Determining your budget is an essential step in the home buying process, as it allows you to determine your financial conditions and sets the foundation for your property search. This article outlines five key steps in establishing your budget.
Assess your finances: Begin by evaluating your current financial situation, taking into account your income, savings, investments, debts, and any other sources of funds that can be allocated towards purchasing a home. If you plan on taking out a mortgage, consider your monthly cash flow to help determine how much you can afford.
Figure out your affordability: Next, figure out what you can afford in terms of monthly mortgage payments. To give you an idea, a general guideline is that your monthly housing costs should not exceed 25-30% of your gross monthly income — this includes mortgage principal and interest, property taxes, insurance, and homeowners association fees, if applicable. There are various mortgage calculators available online to help give you an idea — try Bankrate, NerdWallet, or Bank of America.
Consider additional costs: Apart from the mortgage payments, there are various other costs associated with homeownership that need to be considered. These may include closing costs (such as appraisal fees, attorney fees, and title insurance), property taxes, homeowner’s insurance, maintenance and repair expenses, and any potential renovations or upgrades you plan to make. Factoring in these additional costs will give you a more accurate picture of your budget. A good rule of thumb is to assume it will cost $1/year for every square foot of your house’s living space.
Get pre-approved for a mortgage: Once you have a general idea of your budget, it’s advisable to get pre-approved for a mortgage from a lender. This process involves providing your financial information to the lender, who will then assess your creditworthiness and provide you with a pre-approved mortgage amount. This step helps you understand the maximum loan amount you can secure. In a competitive market especially, mortgage pre-approval demonstrates to sellers that you are a serious buyer. In a bidding war, the only thing that beats a mortgage pre-approval is an all-cash offer or a higher bid.
Floating rate or adjustable rate?: A fixed-rate mortgage protects you from increased interest rates, but will leave you paying more than you would have if interest rates fall. An adjustable-rate mortgage will give you lower mortgage payments if interest rates fall, and higher mortgage payments if rates rise. Which one is better? It depends on inflation and what the federal reserve decides to do. Interest rates in the US are at a roughly 20 year high after recent rate hikes designed to combat inflation. Most analysts think they’re unlikely to increase much further, and could fall somewhat over the next couple of years. But you will need to make your own judgment depending on your risk tolerance.
Consider your long-term financial goals: While determining your budget, keep your long-term financial goals in mind. Evaluate how purchasing a property aligns with your overall financial plan, such as retirement savings, education funds, or other investments. Striking a balance among all of your financial priorities is a smart approach.
In sum, by assessing your finances, calculating your affordability, considering additional costs, and obtaining a mortgage pre-approval, you can confidently determine your budget and begin your property search. Remember to be realistic and choose a budget that allows you to comfortably manage your monthly expenses, while also considering any future financial goals.