August 3, 2017
Picture it: You’ve been approved for a mortgage and you receive a letter from your lender, featuring the dollar amount you’re approved for. You’re excited, you’re ready to shop, you approach your Realtor with your approval letter in hand and tell her to show you the goods! But put the brakes on for a second. There might be a difference between what you’re approved for and what you can comfortably afford. No one wants to be in a situation where they can pay their mortgage but can’t afford to treat themselves to a large iced latte every now and then!
Experts suggest that mortgage expenses should not exceed 25 to 30% of your monthly income. Some financial experts say that this budget item (your mortgage) should be based on take-home income, while others advise that your mortgage expense should be based on pre-tax income.
And get this: an article in U.S. News – Money quotes the U.S. Bureau of Labor Statistics as suggesting that a mortgage payment should typically be around 58% of your income. By almost any standard, this seems pretty high!
With such wildly different advice coming at you from all corners of the financial landscape, it is difficult to know how to proceed. The good news is that with a little thought and planning, you can accurately determine how much mortgage you can afford.
Before you determine this magic number, you need to know how much you are spending and how much you anticipate your spending will increase. In other words, it’s time to make a budget. Budget Simple, Mint Life, Quicken, and many other sources are available to help you with this. All of these will have a pretty similar list of items, including housing (i.e., your mortgage), savings, utilities, health care, consumer debt, food and groceries, personal care, entertainment, etc. Don’t forget the little things that add up… do you have a monthly gym membership? Do you subscribe to Netflix? What else?
And don’t forget unexpected large expenses, like home repairs, sick pets, dropping your cell phone or your laptop, kids’ extracurricular activities, appliance replacement, etc. Perhaps you like to travel – if so, figure this in.
Once you have created a budget, you are ready to get down to the business of buying your home, since you now know what you can afford. The first step here is to factor in your down payment. If you can put down 20% or more, it is likely that you will not need to purchase private mortgage insurance (PMI). This can be quite a savings. There is a great article in Investopedia that provides some good reasons for avoiding PMI if possible. Keep in mind that in a hot real estate market, the longer you wait to build up your down payment, the more you will pay for the home, which could wipe out your “no PMI” savings.
Another important consideration is your existing overall debt. When calculating what they will offer you, lending institutions generally use a 43% rule. Specifically, you should fit into this 43% not only your mortgage payment (now part of your overall debt), but other debt such as car loans and credit cards. Lenders will also include persistent, unavoidable expenses such as utilities into the 43%.
Finally, don’t forget that whatever you budget, home ownership is an adventure into the unknown – but you will find that it is worth it… hopefully with that latte in hand.