Phil 0:00

Welcome to the first Time Home Buyers podcast. When buying a home, one of the most frequent questions I get is how much should we spend on a home? Everyone's situation is so different, but I think it's important to talk about the fundamentals and give you some overall guidance that you can use to come up with your ideal budget. All right, let's talk about budget. There's two things that we need to concern ourselves with on this episode that I'm gonna go over. The first is, what price home will your budget allow for? And the second is, what price home should your budget allow for? The main difference is what will lender approve you for and what are you comfortable with spending? Now let's start with what a lender will approve you for, which is actually the easier number to come up with. This part is though a bit confusing, but there's two limits that are used. Both are calculating your debt to income ratio, commonly called dti. There are two kinds of DTI front end. And backend. The first front end debt to income ratio is your housing expenses. So this is gonna be your mortgage interest rate, taxes, insurance, and if you have an HOA divided by your pre-tax income. basically this is how much your mortgage will be. Divided by how much you make before taxes. This number ranges from 31% to 40%, but typically 31% is what we'll use. So if you make $10,000 a month, your total mortgage payment cannot exceed $3,100 up to $4,000. Depending on your credit and which program you're looking at, that's the max you can go. With that calculation, a lender is not going to approve you for more than that, so you're looking at a payment between $3,100 and $4,000. Now let's look at back-end DTI ratio. This is your housing expenses, your principle. Interest. Taxes. Insurance. And if you have it. HOA, and all of your other debts like your auto loans, credit card payments. And then we divide that by your pre-tax income. So again, the biggest difference between front end and backend is backend is going to include all of those other debts like credit cards. Since there will be more debts, this percentage is higher in the case of fha, your standard is 43%, though higher credit can get you upwards of 50% and they do sometimes even go higher. So let's assume that you've got car payments, credit cards, things like that that maybe add up to about a thousand dollars. Here's how we're gonna calculate your backend D T I on that same $120,000 a year salary with a thousand dollars in debts. Add a DTI of 43%. So we're gonna take your mortgage payment plus your other debts, and it can't go over $4,300, which is 43% of $10,000 a month. So this would mean that you could go up to $3,300 a month in your mortgage payment with a thousand dollars a month in debts. At the high end, you'll be able to go up to a mortgage payment of $4,000, plus that thousand dollars a month in debts, whichever is most restrictive, is going to be the limiting factor for your lender. So that's the budget right there. The max you'll be able to go will be about $4,000 a month, but. Is that realistic? Is that something you'd actually be comfortable with? There's several different budgeting philosophies. One general rule says, don't spend more than 25% of your pre-tax income. Others, it's 25% of your take home income. But let's just say you're making $10,000 a month. Your monthly mortgage payment shouldn't be more than $2,500 a month. That's a significant amount less than what the lender would approve you for. But again, everyone's different, and that's one of the main things that I pointed out at the beginning. Your lifestyle expenses and the cost of living will vary person by person. So I suggest using these two numbers just as a starting point. The lender approval should be your absolute highest, while the 25% rule should be a number to strive for. So let's walk through three areas that I want to cover to go over budgeting and really understanding where your money's going and how much you can afford comfortably. The three main sections I want to cover. Number one, creating a budget and understanding how much you actually spend monthly. Number two, looking at both your budget and the amount a lender will approve you for. And number three, short-term and long-term planning. How your career, living expenses, rent increases, and housing expenses should all factor into your plan. So let's jump into the budget. I have an actual budget Google sheet that I'll share on the show notes as well as on the website, and I'll walk through all the line items to help you understand where your money is going. The overall breakdown of this sheet is that you should update this every month, and it has two main areas. It has projected. And actual, so you could see how close were you to what you budgeted for during that month. First, we're gonna look over last month, and I want you to fill it out. You should have your bank statements, credit card statements. If you've paid cash for anything, do your best to remember what you spent. If you don't have the info, maybe just start saving all of your receipts for a month and then run through this exercise. Now, each section has, like I said before, a projected column and an actual. Your projected is your budget, your actual is what you really spent. This is gonna get eye-opening really quickly when you realize where your money is going. So let's talk about each of the different sections and how they play into your budget. The first section is income, and this is any money that regularly comes into your household. It's best to be conservative here. If you regularly get commissions or bonuses, try to use what you would average over the year if you do any side work or you get any. Regular extra income. This is where to put it. It's okay to not put anything in projected. If it's not regular, you'll add it to the actual at the end of the month and you can see how much more money you are making on these extra side projects throughout the year. The expenses section, this is looking at general expenses. Most of these are your must have expenses like rent. Utilities along with things like cell phone. Since this budget works well with homeowners as well as renters, there are some line items that you'll leave blank, like improvements or maintenance that should already be covered under your rent daily living. This is also another must have section. But it's more discretionary included are things like groceries and clothing. Dry cleaning and eating out are included on here as well. This is an area where you can really start looking at being able to cut back some costs, but you still are going to have to put money towards these areas. The next is children and family. Well, obviously they're not free. Everything from medical expenses to school, lunches, daycare. This tends to be rather fixed, but it's important to see just how much of your money is going here, and then transportation's next. This is gonna be things like your car payment, maintenance, registration. If you take public transportation, Put the cost here. Really see how much that's costing you. Health, gym, memberships, doctor, or dental visits. Payment plans for dental or ortho type work would fit well here. Health is a very important area in your life. You wanna make sure that you have enough money to properly take care of yourself. Insurance. Many of these are likely already built into other areas, but you might have extra life insurance or rental insurance that isn't allocated elsewhere. This is also helpful to track small extra insurances that you may have that you don't really notice come out of your account. Every dollar will count when you're looking at your budget. Charity and gifts. Do you donate at church every Sunday? Do you spend money every holiday, birthday, or anniversaries on gifts? Track that, because if you've got a big family and you're constantly buying gifts for people, this is a great area to see just how much that is actually impacting your budget. The next is savings. You should have an emergency fund and you should have at least a thousand dollars in it at any given time and try to put money away on a regular basis, more is better. So I always suggest having some kind of small auto transfer on payday to a savings account just to ensure that you have that available. Any other investments that you have that aren't automatically deducted from your paycheck would go here. Obligations. So these are things like your student loans, credit card payments, personal loans, really any other monthly credit obligations that you have would go here. This one, really think of what are the things on your credit report that are gonna be locked in, that you aren't gonna be able to change that. Oftentimes things like student loans or credit cards, those are gonna be long term. You're always gonna be paying those. This can add up quickly if you use any buy now or pay later. Put that monthly mountain here for all your purchases as well really track to see how much that's costing you and affecting your budget business expense. Now I have this in here. It's really not for everyone, but if you do things like Uber on the side or Instacart, this is really a great place for you to notate what your expenses are. So if you are spending gas specifically for that, this is a great area to see just how much money that's actually costing you to make sure that that's making you money. Entertainment. We all need balance in our lives, and so this one will get filled up. Maybe this gets heavier during summer. Maybe you like staying home and your books are the most expensive thing on here. Either way, make sure to put a dollar amount to everything you spend for entertainment. If you go to a carnival or a theme park, the cost of park food tickets and anything else would go here. Really see how much that is affecting your budgets. Miscellaneous loans, If you've got payday loans or something that doesn't fall under the obligations section, put it here. If you have a lot of buy now, pay later, this could be a good section for that. This is also a good section if you're paying back a friend or family member, and it's not something easy to track. Subscriptions, not for entertainment or business purposes, but maybe you have to pay for parking or dues for a membership or a club you're part of. This is where you would want to put that in vacation. If you're spending any money on vacations or if you often go on weekend trips, this is a good place to put that. It's also really eye-opening to track exactly what you spend on a vacation to see how much that really impacts your budget. Miscellaneous. This last area is for anything that isn't already categorized. I included things like bank fees or postage. If you mail things often, this area is good to see what you might be spending money on that doesn't fit into the other categories, and neither try to categorize it or ensure that it doesn't take up a large amount of your budget overall. Now that you've documented your budget, the top of the document will actually add everything up and tell you how much of a surplus. Or loss you're at each month. Once you fill this out for a month, you can also see how much variance there is from your projected and your actual budget. I suggest making a new tab for each month and use this to gauge how much you are really spending. You can start moving around different numbers and see how much increasing your housing expense, daily living, or even how much you're putting away for savings, will affect your overall budget. As I mentioned before, 25% of your take home pay is a great gauge to what you should aim for when purchasing a home. Try putting that amount in your housing payment field and see how that affects your budget. Does it keep you with enough money that you aren't house poor and struggling to make payments? You can try increasing your number and just see how it affects your savings and lifestyle. Now the second major area I wanted to talk about was looking at both your budget and the amount a lender will approve you for. So I tried to give you some tools that you can use to better understand what kind of home you can afford based on what you're currently spending, as well as what a lender would approve you for. And now is the time to take both those numbers. And use that as your max range. You absolutely can't go over what a lender will approve you for, and you can't go over what your budget says you can afford. If you have more expenses than others, especially expenses that don't show up on credit reports like club memberships, a lot of dining out or maybe you like taking a lot of vacations, your budget will likely be your limiting factor. Use these to decide. Where you would be most comfortable. I highly suggest starting with the max lender payment, plugging that into your current budget in this Google sheet, and seeing where that puts you slowly back that down and see where you're most comfortable and run that through a payment calculator to see what that home amount is that will give you your budget. This all assumes your overall payment, income, and lifestyle don't change over time. So let's talk about that third area to consider. Number three, short-term and long-term planning. How your career, living expenses, rent increases, and housing expenses should all factor into your plan. Buying a home is an investment in your future, and it's important to have a plan for both short term and long term. You need to consider things like job stability, potential rent increases in the area, housing expenses, including the cost of upkeeping, repairs, insurance. All of these should be factored into your overall budget when you're looking at purchasing a home. So let's break down the short term cost for long term with moving from an apartment or maybe a small home to purchasing a single family home, HUD has a fair market rental rate. And that data dates back to 2000. Let's just look at the last 10 years, and I'm gonna choose Riverside County. They're right next to San Diego, orange County, and LA County. It's a relatively affordable area for Southern California, and I do like to use it as a benchmark for cost in 2013 in Riverside County, a three bedroom rental averaged $1,577 a month in 20 23, 10 years later. A three bedroom rental averaged $2,376 a month. That's a 50% increase in just 10 years. Now let's look at purchasing a three bedroom home using those same dates. In April, 2013, the average purchase price for a single bedroom single family detached home in Riverside County was $240,000. Interest rates were at about 4%. If you put just three and a half percent down, your monthly payment would be about 1585. In this scenario, you would have been breaking even right away, and in less than a year, it would've cost less to purchase than to rent. However, now on April, 2023, the average purchase price for a three bedroom home is $565,000, and with interest rates in the low sixes, your monthly payment would run you about $4,250. If we were to try to keep the. Numbers about the same and use the same interest rate. So that 4% rate. Your payment would actually be $3,552. Now, if we look at what that three bedroom rental is that 2,376 a month. And we expect that to go up at the same rate as it did over the last 10 years. It would actually be $3,564. Within $10. Of what that mortgage payment would be at that 4% rate so you could see that 10 year mark is when it really makes a lot of sense that that rental is really starting to cost you a lot more. And again, that might go up even more. If there's higher demand for rentals. we're looking at these budgets, I think it's really important for you to remember that every single month, a portion of what you're paying in your mortgage, that principle amount. Goes into the equity of your home and year over year, that money is just building and building that's yours. When you sell the home, that's all coming back to you. When you're renting, every single payment is going towards someone else's mortgage and you are giving them their principle back. And so it's really important to think in the long term, where is your money going? If you're gonna be paying about the same as rent as a home. This is a great way to build equity and generational wealth. Home prices have outpaced wage increases, and with inflation, it's not quite the same as it was 10 years ago, but these are the types of things to think about. Nobody wants to overpay for a home, but real estate is one of the few assets that consistently appreciates over time. An average home appreciates between three to 6% annually. And when we look at average home price index appreciation from 1975 to 2014, California homes appreciated 6.77% annually, Colorado at 5.25%. Florida 4.09, Georgia at 3.49 North Carolina at 4.06% New York at 5.57%, and Virginia at 4.92%. To give some just general examples across the country, If you're currently renting, you can expect your rent to increase anywhere from one to 5% each year. So far in the last 20 years, the national median rent has increased at an annual rate of 4.17% year over year. Rent changes have not fallen to a negative rate, meaning year over year. They didn't go down since 1934, so you shouldn't expect your rent to ever drop or even stay the same from lease to lease. Basically what I'm getting at here is that you can expect the value of your home to increase, but your payments not to. But you can count on your rent to increase each year, so consider that into your affordability calculations. Is there a high demand for rentals in your area? Will that drive up the cost of what you're paying? Now you also need to look into what areas of your mortgage could increase in some parts of the country. You can expect property taxes to go up on a regular basis while others have more stringent limits. So a mortgage payment includes your principle interest, taxes, and insurance. Your principle will not change for the life of your loan. Interest, unless you're in an adjustable rate, mortgage will not change for the life of your loan taxes. This can change each year, but it's something you'll pay monthly into an escrow account. Some areas have limits to how much this can change each year. Others, not so much. You may be reassessed every two years and need to pay the property taxes on that new rate, or like in California, it's limited to no more than 2% more each year, so it's a very minimal increase. Insurance, this is almost a wild card in some areas. This doesn't change much in other areas like parts of Florida or areas with high prevalences of wildfires. We are seeing these numbers double or triple. Let's talk about utilities. Now, when you do buy a home, typically it's gonna be larger than an apartment. What that means is that your utilities will likely cost more, but as with a rental, you are typically paying utilities anyways. Any kind of increase in cost is going to be similar. On a home versus an apartment. The numbers might just be a bit larger. So if your electric bill is a hundred dollars a month in an apartment, it might be $200 a month in a home. If those go up 50%, it's still going up 50% for either of them. So again, there are some variables that do increase on a home purchase, but at the end of the day, they are rather minimal. And when compared to rental, those rental increases go up much faster than a market increase could over a term. And one of the things that I think a lot of people forget about is that after 30 years, You have paid your loan off, you are no longer paying your principle or your interest. You just need to pay taxes and insurance. And many times, that's only about 25% of your normal payment. So if you're paying $3,000 a month, you're probably only gonna have to pay about a thousand dollars a month in total for your home, for the rest of your life, and that's quite a deal. So then let's continue with the previous idea of buying compared to renting. You need to really think about what changes you'll be making in your life in the next five, 10, even 20 years that you can work into your budget. And I want you to really look at two major areas. The first is, how will your income change over this timeframe? And the second, how will your expenses change over this timeframe? So income, if you're planning to stay in the same job. Have you been getting regular raises? If you're in a union or a type of job that has scheduled increases, you should consider how that looks as well. If your job has a lot of variability such as sales, you may wanna be a bit more conservative as you don't know how the market might change. If you've been working your way up the corporate ladder, adding extra income on a regular basis and have a long-term career strategy. Then you can likely take that into account. How will your mortgage payment be in three or five years? We see this a lot in the medical and education fields. The first few years tend to be lower paying, but once you hit a certain threshold, your income increases significantly, and that mortgage payment all of a sudden becomes very affordable. But buying a home three years later maybe wouldn't have been as easy, and that mortgage payment would actually be much more difficult to attain. Expenses. Think about areas that could change, such as having children, educational costs if you continue with additional certificates, licensing, or continuing education to push your career. Overall, inflation and general cost of goods will always go up, and that should be taken into account if you generally receive a 3% raise each year. That is just keeping up with inflation in most parts of the country, so your budget would likely end up about the same year over year from what you have left over. These are all things to take into consideration and pay careful attention to when you're making a decision on how much your budget is. These nuances can make all the difference in the end. It's always important to do your due diligence and research before making any major decisions. I have this budget Google Sheet, along with the home affordability calculator and mortgage calculator all on our site@fthbpros.com. If you guys have any questions, feel free to email us. Go to the contact page on fthbpros.com. You can email us, call us. Happy to take those calls or texts. Head on over to the website. We've got all of our other podcast episodes, articles, newsletters, some resources along with the Facebook group. We've got a bunch of lenders and agents all there to help answer your questions. So again, thank you for your support and happy home buying.