How to Know If You Can Afford a Home

2009 is almost certainly the best time to buy a home within the last 20 years. There are many homes on the market with relatively few buyers. Home prices have dropped significantly within the last 24 months, interest rates on 15 and 30 year fixed rate mortgages are at historical lows, and you’ll get an $8,000 tax-credit to buy a home if you are a first-time homebuyer or have not owned a home within the last three years. It’s an excellent time to make a home purchase, but you should only do so if you are financially ready to do so. How do you know if you can afford a home and if you can afford a home, how much home can you afford?

The first thing to consider is the amount of consumer debt that you have. Do you have credit card debt, car loans or any other sort of consumer debt? If so, these monthly payments will eat away at your income and give you a lot less wiggle room to make a house payment. If the amount of consumer debt that you have is more than 25% of your annual income, you should almost certainly focus on paying off your debt before buying a home. By paying off your consume debt before buying a home, you will be in a much better place financially to buy a home.

You should also consider what sort of down payment you can make. It’s becoming very difficult to purchase a home without a reasonably large down payment. Typically one shouldn’t buy a home unless they can afford a 10% down payment. Ideally, one would put down a 20% down payment because that would make it so that the home-buyer does not have to pay for private mortgage insurance (foreclosure insurance for the bank), which ends adding $50.00 for every $100,000 of home that you buy per month.

It’s also a great idea to have an emergency fund of three-to-six months of expenses in the bank before buying a home. Having a good sized emergency fund will make it so that you don’t get behind on your house if you lose your job. An emergency fund will also take care of any unexpected home repairs that you might need after buying your home.

If you don’t have any consumer debt, have an emergency fund and have money for a down payment, you are in a great position to buy a home. If this is the case, the next step is to determine how expensive of a home you can afford. Most financial advisers will recommend that your mortgage payment does not exceed 25% of your take-home pay on either a 15 or 30 year fixed mortgage. Don’t mess with interest-only loans or adjustable rate loans; they will only get you into trouble.

You can find dozens of mortgage calculators online that will help you figure out how much you can afford. (Bankrate has a pretty good calculator). For example, if I made $50,000 per year, my take-home pay would be about $3500 per month. This means that I could swing a mortgage payment of about $885. This means that I could afford about a $162,000 home using a 30 year fixed-rate mortgage at a 5% interest rate.