Financial Wellness @ Work

How Can You Avoid Being a Slave to Your Mortgage?

Lately I have talked to a lot of people who are interested in buying their first home and with a combination of today’s low interest rates and a housing market that does not have prices appreciating rapidly, this might just be a great time to be in the market to buy a house.  They understand that part of it but then don’t know how much house they can afford.  They are getting different opinions from different people in their lives.  So, are there any objective measures by which we can figure out how much house someone might want to consider buying?  Sure…

But first, for anyone considering buying a house, there are a few “prerequisites” that you should ensure that you have in place prior to making the purchase.  The first is to have a down payment so that you can qualify for a mortgage and be ready to move in to your house.  That can range from as little as 3-5% to qualify for some federal mortgage programs to 20% or more to qualify for most conventional mortgages.

But, the down payment is merely the first part of the prerequisites.  The next part is even more important!  When you own a house, it is inevitable that things are going to go wrong.  When things go wrong, you’ll need money to fix them.  So, if you want to avoid going into debt in order to fix the inevitable, it would be enormously helpful to have your emergency fund in place.  You could start with a goal of $1,000 – $3,000 to cover most household repairs and work your way up to 6-9 months of expenses.

And with timing being what it usually is, the first repair will be needed very shortly after you’ve spent money on changing the paint color, getting curtains and buying some things to decorate the house, so you’ll have very little extra cash lying around.  That means that you’re going to need to plan for it, and the emergency fund is just that plan.  If you have it in place prior to buying the house, you set yourself up for success.  From there, you’re ready to figure out how much you can afford.

There are ratios out there that lenders use to figure out how much they will lend to you when you’re buying a house and it’s important to understand that there are maximum levels as well as below-maximum levels.  When you think about how mortgage lenders and real estate agents get paid, you’ll see that their incentive is for you to purchase as much house as you can afford.  Realtors get paid a percentage of the purchase price of your home and lenders get paid based on the size of your loan.  For them, the bigger the loan the more they get paid.  Only it’s YOU that has to repay that loan for the next 30 years, not them.  So, is their motivation to get paid or to truly help you?  There are lots of reputable people in those industries who do the right thing every day, but knowing how they get paid can help you make a better informed decision.

OK, back to the ratios. The first one is the amount of your total monthly income that is consumed by your mortgage payment.  Most lenders will not approve you for a mortgage if the payment is going to be in excess of 33% of your total income before taxes.  If that’s the maximum, you may want to consider something smaller in order to provide a margin for comfort.  Too many people buy a house and then can’t afford to do anything else because they borrowed the maximum amount for their house and after paying for taxes, benefits, the mortgage, gas, utilities and a few bags of groceries, there is nothing left over.  Consider looking at a mortgage that consumes only up to 25% of your total monthly income.  Does that mean you’ll buy a smaller house?  Probably!  But the upside is that you’ll pay less to heat it in the winter!

The next ratio is the “total debt” ratio, which rolls in debts other than the mortgage.  Things like car loans, credit card payments and student loans are included in that ratio.  For this, most lenders would like you to have your total debt payments less than 36-41% of your income.  Here’s the issue I see with reaching the top end of the range, which means you bought the most expensive house you can afford.  If you are spending 41% of your income on total debts, 25-30% of your income on taxes, you have very little left over for gasoline, utilities, insurance, healthcare and SAVINGS!!!!

So, if you’re trying to figure out how much house you can reasonably afford, consider using the lower end of the ranges (or something even lower!) to determine how much of a mortgage payment you can afford.  If your mortgage payment is less than 25% of your total income, you should be in a manageable situation.  If your total debt, including mortgage, is under 35% of your total income then you should be able to not only make your mortgage payment but have enough money left over each month to save for your future.  If you plan it safely, you should never be house-poor and owning a home can make your monthly budget less stressful.

 

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