How much home can I afford? By Suze Orman

Buying a home has always been a big financial step, but the stakes right now border on dangerous if you’re not smart and careful.

The median price for a single family home rose 16% last year to $364,000 at year end, according to the National Association of Realtors.  That median price has increased nearly $100,000 since 2019.

I sure hope your career is going gangbusters, but chances are your salary hasn’t kept up with the increase in home prices. And that’s what makes home buying today potentially dangerous. Stretching to buy a house that isn’t truly in your financial comfort zone can be a mistake that will weigh on you for decades.

Here’s my guide for how to make sure you don’t end up making a costly financial mistake.

What every renter MUST understand

If you are a first-time home buyer, please do not make the rookie mistake of thinking that your current monthly rent is a good guidepost for the monthly mortgage payment you can afford. As a homeowner you will have significant additional costs: property tax, insurance and maintenance. My rule of thumb is to add 30% to the base cost of a mortgage to cover all those expenses. For instance, if the base mortgage is $1,000 a month, I recommend assuming your monthly cost to cover tax, insurance and maintenance will be $1,300.

And keep in mind, that to land a mortgage, a lender will generally want to see that your monthly mortgage is no more than 28% of your gross (pre-tax) take home pay, and that your mortgage payment plus any other debt payments (credit card, student loan, car loan) is no more than 36% of your gross monthly take home pay. These are known as the front-end (28%) and back-end (36%) debt-to-income ratios. DTI

Some loans allow even higher DTI ratios. I don’t think that’s necessarily a good thing. It is a yellow flag to me that you are taking on too much debt. You have all sorts of options. Look for a less expensive home. Or spend some time cranking on repaying other debts so you will have the lowest possible DTI, not the highest allowable.

Aim to make a down payment of at least 10%

Notice I said “at least.” To be honest, my best advice is to make a 20% down payment. You need to realize that any mortgage with less than 20% down is going to require you to pay for private mortgage insurance (PMI). And the lower the down payment, the more PMI you will likely owe. A low down payment can also mean the interest rate on the mortgage may be higher as well.

And my bigger issue is that if you are only able to make a very small down payment, I think that’s a signal you are stretching your finances.

I am not suggesting that means you can’t afford to buy a home.  I am suggesting that you look for a less expensive home.

Have one year’s worth of living expenses set aside in a savings account

When you apply for a mortgage, the lender will likely insist that you have enough in savings to cover a few months of mortgage payments. Consider the Alliant Ultimate Opportunity savings account. That gives you peace of mind that in the event of a layoff, or a serious injury or illness you have plenty of money to stay on track with the mortgage and all your other housing costs.

Research home owner’s insurance costs

This is an ongoing cost that too often people don’t carefully work into their housing budget. My advice is to purchase a policy that provides “extended replacement cost” coverage. It is far better than actual cash value and replacement cost coverage.

Actual cash value will have the lowest monthly premium, but I think it can end up costing you big time because when you make a claim you will get paid the depreciated value of what you need to repair replace. That’s not going to cover your costs.

I also am not a fan of “replacement cost” because in the event of a total home loss, your payout is limited to 100% of the original value of the home and your possessions. That original cost means you aren’t protected from rising prices.

Only extended replacement coverage provides inflation protection, as the payout can be more than the original value stated on your policy. For example, replacement cost will pay up to 100% of your policy’s limit. But with extended replacement coverage, your coverage can be as high as 120% to 125% of your policy value. I think that’s the best way to guard against the rising cost of construction materials and labor.  I want you to make sure that your housing budget can cover the cost of having extended replacement cost coverage.

Focus on the home you need

Okay, by now you may be getting a bit peeved with me. Making a bigger down payment and buying the more expensive homeowner’s insurance might seem like a way to big hurdle.

I don’t think so. You just need to broaden your search. 

You may want the 4-bedroom on your dream street or neighborhood. But the 3-bedroom in a less costly area is how you right-size your home costs. Again, stretching to afford a bigger home, or a place in a high-demand area is dangerous if it keeps you from other important financial goals. It also can lock you in to a lifestyle you may come to regret. People with big mortgages and high housing costs typically won’t be able to consider career shifts, or time off to recharge. The less expensive home gives you room to work on other financial goals (retirement, retirement, retirement!) and also can buy you more flexibility in the years ahead. Isn’t that your idea of a dream home?

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Suze Orman is the author of 10 consecutive New York Times bestsellers, a two-time Emmy award winner, and your go-to for honest answers on everything finance. She is the most recognized personal finance expert in America today and host of the Women & Money (and Everyone Smart Enough to Listen) podcast. Suze is excited to be a contributor for Money Mentor.

Suze and Alliant teamed up to help Alliant members make the most of their life by teaching them to make the most of their money. New Alliant members are also eligible for The Ultimate Opportunity Savings Account.