or principle, interest, taxes and insurance? Not to mention maintenance and exciting projects? It's important to get really clear on this monthly number before getting excited about your dream home. If you're renting, think about what you're paying now. Could you comfortably pay more, and would you do so happily knowing you were gaining equity in a home? Would you still be able to save for retirement, vacations, car repairs, and other necessary and fun expenditures?
How much will I qualify for?
Banks will often loan you an amount that might seem overwhelming once you're committed. They will calculate the price tag of the home you can afford based on your monthly PITI payment being anywhere from 28-45% of your gross monthly pay. It's important that you, and your partner if involved, first decide on what is a sustainable number for you to contribute to housing before getting caught up in what a bank will lend you. Once you know that, you can use mortgage calculators to estimate the ticket price of your affordable home.
What defines affordable housing?
‘Affordable housing’ in this country was originally defined as 25% of your pay, and now HUD states that anyone paying more than 30% of their income towards housing is ‘cost burdened.’ Officially this is based on your gross pay, but most people will warn you to base this on your take-home-pay to be safer. However, what’s affordable is up to you — you might be willing to spend 30% on your dream living situation, or if you’re someone who is always out-and-about, you might not value it as much and may be more comfortable only spending say 20% of your pay.
Home buying affordability case study: $40,000
If you make $40,000 per year, the government says what would be ‘affordable’ for you to pay toward housing is $1000/month (30% of $3,333/mo pay).
Again, this is based on your PITI, or mortgage, taxes and insurance combined. Let’s figure in maintenance costs too (at least 200/month, or $1200/year, or $6000 every 5 years).
If you want to live alone and make $40,000/year, and are willing to spend 30% of your income on housing, then your monthly payment would be $800/month factoring in maintenance.
Let’s look at Portland, OR. Based on 2018 interest rates (4.5%) and average Portland property taxes ($3000/yr), even if you put down 20% ($26,000) to avoid PMI, then you could only afford a $130,000 house, with these monthly payments:
Home Cost: $130,000
Money down: 20% or $26,000
Total Monthly Payment: $810
Principle & Interest: 527
Property Taxes: 250
Granted, this case study would look different in a place with lower property taxes. If you know where you want to live, scope out some homes you’re curious about on Zillow and see what their property taxes are.
Home buying case study number two: Income of $70,000 (or, a roommate)
How much home could you afford if you made $70,000/year? Or if you and your partner combined made $70,000? Let’s say you’re only able to save a 10% down payment in this case. Using the same estimations as before, you could afford a $255,000 house.
Home Cost: $255,000
Money down: 10% or $25,500
Total Monthly Payment: 1559, + set aside $200/mo for maintenance = $1759/mo total
Principle & Interest: $1,163
Property Taxes: $250
Now, let's say you still only make that $40,000 but are willing to have a roommate, or to share your house with a partner. If the other person can afford to contribute $750/month, then you would still be able to ‘afford’ $800/mo going toward the monthly payment.
Granted, now you would have to pay PMI until you’ve paid off 20% of the principle of the loan. You are also now committing to always having a roommate in order to afford the house, unless your income goes up to $70,000/year, which would make the payment more comfortable alone.
I want to buy a more expensive house than that!
Now on the west coast, these case studies may seem like a harsh reality. However in many parts of America, you can buy a lot of house and land for $276,000.
If you're wondering how other people afford it, 62 percent of all American workers make less than $40,000 (in 2014 anyway, no 2016 data yet) according to the Social Security Administration. Most of these people who own homes are not buying them in expensive city centers.
How can I get creative to pull this off?
If you are serious about buying a house, my advice is to get creative and work the numbers. Consider if you’re willing to have roommates, rent out a portion of your home, or possibly airbnb for extra income.
You could also consider taking out more of a loan in order to make the basement into an apartment, or build an exterior bedroom, for example.
If you are willing to live with others, and therefore share the mortgage cost, consider seeing if anyone in your life would be willing to cosign on the loan with you in order to get approved for a higher amount. Or course this is a big favor to ask and makes them responsible for your debt payments as well, so this subject shouldn’t be broached lightly.
If you and a partner are buying a home together
Make sure to talk about if this is an equal investment, or if both of your names will be on the mortgage and title. If for credit reasons only one person’s name is on the loan, you can always add someone to the title afterward very easily. You also might want an agreement beforehand of who would buy the other one out if you ever split up, and how that number would be calculated.
Check out an quick piece I contributed to this month called Here’s Your Month-by-Month Plan to Save for a Down Payment in 5 Years or Less.
Some caveats to the article:
I don’t think buying a home is necessarily the best decision one can make. In cities like Portland, OR, it actually costs more money to buy than to rent for most people. So if you’re a renter and you love it, and value travel/freedom/not-being-responsible-for-broken-pipes, owning a home might not be for you. In fact, in many cases simply investing the money you would have put in into retirement savings will yield just as much or more return (and save lots of time).
Though I was comfortable putting less than 20% down on my first home, that was an educated choice. I have already begun making extra payments on the principle of that house and plan to pay it off ten years early. (You’d be surprised how little this takes some times- check out this calculator for how extra payments will shorten the life of your mortgage, and save thousands in interest…)