Before getting starry-eyed house hunting, don't forget that buying a home is a long-term financial commitment, accompanied by closing costs, mortgage payments, taxes and day-to-day maintenance. How can you determine how much buying power you have?
Every first-time homebuyer should follow three easy steps to determine how much home he or she can afford, says Nicole Hall, editor-in-chief of LendingTree's Smart Borrower Center. The first step, she says, is to get pre-approved by a lender. The lender will look at your income, debt, credit history and savings to determine how much of a loan is in your borrowing ballpark.

Keep in mind, however, that just because you qualify for a certain amount doesn't mean you should borrow it. "There are so many factors you need to consider when determining how much you can really afford," says Matthew Connelly, general manager of GoApply, a lender search service. "It's a terrible thing to be house rich and cash poor."

For that reason, step two should be doing some of your own calculations. One common rule is to spend no more than 28 percent of your gross monthly income on home payments, which include loan principal and interest, private mortgage insurance, hazard insurance, property taxes, and homeowners association dues. Under that scenario, someone with $75,000 in gross income should spend no more than $1,750 on housing-related expenses.

But, that calculation doesn't take into account other kinds of debt, such as credit-card payments, student loans and car loans. For that reason, many experts swear by this rule: Your debt-to-income ratio should not exceed 36 percent. By that measure, the same borrower should make sure he or she spends no more than $2,250 on mortgage payments and all other debt.

The final step is accounting for your lifestyle. All things being equal, someone who spends a lot on, say, meals out and trips to Europe may not want to shell out as much in housing as someone who prefers to cook at home and spend vacations lounging in the backyard. To that end, Hall recommends taking stock of your monthly expenses (if you haven't already) and adding your potential housing costs to the mix to see what buying a home will do to your total household budget. You may even want to take that a step further by making the house payments for a few months (set aside the money into a savings account) to really see how ownership affects your finances.

Of course, the costs of owning a home go beyond the predictable monthly payments. Things come up. So leave a little bit of a cushion in case the water heater breaks or termites are squatting in the basement. "Many people forget that they're not just buying a home but owning a home as well," says Hall.

Source Inman