How to Know How Much Property You Can Afford

Should You Buy Real Estate?

Start by asking yourself whether you should invest in property. The answer depends on two key factors:

• Your current financial health;
• Your goals for the investment;

Just because you have enough to purchase real estate or a lender is willing to approve a mortgage doesn't mean you have to jump into ownership automatically. It's a big commitment that will take up large sums of money for years and your time and energy. 

You should also carefully consider your plans for the property. Will you use it for yourself, rent it, or renovate and flip it? Each of these avenues leads to a different end. If you keep it for yourself, real estate will first take from your funds but will be appreciated over time, allowing you to build equity. 

If you rent it out, you'll have to cover expenses related to maintenance, but you'll be able to generate income regularly. And if you're planning to fix and resell it, you'll potentially gain a one-time return on your initial investment. 

Now that you have clarity on the matter and are still willing to buy real estate, you should know this to determine how much property you can afford.

What's the 28/36% Rule and Why You Should Follow It

Nine out of ten financial advisors would tell you that you shouldn't spend more than 28% of your gross monthly income on real estate (whether as mortgage or rent) and more than 36% on total debt. 

The 28/36 per cent rule is a tried-and-tested guideline to discover the baseline for what you can afford to pay monthly. For instance, let's assume you earn €2000 per month. It means your maximum mortgage or rent is €560, and your debts should add up to no more than €720. What you do with the rest is entirely up to you, but make sure to cover essentials such as food and transportation. Also, set a small sum on the side to add toward your savings.  

Abiding by the 28/36 per cent rule will enable you to evaluate your financial capabilities correctly and, more importantly, will stop you from going into the red, which happens often when individuals and businesses purchase real estate beyond their means.

Factors That Impact Affordability Calculation

When calculating affordability, the following key indicators are taken into account:

• Gross annual income – This is the year's overall earnings before taxes and other deductions are applied.  
• Total monthly debts – These are regular monthly expenses like minimum credit card payments, student loans, car payments, etc. 
• Down payment – The amount required upfront for buying a property. Most loans necessitate a minimum down payment of 3%. Usually, a 20% down payment is ideal as it would avoid private mortgage insurance, lower your monthly fees, and increase your affordability.
• Interest rates – The sum lenders impose on borrowers for taking out a loan. Typically, interest rates are charged as an annual percentage of the loan balance. Debtors make payments with interest over a predetermined period until the loan is settled. 
• Saving goals – The amount you want to set aside after you've paid your debts and monthly expenditures.
• Spending habits – Bad spending habits can impact your affordability, compromising your suitability to obtain a loan at reasonable rates, if even you're granted one. 

Other factors to consider when calculating affordability are real estate taxes, ownership insurance, debt-to-income ratio, ownership association dues, and mortgage insurance. 

What's the Debt-to-Income (DTI) Ratio?

Lenders care tremendously about this metric. They want to give loans to individuals and businesses who won't be overwhelmed by their debts and unable to make their payments on time. 

There are two types of DTIs:

• Front-end DTI – It only includes property payments. Lenders don't want you to spend more than 31% to 36% of your monthly earnings on insurance, real estate taxes, and interest.  
• Back-end DTI – This adds your current debts to the proposed mortgage payment. Lenders want this metric to be no higher than 43% to 50%, depending on the type of mortgage.

If the DTI ratio isn't in your favour, there are three ways to improve it – consolidate debt, increase income, or pay off debt. 

Alternatives to Invest in Property Without Taking a Loan

How would you react if we told you you can purchase only the portion of a property you can afford? Yes, that's possible with modern-day technology. The introduction of smart contracts, blockchain technology, and tokenisation has significantly changed the real estate industry. 

Today, undeveloped land, residential complexes, and commercial properties can be digitised and divided into tokens, each representing an ownership share. These tokens, sometimes known as coins, are bought, sold, stored, or traded on blockchain networks. 

There are different blockchain-based solutions applicable to the real estate sector. Crowdfunding and Decentralised Autonomous Organisations (DAOs) are arguably the most popular. The former uses blockchain to raise funds for projects and ventures, while DAOs are governed by rules encoded as software controlled by the blockchain community. 

Conventional vs Modern Solutions

The main differences between traditional and technological approaches when buying property are:

Conventional ways require that you have the entire sum in advance or take out a loan to finance the purchase. Spending your savings or money you don't have can limit your options and harm your financial health, putting you in a disadvantageous position.
Modern alternatives enable you to acquire a piece or an entire property without dealing with third parties and intermediaries.  It also allows you to invest in real estate managed through decentralised authority, meaning you'll have a say in all decisions. 

Conclusion

Now that you know how to calculate how much of a property you can afford and your investment options, you can make an informed decision that will minimise financial risk and help you attain your dreams of ownership.