Buying a home may be, for some people, the ultimate symbol of adulthood and even success. But you shouldn’t sacrifice your other financial goals just to be a homeowner.
Saving for retirement, putting aside money for your children’s college and contributing to an emergency fund are also important financial aims to balance along with meeting your day-to-day living expenses. Adding a mortgage and other homeownership expenses shouldn't make you house-poor, and compromise your ability to balance all your financial priorities.
To understand how much you can afford to spend on a home, some financial professionals recommend using the 50/20/30 rule, a budgeting guideline that divides your spending into three broad areas:
- Dedicate no more than 50% of your income to fixed costs such as housing, car payments, insurance, utilities and so on.
- Put 20% into long-term financial goals such as retirement, an emergency fund and college savings.
- Spend the last 30% on fluctuating categories including dining out, hobbies or shopping.
If your money is all tied up in a house you can’t really afford, you won’t have any left over for these other goals, and it will be hard to build a financially comfortable future – or a secure life right now.
Know your budget
It’s easy to see how you might get in over your head with a home purchase. You fall in love with the perfect house that’s just outside your price range. When you put in an offer, there’s a bidding war and you find yourself spending more than you planned – sometimes as much as 10-15% above the asking price and above the amount you have been pre-approved to spend.
You went into homeownership with your heart instead of your head. Many homeowners, of course, learned an extremely painful lesson about overextending themselves during the housing crash and financial crisis of 2008. While the market has largely recovered, buying more home than you can truly afford remains a dangerous game.
How can you ensure you are seeing the full financial picture and avoid getting in so deep with your dream home that you’re threatening your other financial goals?
Understand the hidden costs
Remember, a mortgage is just the beginning when it comes to all the other expenses you have as a homeowner. Depending on where you live, you may find it’s actually cheaper to rent than to own. This may mean you are able to put more away for those other crucial financial goals – including saving up for a down payment for a future home purchase – by renting.
Other costs of homeownership you may not be aware of include:
- Property insurance: you need enough coverage to be able to replace your home in case of a major disaster. Plus, mortgage lenders require you to carry it.
- Property taxes: as states and cities try to close budget holes, property taxes are likely to increase.
- Maintenance: homeowners should budget 1% to 2% of a home’s purchase price for maintenance each year, according to the University of Illinois Extension. On a $300,000 home, that means $3,000 – every year.
- Homeowner association fees: many communities charge residents a fee to maintain common areas
Leave your options open
You never know when job opportunities, romance or family obligations might shape your future residence location. You might want to consider holding off on buying a home until you feel reasonably locked into some of your other life goals and responsibilities: career, love and family.
While you may be able to get a loan with only 10% down (or, in the case of Federal Housing Administration loans, just 3.5% for borrowers with poor credit), a 20% down payment puts you on much stronger financial footing.
It lowers your monthly mortgage cost – both because you’re borrowing less and because you might pay a lower interest rate when you have more equity in your home – and eliminates the need to carry private mortgage insurance, yet another expense.
Take time to build up your down payment as you also work on other short- and long-term financial goals, so you have a better chance of getting a loan with the best rate and terms.