House Rules: How to Buy Smart
1. Budget wisely.
If you pay $1,200 a month in rent, that doesn't mean you can handle a $1,200 monthly mortgage. On top of the base cost, you'll have to cover property tax, home insurance, utilities and repairs. Plan on adding about 40 percent to your base cost. If your mortgage is $1,200, add $480 to get a better estimate.
2. Play house.
Spend six months depositing into a savings account the difference between what you spend on rent and what it will cost to own. For example, if your target total cost is $1,600 and your rent is $1,200, put away $400 a month. After six months, if you've been able to keep up the deposits and pay your other bills, that's a sign you can afford to buy. Put your savings toward the down payment.
3. Pay off debts.
To quality for a mortgage, one of the most important factors banks consider is your debt-to-income ratio. As a general rule, they don't want housing payments to be more than 28 percent of your gross monthly pay, and a mortgage shouldn't bring total debt to more than 36 percent. Estimate what your mortgage payment might be for a home in your area, then add that to what you pay each month for loans and any other debt. If that figure is higher than 36 percent of your monthly salary, you know that decreasing your debts is the necessary first step before you focus on buying a home.
Suze Orman is the author of The Money Class.