Are you thinking of buying a new home? Are you unsure of whether or not you can afford it? The first step in the process is to look at your current expenses.
Do you hold any high-interest debt, such as credit card debt, with an interest rate above 8 percent? If so, you're probably not ready to buy a home yet. Focus on repaying your credit cards before you start shopping for a home. Your mortgage isn't the only bill that you'll pay. When you own a home, you're responsible for paying maintenance and repair costs.
You're also highly likely to want to decorate and furnish your home, which will add to your costs. You'll need to pay for inspections and closing costs, some of which will come out of pocket. Unless you get a Veteran's Affairs (VA) loan, you'll also need to make a down payment on a house.
In short, buying a house is expensive. If you're in debt, you probably don't have the capacity to make all these payments. Think of rent as the price of patience, to paraphrase bestselling author Dave Ramsey. Focus on conquering your credit card debt before you add more financial responsibility.
Debt-free? Congratulations. The next question: do you have an emergency fund? Keep three to six months of your basic living expenses set aside in a savings account that you don't touch unless you face a true emergency, such as losing your job. It isn't money that you use for holiday gifts. It is money you tap into when your car breaks down in the same week that a large hospital bill is due.
If you don't have an emergency fund, you may be a pink slip away from total financial disaster.
Ask yourself: am I saving an adequate amount for retirement? If you have a workplace retirement plan, like a 401k, contribute at least enough to get the full employer match.
If you don't have a workplace plan, open an IRA, and contribute at least 10% to 15% of your paycheck. You don't need an employer benefits package to open an IRA, which is why plenty of self-employed people, as well as people with jobs without benefits, choose to open them.
Before you buy a house, make sure you're saving at least 10%, or 15% ideally – for retirement.
Look at your budget – can you afford the cost of buying a home, or trading up from your current home? As a rule, your home-related expenses including utilities should come to no more than 35% of your overall pay, according to the five-category budget.
In other words, if you earn $2,000 per month, your home-related expenses should come to no more than $700. If you earn $4,000 per month, your home expenses should come to no more than $1,400.
Remember that you won't just pay for the cost of a mortgage. As a homeowner, you'll pay additional costs like repairs, maintenance, and renovations. Budget enough wiggle room in for this. The sum of all of these home-related expenses should come to no more than $1 out of every $3 that you earn.
You'll need the rest of your money for other purchases, like groceries, as well as savings. All your necessary purchases – including your mortgage, utilities, gasoline, groceries, car payments, and insurance premiums – should come to no more than 50% of your income, according to Elizabeth Warren's 50-30-20 budget.
This plan also says that you should save at least 20% of your income, also put aside at least 10% to 15% in retirement accounts, and the other 5% to 10% in a savings account until you have an adequate emergency fund. After that, put the remaining 5% to 10% into a college savings fund, home repair fund, savings for big-ticket items, or invest the money.