How Much You Should Spend on a Home

People buy homes for many different reasons and to answer this question properly one must first know the purpose of the home purchase. Is this a first or second home? A vacation home? Is it for retirement or investment? How long do you plan on staying in the home? As you can imagine the answer to these questions can go a long way in determining how much you should spend on a home.

Focus on 40%

For purposes of this article let’s assume that this is a first home and will be your primary residence. In this scenario, most experts agree that the annual amount you spend on your home should be no more than roughly 40% of your overall income.
This includes mortgage, real estate taxes, homeowners insurance and in the case of a condo or co-op, possible maintenance fees. This does not include utilities, food, clothing, or other necessities of basic living as you will have those regardless of whether you own your own a home or rent.

The 40% figure also assumes that you have an average debt to income ratio of no more than 20%. This is for items like car payments, credit cards, or other loans. If your debt is higher than 20% of your income, then you may have to adjust down what you spend on a home or consider paying off some debt prior to purchasing. Banks will look at this in addition to your employment history, income and credit in determining how much they will lend you in the form of a mortgage.

The Risk of Spending Too Much

Paying more than 40% of overall income to service the cost of owning a home can result in an individual becoming ‘home poor’ or worse.  The reason being that it can create a situation where paying for the home results in all other expenditures having to be reduced, such as vacations or retirement contributions.  In a worst case scenario, it creates a situation where an individual has such a thin financial margin that a one-off issue, say a medical expense or being unemployed for 1-2 months, can see them unable to pay their mortgage.

What if I Have To Pay More Than 40%?

For many, the urge to purchase a home can result in poor long-term financial decisions being made, either through purchasing too soon or buying something that isn’t really affordable.  The social pressure to do so can be immense as family and friends ‘expect’ people to own a home as they get older and start a family.

Resisting this pressure is important and if the cost of buying a home right now is too costly, an individual should wait a few years and focus on increasing the down payment they can make. Every dollar paid up front is one less paid over the next twenty or thirty years, and which sees interest charged and compounded on it.  Often a few years of extra savings before buying a home can result in a mortgage burden that is far more manageable for most investors.
By Jeffrey Glen

Copyrighted 2016. Content published with author's permission.

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