How to Determine If You Can (Actually) Afford a Home Right Now

How to Determine If You Can (Actually) Afford a Home Right Now

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In 1959, my Italian grandparents purchased their first home in South San Francisco.

They were both in their mid-20s and my grandfather was just returning from the Navy where he served in World War II.

This simple 3 bedroom had many great memories along with a few hiccups including a chimney that collapsed in 1960 during an earthquake and constant water issues that often flooded the house with heavy rain.

And the cherry on top? This home would cost them a whopping $20,000.

My grandparent's home, South San Francisco, Ca. Circa 1965.
My grandparent's home, South San Francisco, Ca. Circa 1965.

When you hear this story, you might also imagine your parents or grandparents who bought a home and lived their American Dream. But when will it be your turn?

Can you afford a home right now? And if you can, should you actually buy one?

The dead simple truth comes down to answering these three questions.

  1. What are the signs I should NOT buy a home?
  2. What is my total cash requirement?
  3. What is the cost of staying in my new home?

So follow along as we dig into these three questions.

1. What are the signs I should NOT buy a home?

Here are 5 signs you probably shouldn’t buy a home right now.

  • You are only planning to live there for a short period of time. Real estate purchases are like red wine. Time makes it better. If you only live there for a short period of time, you'll find yourself breaking even or even worse.
  • You have a significant amount of debt. If you're a graduate with a significant amount of student debt, it more than likely will be difficult for you to get a mortgage. This can be especially difficult for new physicians and lawyers. Depending on your salary and total debt, it might make sense to wait.
  • You're in a rush to buy. Being in a rush can bring about a few challenges. This could lead to unnecessary compromises and buying a house that you aren’t truly happy with.
  • It will deplete your emergency fund. Buying a home should not deplete your emergency fund. Overextending yourself and depleting your emergency fund can ruin financial stability. Don’t comingle your emergency fund with your down payment.
  • It will make you “house poor.” This can happen when you take on too much mortgage debt relative to your income, or when your monthly housing costs, including mortgage payments, property taxes, and insurance, exceed your budget.

Everyone has a unique situation, but these are the common signs. Say these seldom apply, how much money do I actually need to make this happen?

2. What is My Total Cash Requirement?

The true cost of owning a home starts with the cash requirement.

Knowing the price is a good start, but you need to understand how much cash you'll need to actually buy it.

I am not just talking about the sticker price. Know the closing costs which are generally 3-5% + down payment (20%) + miscellaneous costs (3%).

Let’s look at an example:

Putting 20% down on a $700,000 home requires $140,000. Closing costs are generally 3-5% of the mortgage amount and include items like lender fees, prorated property taxes, inspection, appraisal, attorney fees, title search, and insurance fees. Let’s be conservative and use 5% of a $560,000 mortgage, or $25,000 for closing costs. Then, add another $15,000 as a budget for anything miscellaneous. Lastly, let’s make sure you have a cash reserve of $30,000. In total, your cash requirement for this home is $195,000.
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Say you are planning to purchase the home mentioned above, let's assume you've done a good job saving and already have $125,000 in the bank.

If you want to buy this $700,000 home in the next two years you would need to set aside approximately $2,916 a month over the next 24 months to save the remaining $70,000.

It's also important to mention that it is rarely a good idea to invest that money. Markets can take that money and set you back months or years if the timing is wrong.

I often recommend using a High Yield Savings Account or Certificate of Deposit (CD).

The next step is to know how much it costs to actually stay in the home after purchase.

3. What Is The Cost of Staying In My New Home?

With our prior example above you’re looking at an estimated total monthly payment of $4,863/mo.

You can use this simple and free mortgage calculator to play around with your own budget.

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If your household earns around $208,000 Gross Income per year that's around 28% of your total income going to your home.

The 28% is usually a ratio that lenders use to assess if you are eligible for a loan. But it does not include your other debt. It’s also useful to compare this number to what rent would cost.

The great thing about a fixed mortgage is that you are not subject to your landlord increasing rent.

Thus the payments stay consistent through the decades.

At the end of the day, owning a home is a cherished part of the American dream. But it may also be the largest financial investment you will ever make.

That’s why it’s so important to get financially ready to buy and take care of a home and to feel confident that now is the right time for you to step into the shoes of a homeowner. This is where financial planning can help make this decision even more crystal clear.

At the end of the day, this is a personal calculation and nothing else matters if you can't afford to live comfortably.

Final Thoughts And Action Items:

Knowledge is only valuable if you put it into action.

Your mission, if you choose to accept it, is to:

  1. Calculate your cash requirement on a home you wish to buy.
  2. Determine if you can afford to live in the home. Here is a free mortgage calculator you can use: https://www.mortgagecalculator.org/
  3. Download my free guide: The Ultimate Planning Checklist for Buying A Home

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