The surprising way to know how much you should spend on a home
Personal finance gurus often tout a standard formula for how much house you can afford.
Sometimes it’s that you should ‘spend 30% of take home pay’ on your mortgage. Or sometimes, because housing is getting more expensive, the new number is 40%.
Why percentages don’t make sense
If you think about it, percentages don’t make any sense at all.
Here’s why. You have different goals and completely different circumstances than other people.
Consider these two friends, Frank and Dave. Frank and Dave make the exact same amount of money.
Dave is single, likes to travel the world and is looking to retire before the age of 50. He has no student loan debt and doesn’t plan on having kids.
Frank, on the other hand, is married with two kids. His wife works also and makes the same amount as he does. He’s not big on fancy vacations. He pays alimony to his previous wife, and is also taking care of his parents. He contributes to a 401k and a college fund for his kids.
Each of them has individual responsibilities, lifestyles and goals. If you slapped a 30% mortgage on both of them, it wouldn’t take into account their unique situations, responsibilities or dreams.
Why your mortgage loan officer shouldn’t decide either
The more your loan is, the bigger the commission your loan officer may get, depending on how they are compensated. They shouldn’t be the determining factor in figuring out how much should you spend on a home.
They will qualify you for the largest loan that you can qualify for with your credit score and income profile, so that you know your absolute limit.
That does not mean that you should necessarily spend that much. You would be letting the loan officer decide on your future finances!
The surprising (and straightforward) way to know what to spend
- Figure out how much you make and spend. Remember to include things like credit card bills, other debts, and expenses for things like trips and entertainment along with your regular bills.
- Paint a picture of your expenses after you buy a home. What will change? If you are renting now, be sure to compare household bills now with one of a homeowner, like homeowners insurance, and home maintenance. If you want to learn about the true cost of owning a home, take a look at this guide.
- Determine your short and long term financial goals. Do you plan to have kids, boost your retirement savings or increase your investments? Make sure to include your life goals in your financial planning.
You will come up with a nice picture of how much should you spend on a home and still live the life you want and deserve.
And, you’ll be prepared when the loan officer says you can afford a certain sized mortgage. You’ll say, “pump the brakes! I already have my magic number!”