April 11th, 2018 6:38 AM by Jackie A. Graves, President
Many Americans qualify for more than they can handle. Tips to
avoid that trap.
Buying a new home is a big decision. Most people focus on the
number of bedrooms or kitchen appliances, but new homebuyers should be thinking
more about how much mortgage they truly can afford.
It's a question many people may
be facing soon. Almost three-quarters of Americans believe now is a good time
to buy a home, according to a recent homeownership survey from the National Association of
Realtors. Interest rates are slowly rising, and the housing market has recovered in many areas
of the U.S. With mortgage defaults still at relatively low levels, banks are
eager to lend to prospective homebuyers.
problem is, many Americans qualify for mortgages that are larger than they can
easily afford. Taking on that big of a burden can hurt your ability to reach
your other financial goals, such as saving for kids' college education or your
planners recommend limiting the amount you spend on housing to 25 percent of
your monthly budget. Yet the average married couple with children spends just
over 31 percent of their budget on housing, and single people spend almost 36
percent, according to the most recent data from
the Bureau of Labor Statistics.
a big reason more than 80 percent of current homeowners say their mortgage
payment makes it difficult for them to save money, according to a recent Bankrate report. Parents in particular have a
hard time juggling their competing financial priorities.
to make sure you don't fall into that trap, here are some tips for getting an
straightforward way to make sure you can afford your mortgage while managing
your other goals, according to Eve Kaplan, a certified financial planner based
in New Jersey. “Housing—including maintenance—ideally shouldn’t consume more
than 25 percent of a household budget. This goes for folks who rent, too,”
bankers would disagree. They use various calculations to figure out how much
you can afford, and the amount is often much higher than financial planners
recommend. One common measure is the debt-to-income ratio (DTI),
which, for a qualified mortgage, limits your total debt payments, including
your mortgage, student loans, credit cards, and auto loans, to 43 percent.
homebuyers see their home as an investment for the future, which can be an excuse
for spending more today than they can easily afford. But real estate can be
volatile, as we saw in the 2008 housing crash. Having too much of your net
worth tied up in your home can be risky.
you and your spouse make a combined annual income of $90,000, or about $5,600
per month after taxes. Based on your DTI and depending on your other debts, you
could be approved for a mortgage of $600,000. That might sound exciting at
first, but with a monthly payment of about $3,225, it would eat up more than
half of your take-home pay.
Kaplan’s 25 percent rule, a more reasonable housing budget would be $1,400 per
month. So taking into account homeowners insurance and property taxes, you'd be
better off sticking to a mortgage of $240,000 or less. If you have enough for a
20 percent down payment, the maximum house you can afford is $300,000.
think, 'I’m making really good money, I should be able to afford this,'” says
Mary Beth Neeley, a certified financial planner and chief compliance officer at Retirement Strategies, a financial planning firm
based in Jacksonville, Fla. “But most people don’t consider saving for the
future. You have to put your priorities in place and look at all your goals.
You don’t want to have a house that adds stress to your financial situation.”
asks clients one important question when trying to help them determine what
they’re willing and able to spend on housing: “Do you really want to change
your lifestyle to have a more expensive home?”
amount of mortgage you can afford also depends on the down payment you make
when buying a home. “In a perfect world, we recommend a 20 percent down payment
to avoid paying mortgage insurance,” Neeley says.
down payment is less than 20 percent, your costs rise. You typically have to
pay private mortgage insurance, which can cost up to 1 percent of the entire
loan amount each year until you build up 20 percent equity in your home. On a
$240,000 mortgage, that’s $200 per month. Keep in mind you will have other
ongoing costs related to homeownership as well, from taxes to insurance to
utilities. All of these expenses need to be estimated before you settle on a
monthly mortgage payment.
says homeowners typically
need to stay put for at least five years to make the closing costs of buying a
home worthwhile. If you are thinking of staying that long, you may be tempted
to opt for a mortgage that is higher than you can comfortably afford now. But
predicting future income isn't as easy it may seem. Kaplan cautions that
stretching your budget can backfire if you become unemployed for an extended
you don’t stretch your budget, an unexpected job loss or other life event could
cause you to struggle to make your mortgage payment. The more affordable the
home was in the first place, the better chance you’ll have of recovering.
Building up an emergency fund is
easier if you limit your mortgage payment to 25 percent of your take-home pay.
The more cash you have on hand, and the lower your monthly obligations, the
better chance you’ll have of staying afloat if difficult times strike.
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