How to know if you can afford to buy a house

Can I afford to buy a house?

This is one of the most common – and most difficult to answer – questions asked by first time homebuyers. Buying a house is a major financial undertaking; done without the right preparation, it can leave new owners scrambling to make ends meet.

While every buyer is different, there are a number of ways to gauge whether or not you are financially secure enough to buy a home. Having an emergency fund that doesn’t need to be touched for the down payment or closing costs, carrying few other debts, or spending less than 30% of your income are all signs you can likely afford to be by a home. The following four questions can help you determine if you are ready to become a homeowner.

1. Have you budgeted beyond the monthly payment?
The cost of homeownership goes beyond the monthly mortgage payment. Make sure to factor in additional expenses such as homeowner’s insurance, trash removal, cable and internet, and utilities. Homeowners association fees can be an additional monthly expense; average HOA fees [] are between $200-$300 per month.

2. How much of your income are you spending?
Is the total amount of the mortgage, insurance, and other expenses less than 30% of your monthly income? If so, you are probably ready to buy. Keeping housing expenses at less that 30% of the income gives you the freedom to continue to invest and save – and prevents you from becoming house poor.

3. Can you afford the down payment without dipping into your emergency fund?
All adults should have an emergency fund that is the equivalent of three to six months of their salary; this is to ease financial stress in the event of job loss, major medical event, or more. If you cannot afford to make a down payment or cover closing costs without dipping into your emergency fund, you may not be ready to purchase a home.

4. Can you make a full down payment?
The majority of lenders require a 20% down payment for traditional mortgages. Paying less than this requires PMI, or private mortgage insurance. PMI can cost between 0.3% and 1.2% of the balance of the loan; having the full 20% down payment eliminates the need for this additional expense.

5. What is your debt to income ratio?
While it is possible to have other debts and purchase a home, a high debt-to-income can make it difficult to be approved for a mortgage. Calculate your debt-to-income ratio by adding up the monthly payments for debts such as student loan payments, car loans, or credit card debt; then, divide this amount by your monthly income.

Most lenders want potential buyers to have a debt-to-income ratio of 36% or lower, while 43% is generally the highest ratio a buyer can have and still be approved for a mortgage. Buyers with lower debt-to-income ratio can often get lower interest rates – and higher approval odds; lower your debt-to-income ratio by paying off as much debt as possible in the leadup to buying a home.

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