Photo: Flickr/ Images Money.

So you think you want to buy a house. Don't do it until you read this first.

Still ready to buy? Your next step then is to understand your finances. A home is a big purchase, probably the largest of your life. You'll be investing a good bit of your cash into the down payment. You'll probably be taking out a sizable mortgage loan, committing yourself to 360 months of payments.

So your objective here is twofold. First, determine what monthly payment you're comfortable paying. The subprime-mortgage crisis taught us that banks will lend money to individuals who can't afford to pay it back. So Step 1 is doing your own analysis.

Step 2, of course, is qualifying for the mortgage. Here's how to accomplish both, and then how to move on to the third and final step.

Step 1: Check your credit
Don't waste your money paying to see your credit report. You can view it for free at Take a few minutes to view your report and verify that it's correct. 

Some banks and mortgage companies require that an individual have a certain number of existing or historic debts. These can be student loans, auto loans, or even credit cards. If you've never taken a loan before, you may need to apply for a credit card or take out other debt first to establish your credit. If you fall into this category, I highly recommend speaking with a mortgage professional who can advise you on your specific situation.

Have you paid all of your debts on time? Have you ever gone 30 days or more past due? Have you ever had to deal with a collection agency or declared bankruptcy? If so, obtaining a mortgage will be challenging. Not impossible, but it won't be easy. 

If you find errors on your credit report, then immediately follow the instructions to dispute the erroneous records. The credit reporting agencies do make mistakes, and it's the individuals responsibility to alert them of the mistakes. 

If everything looks in order, then it's time to move to Step 1.

Step 2: Make a budget
Making a budget is the first step to understanding what you can comfortably afford. The budgeting process is substantive enough to warrant a post all to its own, and here The Motley Fool has you covered. Check out Dayana Yochim's "Budgeting for Lazy People."

The basic idea is to understand where your money is going today, make a conscious decision of where you want your money to be going, and then create a plan to achieve this goal. 

You don't want to put all your monthly cash flow into a mortgage payment and then have no money to do the things you love. Making a budget up front ensures this won't happen.

Step 3: Translate your budget into a price you can afford to pay
Banks consider a variety of factors when reviewing your mortgage application. I'll be exploring those factors in more depth in Part 3 of this "Guide to Buying Your Home" series. At this point in your journey to homeownership, we do need to consider the mortgage payment and your cash flow. 

In your budget, you've determined how much you can afford to pay each month on the mortgage. Now we'll translate that monthly payment into a loan amount and from there into a home price.

Typically, the money a homeowner pays to the bank each month consists of four components.

  1. Principal -- the money you borrowed.
  2. Interest -- how the bank makes money from your loan.
  3. Taxes -- property taxes levied by your county, city, or both.
  4. Insurance -- premiums paid to insure your home against damage, fire, flood, and other unfortunate circumstances.

Taxes and insurance will vary based on your location and specific home. Visit your local tax assessor's website to determine the property tax rate in your area. A quick phone call to an insurance agent will give you a reliable estimate for insurance premiums. 

Add these two estimates up and subtract them from your budgeted monthly payment. The remainder is what you can afford in principal and interest. Use a mortgage calculator, like this one available from, to determine the loan amount that will yield a payment near what you can afford. 

The last piece of the puzzle is your down payment. If you've saved up money for a down payment, add this amount to the loan amount you've just calculated. This sum represents the price of the home you can afford. 

Finding the house
Now that you know what you can comfortably afford, the next step is to begin the house hunt. We'll cover that in Part 2 of the Guide to Buying Your Home.

