How much can I afford?

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Once you have a general idea of what type of home you are looking for and where, you need to determine how much house you can afford. This depends on many factors, such as your income, savings, and spending preferences. If you aren’t realistic and buy more than you can afford, you’ll be on the path to foreclosure and the loss of your down payment.  From your years of renting, you should have a good idea of what monthly payment you can afford.  Typically your mortgage payment should be no more than 25 to 30 percent of your monthly income.  It may be helpful to use an online calculator to give you an idea of how much you can afford. 

In addition to your monthly payments, you will need to be prepared to pay all of the upfront costs. Here are the major components:

Down Payment
Mortgage lenders almost always require the home buyer to pay at least about 20% of the purchase price at closing. This protects the lender in case the value of the home drops: a homeowner who owes more than the home is worth has no incentive not to walk away from the property. It also helps the lender recover a larger portion of its investment if it has to sell the home through a foreclosure sale. Don’t deplete your savings to cover the down payment. Protect yourself from unforeseen circumstances by ensuring you still have enough savings to cover at least three months of expenses.

Earnest Money
When a potential buyer makes an offer and the seller accepts, no binding contract is immediately created, due to the complex legal formalities required for a real estate transfer.  Finalizing the sale will take days or weeks.  Yet, if the buyer backs out, the seller will have wasted valuable time, effort, and money on pursuing that sale.  Thus, to protect the seller, a buyer is required to tender earnest money, typically 5% of the purchase price.  When the seller accepts, the money is deposited into an escrow account (an account under the control of an independent party).  If the buyer backs out after the offer is accepted, the earnest money is kept by the seller. 

Closing Costs
At closing, the buyer and seller will face a number of transaction costs in addition to the actual purchase price. The following costs are typically paid at or shortly before closing:

  • Attorney Fees -  Lenders typically require buyers to hire an attorney to ensure that official documents are properly prepared and recorded.  Sellers and lenders, too, will often be represented by an attorney. Each party covers its own attorney fees.
  • Title Service Costs – The buyer or seller will have to pay for title services such as a title search (to ensure the title is valid and free of encumbrances) or title insurance.  Attorneys sometimes offer title services, so the fees would be combined.
  • Recording Fees – When the title to real property changes hands, the transaction must be recorded at a local government office.  One party will have to pay a small recording fee.
  • Survey Fee – Before closing, the buyer will want to hire a surveyor to confirm the lot size and dimensions and to check for encroachments.
  • Mortgage Application Fees – Prior to or at closing, the buyer will have to compensate the lender for the costs of processing the loan application. 
  • Appraisal Fee – Before closing (and probably before making an offer), the buyer will want to hire a professional appraiser to estimate the market value of the real estate.  Lenders will require this to ensure they are not lending more than the value of their collateral.
  • Inspection Fees – Before closing, the buyer will want to hire inspectors to ensure that the structure is in good shape and free of infestations.  Lenders will sometimes require this to ensure they are not lending more than the value of their collateral.
  • Flood Certification – Lenders often require the buyer to pay for an inspection to determine whether the property lies in a flood plain.  If the property is at risk of flooding, the lender will likely require the buyer to purchase flood insurance (since flood damage is excluded from standard homeowner’s insurance policies) to protect the value of their collateral.

Homeowner’s Association Dues
Homes in some neighborhoods are automatically part of the local homeowner’s association, and thus required to pay dues that go to community events and facilities.

The costs don’t stop there.  You may need new appliances or new furniture.  You may need to buy a lawn mower or hire a professional landscaper.  All of these costs need to be considered when determining the cost of your new home.