As we enter into the summer months, real estate activity tends to pick up significantly. Summer is a popular time to buy and sell. Before beginning the housing search, an important first step is to determine how much you can reasonably afford. There are a couple rules-of-thumb to help guide this conversation.
1. Strive to keep your principal, interest, taxes, and insurance payment (PITI) under 25% of your net income. Oftentimes, these four items are all combined into one payment at the beginning of each month. You can easily figure out what the PITI payment at a new house would be by running an amortization schedule based on the debt, length of the mortgage, and interest rate. You can then assume what the insurance and tax cost will be. If this number is under 25% of your net income, it’s likely an affordable home.
2. Your overall housing cost should be less than 35% of your net income. On top of your PITI payment mentioned above, home ownership also entails home maintenance, repairs, utilities, and general upkeep. While maintenance and repairs are often large, unplanned expenses, it’s wise to build to a monthly allotment into your cash flow plan to build up savings for these expenditures. Home maintenance is approximately 1% of the home value per year (on average).
If too much house is purchased, it can be very difficult (if not impossible) to maintain a proper savings rate for the long-term.