Before you begin shopping for a home (or a mortgage), it’s vital to evaluate your personal financial situation, how much debt you carry, how much money you make, how much you spend, and how much you pay out in living and lifestyle expenses each month. To do a complete evaluation:
- Analyze your personal financial situation.
- Determine your maximum mortgage amount.
- Review your credit score.
- Gather and organize the information lenders will require.
Previously, we analyzed our finances but today, we will focus on the second part of a typical mortgage lender’s evaluation:
Determine How Much You Can Afford
Unless you have a bad credit history or bankruptcy, most lenders prefer that borrowers have a mortgage with a monthly payment less than one-third of their monthly pre-tax income. So if your pretax income is $6,000, you’d likely get approved for a mortgage with a monthly payment of up to $2,000. Even that can be a financial stretch.
Should You Get the Biggest Mortgage You Can?
Flat out – NO! Approval does not equal affordable. On a personal note, I was approved for a mortgage that was 50 percent larger than the one I took out. By doing so, I made certain that my mortgage expenses weren’t out of control and in the event I had a drastic change of income, I wouldn’t necessarily lose my home.
To decide whether you can afford a particular sized mortgage, consider these factors:
- Your current financial situation
- Your future job prospects
- Your plans for children
- Your plans for aging parents
- Home maintenance and repair costs
These factors help you personally determine the amount of risk that you can tolerate and should help you decide, for example, whether you should consider a riskier mortgage, such as an adjustable rate mortgage (ARM), or stick with a safer, more predictable option, such as a 30-year fixed-rate mortgage.
You alone should determine how much you can afford
Never rely on a lender to tell you how much of a mortgage you can afford. Always determined this information yourself. Keep in mind that real estate agents, brokers, home sellers, and possibly even the mortgage lender want you to take out the largest possible mortgage. After all, they’re paid a percentage. When one of these pros tries to convince you how large your mortgage can or should be … I personally consider that a conflict of interest.
Instead, always assess your financial situation yourself (Part One of this series!) and arrive at an amount that you feel comfortable borrowing – the amount of debt AND payment that you would feel comfortable with.
Again: Never rely on a lender to tell you how large your mortgage “should” be.
One way to determine the mortgage you can afford is to subtract your total monthly expenses (excluding your rental payment but including everything else) from your total monthly income. The difference should equal an amount that exceeds the monthly mortgage payment you expect to take on by at least several hundred dollars. For example, if you have $1,500 left over after paying all your monthly expenses, you should feel comfortable getting a mortgage with a monthly payment of $1,000–1,200 at the most.
200 times your rent rule
If you currently rent your home, this general guideline could also help you estimate what size mortgage you can afford, but it assumes you’re already maxed out on your rent.
Multiply your rental payment by 200. This rule states that most home buyers can afford a mortgage worth 200 times their current rent payment. For example, if your current rent is $1,100 a month, you can likely afford a mortgage of 200 × $1,100, or $220,000.
How much mortgage can you afford?
Only you should determine that number, whether you “back into it” by calculating your payment at one-third your monthly pre-tax income, use the subtraction method, or the 200 times your rent rule. Always do your own assessment and never let a commissioned salesperson convince you to take on more debt or a bigger mortgage payment than you feel comfortable with.