Before you buy, know how much you can afford

A home is the most expensive purchase most people will ever make, and figuring out how much they should spend can be overwhelming.

Online calculators can give a ballpark idea but shouldn't be relied on for a final decision, said Paul Cocozza, a certified financial planner in Arlington, Va. "That's taking too much of a shortcut for such a large commitment."

How to decide? Your budget is a function of your income, household expenses, credit and savings.

• Traditionally, the guideline was that no more than 28 percent of gross income should go toward housing expenses, including the mortgage payment, homeowner's insurance, homeowners or condo-association fees, and real-estate taxes.

No more than 36 percent would go toward those housing costs plus all other debt expenses, including car notes, school loans and credit-card payments. Many lenders have stretched those requirements, allowing up to 39 percent of gross income to go toward housing and other debt. But just because a lender says you can afford a loan doesn't mean you should spend that much.

• Buyers should be cautious, says Peter Hebert of Allied Home Mortgage Capital in Ellicott City, Md.

"If you're going up to 50 percent, which we will do, you're going to be living paycheck to paycheck. You're only a broken leg away from going bankrupt."

• Those ratios don't cover every possible expense a prospective buyer is responsible for, including some substantial ones such as child care.

"Most buyers have a reasonable idea of what they can afford," said Deborah Knuckey, author of "The Ms. Spent Money Guide: Get More of What You Want With What You Earn."

She suggests budgeting software such as Quicken or Microsoft Money to track spending for those who don't know where their money goes in a year.

• Lenders' ratios don't even cover all the costs associated with owning, such as maintenance.

"How much a lender is willing to lend you is not a useful number," said Harvard law professor Elizabeth Warren, co-author of "All Your Worth" and "The Two-Income Trap."

"That's a little like asking the clothing salesman how many sweaters you should own."

She recommends keeping fixed expenses, including mortgage payments, at or below 50 percent of after-tax income.

• Another key factor is your credit. Your FICO credit score, in particular, determines how much the mortgage will cost. Lenders base their interest rates and fees on the risk that you could default.

With all other factors being equal, the higher the interest rate you have to pay, the less you will ultimately be able to afford for a house.

• Finally, buyers must consider their savings: They will need at minimum enough cash for the down payment and closing costs, with a 20 percent down payment as the gold standard.

More modest percentages are possible, but those mean a bigger monthly payment and will drive up the loan's long-term cost.

They also could mean paying private mortgage insurance, depending on how the loan is structured. Closing costs run about 3 percent to 5 percent of the price of the house, though many buyers ask the sellers to pick up all or part of the tab.

Buyers should also plan to keep something in reserve after closing, Knuckey said.

"The last thing you want to do is buy a house and have no cash cushion in case something goes wrong early on," Knuckey said.

— Mary Ellen Slayter,

The Washington Post