For many first time home buyers, buying a home can be tricky and overwhelming at first. The best advice I can give about that is to make sure that your finances are in order before you purchase a home. With this article, I hope to show how much you actually need to make before you make a large purchase on that house. So, how much income do you need to buy a house? Well, it depends.
Given your monthly income and expenses, you can figure out how much house you can reasonably afford, but it is also wise to have a safety net in case things go sour and you are in need of emergency cash. After all, a typical home can cost $200,000 plus closing costs, spread out in a 30 year mortgage; so that is quite a financial commitment to make.
Aside from your usual expenses like credit card bills, auto loans, student loans, and any other type of recurring debt obligations, you are now adding a mortgage payment. A mortgage payment will include the principal, interest, property taxes, mortgage insurance (PMI if your initial downpayment wasn’t big enough).
The best way to figure out whether or not you can afford a home is to run the numbers first and to see if they make sense. A simple formula to use is:
(Expected Mortgage Payment + Consumer debts (student loans, other loans)) ÷ .36 = Gross Monthly Income Needed To Safely Purchase
Usually, when you go to a mortgage lender at a bank, they will calculate your debt-to-income ratios to see if you qualify for a loan. Their calculations run between 36% to 45% of monthly debt to Gross income. The lower the percentage, the more of a cushion to give yourself.
Most mortgage lenders limit your debt-to-income ratio (how much of your monthly income pays debt) to between 36 percent and 45 percent. While the exact ratio varies by lender and loan type, it’s best to base your calculations on the lower end to ensure that you won’t overextend yourself financially.
Let’s say that your want to pay $1,000 a month on a mortgage, and have consumer debts of $200 per month. Using the equation above, you would require a gross monthly income of $3,333, to pay off your debt and live comfortably with that income. You can never be too safe with planning your finances because you never know what kind of emergency could arise in the future.
A common way to lower your mortgage payment is to either buy a cheaper house, or to put up a larger downpayment. Let’s say you can only afford a $900/month payment on a house or condo but are looking at a $200,000 house. What would your loan look like?
Interest Rate: 3.3%
Term: 30 year loan
Your monthly payment would be $788.32 with total payments after 30 years equaling $283,794.98. Your Gross monthly income required to safely pay this loan would be $2,884.22 with $250 in consumer debt. (Information taken from http://www.mortgagecalculator.org/
So if you are wondering if you are financially ready to buy a home, also keep in mind the stability in your gross income. If you just graduated from school and got a job for 6 months, there is not enough recurring history of this type of gross income, even if you qualify for a mortgage. A good rule of thumb is 3 years of earning history that averages the gross income required.
Determining if you can pay off the mortgage is one thing, but determining if it is a good to take on this amount of debt is another question to resolve. As a cash flow investor, I would recommend having your investments and businesses to pay off the liabilities that arise from home ownership. Even if you do have a fulltime job, have your passive income from stock dividends, rental properties, vending machine business, or eccommerce site pay off the mortgage. That would actually be the smarter way of managing your debt.