When it comes to buying a home, one of the simplest ways to think about how much house you can afford is determining how much you can put toward a monthly mortgage payment. At Better Mortgage, we want to find the best mortgage for you, and that means one that doesn't put a strain on your finances (even if you can technically qualify for the loan). One of the best ways to understand how much you can truly afford is to compare your potential monthly mortgage payment to your monthly budget.
Breaking down a monthly mortgage payment
Your monthly mortgage payment, sometimes referred to as “PITI,” will consist of four components: principal, interest, taxes, and insurance.
Principal: This is money going toward the actual balance of your loan. As time goes by, you’ll pay more toward your principal and less toward interest.
Interest: This is money going toward paying interest on your loan. As time goes by, you’ll pay less interest and more toward your principal.
Taxes: Property or real estate taxes are determined locally, and vary from area to area. Tax rates can be quite high in certain areas, so it’s a good idea to research rates in advance as they can add significantly to your monthly payment.
Insurance: Insurance includes homeowners insurance (which you’ll need to buy after your offer has been accepted and before your loan is closed) and could also include mortgage insurance, which is typically required if you put less than 20% down.
If you have a fixed-rate mortgage (such as a 30-year fixed), your monthly payment will stay about the same for the entire length of your loan. However, keep in mind that property tax rates or insurance rates could change over time. If you’re getting quotes from lenders, make sure they're clear about whether or not their monthly payment estimate includes taxes and insurance.
Some properties, especially condos, may also require homeowners’ association fees (HOA fees). These fees can be several hundred dollars per month, so you’ll want to keep that in mind when searching for homes and assessing your budget.
Examining your monthly budget
If you’re currently renting, your monthly rent payment is a good place to start assessing how big of a monthly mortgage payment you could afford. (Keep in mind that homeownership can entail additional expenses like maintenance and repairs.) Here’s a way to examine your monthly budget in more detail:
- Determine your net monthly income: this is how much hits your bank account each month, after any applicable taxes have been taken out. This includes things like your monthly salary, benefits, alimony, or child support.
- Identify your fixed expenses: think of these as expenses that occur regularly and are roughly the same each month, like your monthly rent, utilities, student loan or other debt payments, child care, gym membership, and other monthly subscriptions.
- Identify irregular expenses: think of these as expenses that don’t occur monthly, like haircuts, holiday shopping, gifts, travel, semi-annual insurance payments, and annual subscriptions or dues. To account for this in a monthly budget, estimate the yearly total and divide by twelve.
- Account for savings transfers: this includes any monthly transfers you make to retirement, investment, or savings accounts.
- Discretionary spending: Once you’ve accounted for all the above expenses, what’s left is your monthly discretionary budget, for things like groceries, eating out, and entertainment.
Assessing what you can afford
Now that you have a better idea of your monthly income and expenses, you can start to assess what your home budget really looks like:
- In addition to your rent payment, is there room left over in your discretionary spending that could go toward your mortgage bill?
- Are there expenses you are comfortable reducing or eliminating, such as subscription services or your discretionary budget?
- Is there room in your budget for the potentially higher utility expenses that could come with your new home?
- Is there room in your budget for potential HOA fees that may come with your new home?
- Do you have emergency savings for surprise home repairs, car repairs, health care expenses, or other emergencies? Without savings in place, you run the risk of having to take on more debt, or even going into foreclosure.
Trial run: practicing your payment
Running the numbers is one thing, having a mortgage bill come in every month is another. One experiment you can try is “practicing” your mortgage payment to get a true sense of how buying a home will affect your monthly budget. If your estimated mortgage payment is more than your current rent, start putting aside the extra amount every month to simulate making mortgage payments. Does your budget still feel comfortable? If not, you may want to rethink how much you can really afford. Bonus: you can put the extra money saved during this exercise toward your down payment.
Whether you’re one month or one year away from buying a home, Better is here to help you assess your options. Click here to get our Guide to Buying A Home or schedule a call with one of our licensed Mortgage Experts.