How much can I afford?

Determining your price range is a very important part of the home buying process. One determining factor will be the loan amount a lender will approve. You have very little control over this, but can select between multiple lenders, most of whom have similar guidelines and will come up with a similar number.

More importantly, you’ll need to know what you feel comfortable spending on a monthly basis. Some lenders will approve your loan well above where a buyer should spend. This is where your budget and cash flow will come into play.

You can start with what you’re paying now in rent (assuming you’re renting). A major difference that should be factored into the equation is the “Mortgage Interest Deduction.” The US government encourages residents to own their own homes. They have created a huge incentive to own. In general, all the interest you pay on your primary residence is deducted from your income at the end of the tax year and your federal taxes are based on this lower number.

For a fixed interest loan, the majority of your monthly payment in the first 10-20 years of a mortgage is interest on the loan. For example, if Joe and Jane’s income is $70k/year and they paid $10k in interest, they’ll be taxed on $60k. Assuming they’re in the 30% tax bracket, this will save them $3,000 in taxes for the year simply by owning. This alone gives Joe and Jane the ability to spend $250/month more in a purchase than a rental and keeps their total expenditures the same for the year. Note: this is not the case with every buyer so check with an accountant to ensure this applies to you.

Your monthly payment is made up of Principal, Interest, Taxes, Insurance, and Condo/Coop/HOA fee (if any). You’ll need to budget for repairs as well. If you choose a 30 year fixed loan, the Principal and Interest part of your payment will not change. The rest is likely to increase each year with inflation. Over time, this is less likely to change than rental payments. Lets discuss each component separately:

Principal: This pays down part of the total balance on your loan . After 30 years, your principal will be $0 and you will no longer have a mortgage payment. You will still have to pay taxes and will likely want to pay for insurance.

Interest: This is the fee the lender charges for your loan, and is typically a percentage of the loan amount. The lender will make interest on the money loaned every month from day one. However, each month slightly more money pays principal than it did the previous month and slightly less goes to interest while your total monthly payment stays the same.

Taxes: This refers to property taxes, unlike the sales tax you paid when you bought the home.

Insurance: If your home burns down, you’ll need protection. Lenders require you to carry Hazard Insurance but it’s necessary even after you pay off your loan. It will protect you from damage/destruction of your home and belongings, and many other situations that you hope will never happen to you and your property.

Condo/Coop/HOA fees: Belonging to a community that requires such fees has benefits that must be weighed while deciding if the property is a a good value. The property fee may include taxes and insurance, exterior building maintenance, common area maintenance and anywhere from no utilities to all utilities.

Call us for more information and further discussion on this topic.

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