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Buying a House That’s Financially Comfortable for Your Family

If you want your house to be something you enjoy, not detest, it’s imperative that you spend time thinking about affordability.

Personal finance guru and national talk show host Dave Ramsey frequently tells his readers and listeners that a house can either be a blessing or a burden. If you want your house to be something you enjoy, not detest, it’s imperative that you spend time thinking about affordability.

The Misconception of Affordability

The average homebuyer has a grave misunderstanding of the idea of affordability. They walk into their local bank or credit union, fill out some paperwork, and get pre-approved for a specific dollar amount. Then, they return home and start looking for houses that are at or around that exact number. The problem is that, in most cases, this pre-approval figure isn’t exactly affordable.

When a bank approves a mortgage amount, they use various formulas, mathematical equations, and ratios to speed up the process. They’re in the business of making sure their clients don’t default on their loans. As harsh as it may sound, they don’t care about much else. They don’t care if a mortgage puts a strain on you financially, so long as they get paid on time, every time. They’re in the business of turning a profit, not holding hands.

While every lender uses its own numbers, most look at a Gross Debt Service (GDS) ratio and a Total Debt Service (TDS) ratio. The GDS ratio takes your gross annual income into account and then looks at projected mortgage expenses (including principle, interest, and taxes). Most lenders believe that your mortgage expenses should account for no more than 32 percent of your income. The TDS ratio says that your total debt (including car loans, student loans, etc.) shouldn’t exceed 40-43 percent of your gross annual income.

While lenders have obviously figured out that these ratios give them the best chance of being repaid, they can put a huge strain on a family. If your family brings in a gross income of $100,000 a year, then spending $32,000 annually on mortgage expenses isn’t a great idea. Your actual income after taxes and health insurance have been taken out is probably closer to $80,000 per year. That would leave you with just $48,000 to cover the rest of your spending and saving throughout the year. It’s doable, but it’s tight.

A much better solution is to use the lender’s approval numbers as a guide. If you’re pre-approved for a $225,000 loan, look for homes in the $200,000 range. Or perhaps spend the next year saving money to put towards a down payment so that you can get the house you want, without going $225,000 into debt. There are plenty of options. Make sure you explore as many of them as possible.

Determining What You Can Actually Afford

Sometimes the bank’s approval numbers make sense. Other times they don’t. But how do you determine how much house you can actually afford? Here are some helpful tips:

1. Be Realistic With Square Footage

Square footage and location are typically the two most important factors in a home’s price. Let’s begin with the former.

Because most home values are influenced by the price per square foot in the area, it’s extremely important that you know how much square footage your family really needs. Buying a home with 3,500 square feet, versus one with 3,000 square feet, might not seem like a big deal on paper. But if the average price per square foot is $150, you’re looking at an extra $75,000. Keep this in mind and be realistic with your needs.

2. Be Flexible With Location

Once you know how much square footage you want, start to be a little more open about location. You might have your eye on a specific neighborhood or area of town, but is it affordable? Sometimes you can get a lot more house by being willing to move a couple of blocks or streets over.

3. Use a Conservative Formula

While Dave Ramsey often catches some flak for being too safe with his numbers, he advises his followers to use more conservative numbers than the lender. His rule of thumb is to multiply your monthly take-home pay by 25 percent to get your maximum monthly mortgage payment (including principle, interest, insurance, and taxes). Thus, if your take-home pay is $5,000 per month, you should be spending no more than $1,250 per month on your mortgage.

Adding it All Up

A home purchase is one of the most important and expensive investments you’ll ever make. By carefully crunching the numbers, you can ensure your new house is a blessing, not a burden. Best of luck!