You wouldn’t buy your jeans 4 sizes too big. Is your loan 4 sizes too big?
Analyze your budget and goals well before house hunting. Is there a wedding, college tuition, or daycare on the horizon that could change your budget? Given future expenses, what size mortgage will make you feel footloose and financially free?
To help you answer these questions, consider the four tips below.
1. Mortgage Affordability Rule of Thumb
As a general rule, homeowners can usually afford a house priced two to three times gross income. For example, if you earn $200,000, you can often feel Financially comfortable in a home priced between $400,000- $600,000.
To apply that rule of thumb to yourself, create a full forecasting budget, including mortgage, property taxes, utilities, insurance, maintenance, HOA fees, as well as the usual family budget items.
2. Down Payment
How much down payment can you make? A higher down payment will result in lower monthly payments. The most affordable loans go to those who put down more than 20%; these homeowners also avoid paying mortgage insurance, leaving more money for the rest of the budget.
3. What Is Your Overall Debt?
Lenders generally follow the 28/41 rule. Total monthly housing costs (principal & interest, taxes, and insurance) should not exceed 28% of your gross monthly income. Total debt, including housing expenses, car loans, credit cards and school loans shouldn’t exceed 41% of your monthly gross income.
An example: Gross annual income: $200,000. Multiply $200,000 x 28%, then divide by 12 (months) = your top monthly mortgage payment. Check that all your additional monthly expenses wouldn’t add up to more than 41%, or $6,832 in this demonstration.
4. Your Current Rent Can Guide Your Decision-Making
Homeowners enjoy great tax benefits. As a result, you can generally increase your housing expense (including taxes and insurance) 1/3 over what you’re currently paying in rent without changing your lifestyle. For example, if your rent is $1000, multiply by 1.33 to see what type of mortgage you may be able to support. In this case, $1330.00 would likely be a comfortable mortgage payment. If your current rent is uncomfortably high, figure out what you can easily afford. Use this number instead in the calculation.
Be sure to talk with your CPA or tax consultant to see what your potential tax implications are for deducting mortgage interest versus taking standard deductions.
To Sum It Up:
Be proactive. Do your research and figure out what loan size is right for you. Buy the that mortgage that hugs your financial curves like your favorite pair of jeans.