One of the most common questions for homebuyers is ‘how much can I afford?’ While it is important to know the ultimate limits of your financial resources, there may be a better question to be asking. ‘How much mortgage am I comfortable with?’ is a much more useful query.
The problem with asking ‘how much can I afford?’ was made abundantly clear during the mortgage meltdown. A few years earlier, lenders and borrowers had been willing to stretch to the farthest edge in order to make and qualify, respectively for the largest mortgage possible. Enter the bursting housing bubble with millions of borrowers already barely making their home loan payments, and the rest is history.
So here’s some ways to figure out how much loan you can be financially and mentally comfortable with, instead of how much you can technically borrow.
Net Income v. Gross Income
Lenders have lots of ratios they like to use to determine how much they are willing to lend you. In general, mortgage lenders prefer that your total monthly mortgage debt is no more than 28 percent of your gross monthly income and that your total monthly debt payments, including your new mortgage, would not be more than 36 percent of your gross monthly income. Just because a bank will allow you to borrow up to that amount does not necessarily mean its in your best interest. Consider evaluating your mortgage payment compared to your net income instead. Once you see how much your mortgage payment might be compared with your actual take-home pay, things might look a little different.
And you can’t just think about the actual mortgage payment when you take on a home loan. The balance and principal are the major expense of owning a home, but there are also monthly and yearly add-ons like property taxes and homeowners insurance and possibly private mortgage insurance. All of this can significantly increase how much of your monthly income is going toward housing.
Credit Reality Check
Finally, take a good look at your credit record. Your score will tell you somewhat about how much mortgage you should take on. Your credit report can give you an honest look at how responsible you are with your finances. If you need to make some improvements, you may want to censor yourself from taking on too big of a home loan.
With a little research and introspection, borrowers can be much more prepared to answer ‘how much can I afford?’ for themselves, instead of simply letting their lenders determine the range.