If you’ve ever been in the market for a house, you know what the real estate agent asks first. It’s not the number of bedrooms or neighborhood or whether or not the home has a detached garage.
“What is your price range?”
Because whatever you have to spend will dictate the size of your house, where it is located and its amenities. Like it or not.
But how do you know how much you can spend?
Luckily, there are a few guidelines that can help you set this price before you even call on the agent. The following three rules use math to set your home-buying budget.
The Total Price Tag: Five times your annual gross salary
Remember how the diamond industry once told young men that an engagement ring should cost the equivalent of two months income? Of course that is simply a marketing plan. But there are similar and reliable guidelines for home buying.
These days, experts recommend spending no more than five times your gross salary on a home.* Let’s say that you gross $32,450 each year. Five times that is the most you should be spending on a house.
5 • $32,450 = $162,250
With that salary, you should spend no more than $162,250 on a home.
Of course the economy should be taken into consideration. If you’re concerned about losing your job, either purchase a much less expensive home or skip home buying until things get more stable. And if you have extra expenses, like college tuition or medical care for an ailing relative, put those in the mix as well. You might consider subtracting these large expenses from your gross salary, before multiplying by 5.
*It’s worth it to mention that the experts disagree on this multiplier: some suggest 1.5 times your gross salary, while others shoot for 2.5, 3 or 5 times. It’s always best to err on the side of caution, but any of these multipliers are much better than simply taking a wild guess.
Month to Month: A percent of your monthly income
Another way to consider this purchase is by looking at the monthly mortgage payment. (You may want to do both!) Financial planners advise homeowners to spend 28% to 33% of their monthly income on housing costs — that means rent or mortgage, and maintance.
It’s okay to look at a ball park figure here. Let’s say you bring home $1,995 each month. Using the percents above, you can reasonably spend 28% to 33% of this on housing.
0.28 • $1,995 = $558.60
0.33 • $1,995 = $658.35
So all things considered, you can budget between $558.60 and $658.35 each month on housing. (Your real estate agent can help you estimate your monthly mortgage payment, which will include taxes, interest and sometimes insurance.)
Maintain and Repair: A percent of the home’s value
But what about those maintenance and repair bills? Owning a house means fixing the furnace if it goes out, getting the gutters cleaned and repairing a leaky roof.
Lucky you: real estate experts have come up with another little guideline that will help you estimate these expenses. The cost of home maintenance can be estimated at 1% to 2% of the home’s valueeach year. Let’s say you are considering a home priced at $155,000.
0.01 • $155,000 = $1,550
0.02 • $155,000 = $3,100
Does this mean you will absolutely spend no more than $3,100 each year in home repairs? Nope. Some years you may not come close, and in other years, you may exceed this amount by thousands of dollars. And as the value of your home increases — as you hope it will! — the cost of repairs and maintenance will increase as well. Still this little benchmark can help you figure out if you can afford the home you have your eye on.
So there you have it. Three rules that can guide your home purchasing process. Do a little math, and you could make a very smart home purchase.
Do you have questions about these figures? Have you used these or similar guidelines in budgeting a home purchase? Post a comment!