How Much House Can You Afford?

Home buying is a major financial step. From saving enough money for a down-payment to qualifying for a mortgage to finding a home that meets your needs (and your budget), there are several crucial steps that must be completed before signing on the dotted line.

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Perhaps one of the most important steps is assessing how much home you can actually afford to buy. Before you start looking at houses, review your financial situation to determine what you can pay down and how large a monthly load you can carry. You'll need this information when it's time to sit down with your lender anyway.

If you don't have a net-worth statement already, it's time to put one together. That inventory of your assets and liabilities will help you determine the maximum down payment you can make. If money you will need is tied up in illiquid assets, such as your current home, land or collectibles, you must allow yourself plenty of time either to sell or to borrow against them.

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From your total liquid net worth, subtract:

1. Savings for emergencies, educational expenses, or retirement

2. Settlement and moving costs

3. Cash you'll need to improve, decorate and furnish your new home

The bottom line will be the sum that you could put down on the new house, if you wished to use it all. The more cash you pay up front, the less you will have to pay month by month on the mortgage, and the lower your total interest costs will be.

Conversely, the less you put down, the greater will be your leverage, tax deductions for mortgage interest, and available funds for other expenses, including decorating and furnishing. Also keep in mind that the money you hold back from your down payment, if invested wisely, might earn you more than the appreciation on your property will add to your equity.

You'll also want to look at your spending habits to figure out how the new house payment will figure into your budget. If you don't have a budget already, use our household budgeting tool to help track your spending.