Many of us want to own our own homes. I mean, isn’t that part of the American dream? The white picket fence, tire swing, two cars, apple pie, and a dog are all a part of the idyllic American lifestyle. Owning your own home is a good goal to have. But how much should business owners pay for a house? This is the question that I seek to answer with today’s post.
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One of the single greatest rites of passage as an American citizen is buying your own home. When you own your own home, you make the rules. You can decorate and modify it however you’d like, have pets, or anything else that you want to do. It’s your home! However, this brings to question, how much should business owners pay for their home? Out of this answer determines your success.
You know, one of the largest determining factors of your savings rate is your home. I know that you’re probably thinking, “Uh, Justin, that would be my income level.” To a point, that is correct. However, people with larger incomes tend to also buy larger houses. Likewise, 29% of homebuyers say that they feel less financially secure than they did before they purchased their home. With so many people that will be buying homes in the next few years, this becomes a very pertinent issue. So, how much should you pay for your home? Well, let’s first look at what you can afford.
There are two primary methods that mortgage lenders use to determine how much of a mortgage you can afford. The first is what is known as the front-end ratio or the housing ratio. This method looks at what percentage of your income would go toward housing expenses. Now, housing expenses go beyond your monthly mortgage payment. Instead, it refers to all of the expenses of homeownership, including your monthly mortgage payment, property taxes, homeowners insurance, and homeowners association fees, if applicable.
To calculate your front-end ratio, add up your monthly housing expenses and divide it by your gross monthly income, then multiply the result by 100. For example, if the sum of your housing-related expenses total $1,800 and your gross monthly income is $6,000, your debt to income (DTI) ratio is 30 percent.
The other method is what’s known as the back-end ratio or the debt to income ratio. This method shows how much of your income would be needed to cover all monthly debt obligations. The back-end ratio factors the mortgage and other housing expenses, plus credit cards, auto loans, child support, student loans, and other debts. However, living expenses, such as utilities and groceries, are not included.
When calculating your back-end ratio, add up all your monthly debt payments, including your housing expenses, and divide the result by your monthly gross income. Let’s assume your car payment is $500 per month, you pay $150 per month in student loans, and $200 toward credit card bills each month. This brings your total to $850. Combine that with your $1,800 in monthly housing expenses and you get $2,650 in total monthly debts. Based on your monthly income of $6,000, your back-end ratio would be 44 percent.
Lenders typically look for a front-end ratio of around 28 percent. Likewise, they generally like to keep the back-end ratio somewhere around 36 percent. They’re hesitant to put the buyer in a position where they are paying much more than this because it often leads to default and that’s not good for any of the parties involved. Foreclosures are damaging to the home buyer’s credit and they cost the mortgage company quite a bit of money.
In order to make an informed purchase and ensure that it’s one that you can afford, it’s a good idea to calculate your front-end and back-end ratios before you begin searching for your dream home. So, how do you find these figures? It’s an easy equation. Simply multiply your monthly income by the target percentage. For example, if your monthly income is $6,000, then your front-end ratio equation would look like this: $6,000 x 0.28 = $1,680.
The same formula applies to your back-end ratio. The only difference is that you will need to calculate your total monthly debt payments and compare them to your results. Sticking with our $6,000 monthly income, your maximum for all monthly debt payments, at 36%, should come out to $2,160. As I said before, you find this with the same formula: $6,000 x 0.36 = $2,160.
However, there are other influential factors that lenders will look to. Depending on the amount of down payment and your credit score, it’s possible that you could receive a mortgage that puts you a little above or below your front and back-end ratios.
Now we know what you can afford. But what should business owners pay for a house? You see, once we begin to get a little success under our belts, the spender tends to come out in us. As business owners, we’ve scrimped and saved and sacrificed to make sure that our business is successful. We know what it means to survive on rice, beans, ramen noodles, and even mashed potatoes and gravy. Having gone through all of that, it’s perfectly normal for us to want to reward ourselves once we reach a certain level of success.
However, the entire crux of this post is to ask the question and to provide the answer. So, how much house should you afford? As small as possible to achieve your goals and dreams. But why does it matter what business owners pay for their homes?
As I stated at the beginning of this post, the home you choose is the biggest determining factor to your success. The size of your home and the materials that were used in its construction can have a major impact on the cost of your insurance coverages. The materials will likely have a significant bearing on your maintenance and repair costs. Likewise, they can determine how much your monthly utility rates are.
Aside from that, the location of your home will decide your taxes. You will have to pay property taxes wherever you live, but you might be able to avoid state-level income taxes. Additionally, your home could affect the wear and tear on your vehicles, depending on how much of a commute you have. Folks, there are so many costs that stem from your home. The more you pay to keep up your current lifestyle, the less you have to save or invest in your future. So, ask yourself, what should business owners pay for a house? And don’t forget to consider how the total cost will affect your financial success.
Friends, buying a home is a wonderful thing. It truly is part of the American dream. However, it’s also one of the most important decisions you will ever make. Be sure to consider the true cost of homeownership before buying more home than you can handle. It costs so much more than your monthly mortgage payment suggests.
Life is hard, but it’s so good. Choosing the right home for you and your family’s needs can be frustrating. However, with a little research and careful consideration, knowing what you should pay for a house can, at least, be financially simple.
As you can see, deciding to buy a home is about so much more than four walls and a roof. Having a great Certified Financial Planner to aid you in your plans can make home-buying simple. Schedule a meeting. The Financially Simple team is standing by!