Can you afford to buy?

Buying a home is exciting, and it's often the biggest financial transaction many people will ever make in their entire lives. That's why when it's time to consider purchasing your own home, the best first step is to take some of the emotion out of the equation. And speaking of equations, when it comes to figuring things out, the best place to start is with the numbers.

How much money do I need to purchase a home?

It depends on the cost of the home, the type of loan you get and the amount of your down payment. From the moment you write an offer on a house and it is accepted by the seller, you will need something called earnest money. This is the first check a buyer will need to write to accompany the offer to buy a home. Then there's the cash needed to pay for a home inspection as well as upfront fees for credit reports and an appraisal.

Next comes the down payment, which is the amount of cash required by the lending institution securing your loan. Based on your credit score, debt-to-income ratio and available cash, lenders will advise which loan products, if any, are available and whether a down payment will be necessary. A down payment is separate from earnest money, and depending on the lender, it can be money gifted from parents or other sources.

In some instances, if you qualify as a first-time home buyer, you can receive down payment assistance and closing cost monies from the county you choose to live in. You can also qualify for below market value fixed interest rate loans.

The next consideration when buying is closing costs. These fees are not part of the financed amount of a purchase and can add 3-5 percent on top of the sale price of the home. While there are Veterans Affairs loans and some conventional loan products that offer "100 percent financing," closing costs are still additional costs that can't be completely wrapped up in the loan. (Note: Some fees, such as the VA funding fee, may be wrapped up in the loan.)

In some instances, closing costs can be part of the home purchase negotiations. Depending on market conditions, some sellers may consider paying for a buyer's closing costs out of their proceeds. In fact, buyers can discuss with their real estate agents or whoever is representing them in the transaction whether to ask the sellers to cover the cost of a home warranty, HOA fees or other expenditures.

Are there any reasons why I should NOT buy a home?

Yes, there are many reasons why you should not buy a home:

• You can't afford it.
• It makes more financial sense to rent.
• You can only afford it with a risky type of loan (e.g., adjustable-rate, negative-amortization loan).
• You plan on living in the house for fewer than 5 years.
• The market is rapidly declining.
• You have too much debt.

Get started

One of the best places to start analyzing whether you can afford to buy a house is with a detailed expense breakdown. Go over your budget by looking at how much you make and spend each month. This will serve as a reality check about what are fixed expenditures and where there's wiggle room in your budget to accommodate the expenses associated with home ownership.

Debt-to-income ratio

Lenders use this ratio to see what kind of mortgage payment you can qualify for. It is good to note that what you qualify for may NOT BE the mortgage payment you are comfortable making. Many buyers have grown wisely cautious about making sure they are not locked into payments that cut too close to their bottom line.

For example, if you can comfortably afford your existing $1,600 rent payment (or existing mortgage if you are trading up), chances are you'll qualify for a mortgage in the same range, or even higher. Lenders will determine how much loan you can afford by using debt-to-income ratios — basically what's left in your budget after your monthly bills are paid. These include credit card payments, car payments, child support, etc.

• Housing ratio (or "front-end ratio"): Lenders want your total mortgage debt (principal, interest, taxes and insurance) and condo fees, if applicable, to be no more than 30 percent of your gross monthly income; 28 percent is standard.
• Overall debt ratio (or "back-end ratio"): These are revolving monthly payments, such as credit cards, car lease or loan payments, student loans, child support and alimony. (They do not include those lattes, but you might want to plug in your lifestyle expenses for your own sake.) The ratio should not be more than 36 percent.

Debt-to-income ratio standards differ from lender to lender and vary based on the loan program, but most lenders will give more weight to your credit history when determining your particular situation. Here is typical ratio for a first-time buyer:

Monthly gross household income	$5,700
Mortgage debt ratio: 28 percent	$1,596
Expenses and overall debt: 36 percent	$2,052

The mortgage debt of $1,596 is right in line with the current monthly rent payment in the example above. As long as the monthly debt obligations and household expenses are no higher than $2,000-2,300, this borrower should have no problem qualifying.

If your credit is stellar, you will be rewarded. Lenders may stretch these ratios to 38/45, allowing you to purchase more home and take advantage of more lending programs. And if you are a first-time home buyer applying for an FHA or VA loan, you may also be able to qualify with a higher back-end ratio — up to 41 percent of your monthly gross income — and get approved for these federally-insured loans.

How It Works

So, back to the question: How much home can I afford?

Keeping in mind the variables on debt-to-income ratios and the many lending programs available, here are sample breakdowns for a mid-range home and a lower price-range home, both purchased with the same loan terms and interest rate.

You can research mortgage interest rates and property tax rates (usually by county) on the Web to find averages for your area, and make the table more accurate for your situation.

Monthly gross household income (pre-tax)	$7,000
Mortgage debt ratio: 28 percent	$1,960
Home price	$350,000
20 percent down payment	$70,000
Mortgage	$280,000
Interest rate on 30-year mortgage	3.25%
Mortgage payment (principal and interest)	$1,219
Monthly gross household income (pre-tax)	$3,600
Mortgage debt ratio: 28 percent	$1,008
Home price	$150,000
10 percent down payment	$15,000
Mortgage	$135,000
Interest rate on 30-year mortgage	3.25%
Mortgage payment (principal and interest)	$588

And the other costs

In addition to the monthly mortgage payment, remember to factor in the added costs of home purchase and ownership. If you don't put 20 percent down, you will need to add private mortgage insurance, also known as PMI, to your monthly payment.

You'll also need to tack on homeowners' taxes, insurance and condo/homeowner's association fees (if applicable).

Keep some money in reserves

Many buyers invest every cent they have into their new purchase, but it's a good idea to keep some emergency cash, or "leaky faucet money," aside in the event of emergency repairs or a job loss. With home ownership, it's best to expect the unexpected.