Broker Check

What House Can You Afford?

October 28, 2020

From online calculators to mortgage approval rates, there’s so much information published about how much you can spend on a house. With all this information available, I always get asked how much can someone spend on a new house.

When buying a house, there are so many conflicts of interest. The purchase of real estate pays realtors, mortgage lenders, title companies, etc., and the more expensive the house, the more each party earns on the transaction. With any transactional relationship, the motivation behind each recommendation is in question. The mortgage lender might lend up to 40% of someone’s gross income, so does that mean you can spend 40% of your gross income on a house? Transactional relationships are complicated. It’s in the mortgage lender’s best interest to put their customers in as much debt as possible. I’m not necessarily suggesting that your mortgage lender is your adversary, but a lender’s interests and a buyer’s interests aren’t always aligned. Understanding the complexities of these relationships might help with responses to information that’s available. For example, if a mortgage lender has a calculator on how much house you can afford, the information is probably biased toward the lender making more money on interest paid as a result of issuing a loan.

When I have a client looking for a new house, I typically ask a few questions to find out what they want from the house. A few examples might be: Is this a long-term house or a short-term house? How important is the neighborhood or community? Do you plan on having more kids? Are you intending to spend lots of time in the house or will you be working long hours and traveling as much as possible? Will there be added time and expenses with entertaining in the house? Questions like these might help analyze the need for a new house. I’ve had several clients come in to talk about buying a new house, and after our conversation, they realized they’re actually in the perfect house for their family.

Sizing up the desires from a new house helps organize thoughts about how much money should be allocated to a mortgage. Some factors to consider when determining how much to spend on a house are economic conditions and future financial obligations. Economic conditions might come in the form of mortgage interest rates or job security. With interest rates low, housing purchases are ideal. But with economic uncertainty and hospitals laying off and furloughing physicians, current and future income stability might be in jeopardy for a couple of years. Future financial obligations come in the form of paying for kids’ college tuition, lifestyle adjustments, and saving for retirement. A long time ago I met with a family and had to boil down a decision to either buy a house or retire. Before they met with me, they received financial advice from a TV guru, and they had aggressively paid down debt to the point where they had nearly zero savings. The entire family was uncertain of their future, but they had delayed a house purchase until their debt was gone. At that point they had little liquidity and assets, and they had virtually no direction to their planning. All their financial decisions had come from a guru’s perspective to eliminate debt at all costs, and they had very little education on building assets and wealth, so our conversations weren’t always easy, but I helped them see their finances differently. They ultimately chose to buy a house and keep working beyond normal retirement age. Financial planning is a series of give-and-take decisions. Home buying is no exception.

As far as decision-making goes, there are emotional decisions and rational decisions. Understanding where emotions cloud reason is critical when purchasing a house. When buying a house, people often buy all the possibilities of future memories. Sometimes a house might even represent a status symbol in size, price, or location. It’s important to understand these reactions are all emotionally driven so clear decision-making can be present at all times during the purchase. Most emotional reactions and responses about a house will fade once purchased, and that can lead toward a feeling of buyer’s remorse.

Ultimately, when a client asks me about what house they can afford, I help them understand the size of a mortgage as it relates to a monthly budget. Then I factor in property taxes, HOA dues, and insurance costs. Once these figures are assessed, we have some basic talking points for relating a mortgage payment to current and future income. There’s no formula for how much to spend on a house, but as a generality, I usually recommend that no more than 15% of your income goes toward your mortgage, so I’ll help calculate what that maximum mortgage might look like. Then I’ll put into perspective how larger living expenses compete with paying off student loans, traveling, retirement, etc. A larger mortgage might mean a smaller and tighter lifestyle everywhere else. A smaller mortgage might mean more savings and more freedom to travel, explore, and play. Whatever choices are made on the house can have a lasting impact on future finances, either positive or negative.

Values, expectations, and reasons for purchasing a house are different for each person. Some people might opt for maintenance-free living and some might prefer acreages. There isn’t preset prescription for buying a house, so even with all the information available on how much you can spend on your new house, nothing beats basic conversations and calculations.