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Don’t Break the Bank — A Mortgage You Can Afford

broken-piggy-bankIf you’re ready to buy your first home, you need to determine how much you can REALLY afford and not be stretched too thin.  You definitely want to avoid being “house poor” so you’ve got enough money left over for other things!

There are a couple “rules of thumb” that experts recommend when it comes to finding the right mortgage payment for your budget.  Let’s do the math:

Math 101

You can typically afford a home priced two to three times your gross income.

If you earn $80,000 per year, you should be able to afford a home between $160,000 and $240,000. You can add these numbers to the amount of down payment you plan to use and voila, that’s about what you “should” spend on a home.

When determining affordability, you also need to take a look at your own budget, specifically your expected monthly costs.  Making a budget is an important step so be honest about what you spend your money on each month.

  • List all the costs of homeownership — property taxes, insurance, maintenance, utilities, and condo fees, if applicable. Your agent can help you with some of these numbers and provide estimates.
  • List all other costs you expect to continue — such as day care payments, car loans, gas or commuting fees, etc.

Both your income and your expenses are the two big factors that come into play when determining affordability, but how much you can afford today can change next year and after that. Yes, your salary will increase but you’ll have new costs, such as kids or a new car. Keep all of this in mind!

28/41 Debt Rule 

• Your entire monthly mortgage payments — home loan principal, interest, taxes, and insurance — shouldn’t total more than 28% of your gross annual income.

• Your total debt shouldn’t exceed 41% of your income. This total debt includes your new monthly payments plus all your other bills, like car loans, utilities, and credit cards. Go back to you budget list!

This is another general rule for calculating how much new debt you can take on. Many lenders use the 28/41 rule but some will approve you for much higher.  In areas where homes are more expensive, like DC, NY, LA, it’s not out of the ordinary to end up somewhere between the 28/41 rule and the 50% that some lenders will allow.

Let’s use the 28/41 rule to show you how the math works. If your gross annual income is $80,000, multiply it by 28% and then divide by 12 months to arrive at a monthly mortgage payment of $1,866 or less. Next, check the total of all your monthly bills including your potential mortgage and make sure they don’t top 41% of your income, or $2,733 for this example.

You (and your lender) want to see that you will be able to afford your current monthly debt obligations AND any new mortgage and homeownership costs, AND still have some cash left over each month. You never want to be wiped clean each month!

Hunker Down

The more money you put down, the lower your monthly payments will be – but there are some great lower down payment loans out that require as little as 3% of the purchase price.

You will need to decide what is best for your own particular financial situation and goals.  A larger down payment will reduce the amount of money you need to borrow for your new home but it might not be the best option for you. No matter what, build up your savings before you start to look for a home and make sure your credit score is as high as possible.

If you put down at least 20% of the home’s cost, you may not have to get private mortgage insurance, which costs hundreds each month. But, if you put as little as 3% down, there are ways to avoid paying PMI such as rolling the private mortgage insurance into your loan amount to save on your monthly payments.

However, don’t use every penny of cash you have toward your down payment just to be able to get 10% or 20% down.  It’s good to have money in your bank account and not in your house, where it’s a little more difficult to access for other investments or emergencies.

Rent vs. Owning  

Owning a home is about one-third more in cost than your current rent payment without changing your lifestyle.

This is my favorite math lesson! You can get a rough estimate on what you can comfortably afford by using your current rental cost situation. Multiply your current rent by 1.33 to arrive at a mortgage payment that won’t bust your budget.

This calculation takes into account the tax benefits of homeownership that can offset some of those additional homeownership costs.

For example, if you currently pay $1,500 per month in rent, you should be able to comfortably afford a $2,000 monthly mortgage payment after factoring in the tax benefits of homeownership.

Determining the best mortgage option that works with your specific budget can be a little overwhelming at times. We’re here to help you sort through it all, so please contact us at any time for more details.