Besides buying a new car or entering a marriage, purchasing a home could be one of the most important decisions of your lifetime.
Not only does buying a home give you a place to live, it could also play into your financial health.
Hopefully, when you do get ready to buy the home of your dreams, it helps you build net worth and obtain some financial freedom. However, if you go ahead and settle on a big home that you really can’t afford, it could backfire and cause stress.
So, how do you know if you are able to afford a big, new house? There are some things to consider before signing on the dotted line.
Way beyond your current budget
If you follow a monthly budget for everything from groceries to utility bills, opting for a large, expensive home may not be in your cards. After all, you are on a budget with everything else, why would buying such a home be any different? If you go beyond your budget at any time and for any reason, this simply means you are stretching yourself too thin.
If you can’t figure out your budget, try to calculate your current income and expenses monthly. You can certainly add in some wiggle room in case your expenses increase, but don’t always count on your income rising. Do consider how much you’d like to save and invest each month. When searching for mortgage payments, any figure higher than this could strain your finances and place you at risk of not being able to keep in line with your monthly budget.
Don’t assume future income and/or expenses
Some homebuyers think they can purchase a larger home (and one that they potentially might not be able to afford) because they will be making bigger money and more of it in the future. Have you ever heard that saying: ‘Don’t count your chickens before they hatch?’ In other words, while it’s nice to dream about making more money at some point, don’t believe it – or spend it before it does happen.
It’s next to impossible to forecast what your future income and expenses will be without knowing what the facts are and really where you will be in the future. This means when budgeting for a new home, take a conservative look based on your current income, and assume most expenses will certainly rise if you plan to start or expand your family. A simpler approach might just give you the incentive to save money, invest, and pay off the house totally at some point.
Can’t put 20 percent down
There are several advantages to placing a sizable down payment down on a home. The more you put down, the less you’ll have to borrow, which means you’ll begin with a bigger piece of equity in the home. Putting more money down also likely means a lower interest rate, and less in interest payments overall. If you can’t place 20 percent down, most lenders require you to purchase private mortgage insurance (PMI), which ultimately adds to the cost of the loan.
Perhaps instead of jumping into buying, consider saving more for a bigger down payment.
Interest rate is way too high
Some say interest rates are low at the time of this writing, but it’s certainly possible that you could end up with higher rates if banks see you as a risky borrower. If you have high debt, a low credit score, or maybe both, this could result in a higher-than-average interest rate. As a result, this could likely mean your monthly mortgage payment will be higher.
If your interest rate seems high to you, ask yourself why. It’s possible that your finances are in less than stellar shape, so if this is the case, consider buying a house that’s not as costly.
Don’t let emotions get in the way
The house in question has a beautiful front and back yard, and it’s sitting pretty at the end of a cul-de-sac. The neighborhood seems ideal and the school district is said to be top-notch. Yeah, the house is expensive, but no question, it’s your dream home.
Sure, but it may also turn out to be your worst nightmare if you let your emotions override everything else. Buying a home is a financial decision, but sometimes we let our emotions take over and make important decisions for us. Don’t let this happen, as you could be in store for an incredible let down if you can’t afford the mortgage payments. Word to the wise: make sure affordability plays more of a part than emotions when home hunting.
Unusual mortgage terms
There are several different mortgage products to choose from, but the most common is when you place a certain amount of money down, and take a loan with a fixed interest rate, paying it back over an agreed-on term (usually 15 or 30 years).
However, this isn’t to say you will qualify for a fixed-rate mortgage. If this happens, it means banks will often offer different kinds of loans. They can include adjustable rate mortgages, in which interest rates may begin low but increase further down the road. Or, they may be negative amortization loans, meaning the amount owed grows larger over time vs. shrinking.
If you are buying a home with a nontraditional mortgage — or if you don’t understand the mortgage terms from the get-go — you could be taking on a home that’s way beyond your budget.
In the end, buying that ‘dream house’ is what many of us hope to accomplish at some point in our life, but it shouldn’t come at the expense of falling into debt. It’s highly possible that you might just have to forgo the big backyard and opt for something smaller and more affordable.