Setting a realistic budget before you begin seriously looking for a home to purchase is key to making the process as efficient and stress-free as possible.
But what constitutes a "realistic budget?" Well, there are plenty of rules of thumb that can give you a ballpark estimate of what your budget should be—such as looking for a house that costs no more than four times your annual income, for example. As you get closer to signing on the dotted line, however, you'll need to get more specific.
The following steps can help you determine how much home you can afford—without getting in over your head or jeopardizing your other personal financial goals:
1. Talk to a lender. Sitting down with a mortgage lender is the easiest way to establish the upper range of your budget. Getting pre-approved for a mortgage, which requires a credit check and verification of your income and assets, not only provides you a firm borrowing limit that can guide and focus your search, but also makes you a considerably more attractive candidate to sellers in the event of a bidding war.
2. Test run the new budget. While on the hunt for a home, start living as if you're already making those mortgage payments: You'll save some extra cash to put toward your down payment—while you can get a mortgage now with as little as 3.5 percent down, putting down 20 percent or more will secure a lower rate and reduce the long-term cost of the loan—and also have a little more time to get used to any necessary lifestyle changes.
3. Consider the true costs of the house. There are plenty of upfront costs to purchasing a home—your down payment and the cost of the move, for example—but also many ongoing expenses to consider as well. Your mortgage and property tax payments are only the beginning; expect to spend more each month on everything from insurance to utilities to landscaping. A 2015 study from Zillow found that unavoidable homeownership costs total more than $6,000 per year. Optional maintenance costs run another $3,400.
4. Plan for the future. Remember, your mortgage lender only looks at your current finances when reviewing your loan application, so it is essential that you factor in the ways your finances may change before taking out that mortgage. If you’re planning on retiring or having a baby, for example, you may suddenly have one fewer income with which to pay all the housing expenses.
5. Keep other money goals in mind. Buying a house is an important investment that can help you build wealth and equity, so buy within your means and take steps to ensure the purchase doesn't negatively impact your ability to keep up with your other long-term financial goals. Continue saving for retirement and make sure that you’ve got at least six months' worth of expenses set aside in an emergency fund.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917