Buying a home—or more than one—is a key component of the American dream. Most first-time home buyers will go to the bank and take out a mortgage without considering how much money they have available to invest in real estate first.
Let’s take a closer look at what you need to consider and how to figure out how much money you can afford to invest.
How to Determine How Much House You Can Afford
1. Look at Your Income
Whether you’re purchasing your first home or investing in a fleet of rental properties, the first thing you need to account for is your monthly or annual income. For a single property, you don’t want to spend more than 30 percent of your income on housing. (1) For multiple properties that will ideally be generating revenue, you’ve got a little more wiggle room.
But you need to have a handle on more than just your income to figure out how much money you can spend on real estate investments. Take a close look at your expenses and how much money you have left over at the end of each month. Then, start collecting information about mortgages in your area you might qualify for.
Whether or not you are eligible will depend on your income, how long you’ve worked at your current job, and your credit score. Keep in mind, these are just a few things the bank will want to know about.
Plug all that information into a calculator (there are many available online) to figure out how much money you can afford to spend on a new property, how much your property taxes and mortgage payments might be, and even what the loan-to-value ratio of your home is.
2. Choose Your Properties
The next thing you need to do is choose the properties you’d like to invest in. This step will vary drastically depending on where you live and what the housing market looks like at the time. If you’re purchasing rental properties, you also need to be aware of the local renting climate. Are people looking to rent in your area, or will your investment properties remain empty for extended periods while you wait for new tenants?
Now, these are all broad-scale criteria you need to think about, but there’s so much more to purchasing an investment property than housing market and rental climate. (2) Consider what you can offer potential renters as amenities.
Is the property close to useful locations like shopping, schools, and public transportation? What about the local school district? Excellent schools nearby would make your property appealing to potential renters with children.
3. Prepare for the Unexpected
Investment properties can generate substantial revenue for you if you’ve got tenants, but they can quickly turn into money sinks if you don’t have anyone staying in them or if your tenants damage your homes.
The best thing you can do is to prepare for the unexpected. You may have months—or even years—when your property sits vacant, or you may end up with a careless tenant who leaves you with hundreds or thousands of dollars worth of damage.
The best thing you can do, whether you’re purchasing one home or many, is to be proactive. Even the most comprehensive background checks can’t weed out all the troublemakers. When you’re dealing with investment properties, try to have enough money saved that you can weather months without a tenant in your property or can repair anything that should happen to break.
Make sure you also have sufficient insurance to protect your investment. Homeowner’s insurance will protect you under most circumstances, but it doesn’t cover all the variables. Depending on where you’ve purchased property, you may need storm insurance, wildfire insurance, or other policies to keep your investment safe if a natural disaster puts your property in jeopardy.
4. Create a Budget
Investing in real estate—actual real estate as opposed to things like timeshares that don’t generate any revenue—can be a great way to earn relatively passive income. It’s essential to make sure you have enough income available before you start seeking out loans or mortgages though. Defaulting on a mortgage or loan can have a devastating effect on your credit score and make it more challenging to purchase a home or investment property in the future.
Start by taking a closer look at your finances and income, and plug your information into one of those calculators we mentioned earlier. These tools will help you figure out how much money you need if you decide to invest in real estate—either locally or elsewhere.
Budgeting is the foundation for every real estate purchase, whether you’re buying your first home or your 50th. Real estate investments can be lucrative, but only if you’re ready to shoulder the financial responsibility. Don’t sign on the dotted line unless you’re sure you can afford it.
Do you plan to get a mortgage or other loan in the near future? Have you done your homework first?
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