I particularly like drawing on my education background to help First Homebuyers answer the burning question “How Much Mortgage Can I Afford?” They’re excited about this great adventure and I am excited to be trusted to help put their plans together. There is a lot to learn about the process and it takes patience and skill to ensure that these dreams do not turn into a nightmare.
There’s a big difference between How Much Mortgage Can I Afford? and How Big a House Can I Buy? Theoretically, a borrower with $50,000 income can afford a $1,000,000 home if they just won the lottery and used their savings wisely to pay the for the taxes and upkeep.
So Not too far into our initial conversation, I always ask the question, “Have you given any thought to How Much Mortgage Payment Can You Afford each month?” Some like John and Beth who just had a new baby and need a place to call home did have a figure in mind. Surprisingly, many reply, “No that’s what we hope you can tell us?” To which I reply, “No, That’s your job!
If you are a First Home Buyer, you might have searched on-line for one of those How Much Mortgage Can I Afford calculators. These calculate your debt-to-income ratio by plugging in certain income, expense and projected housing costs to arrive at an estimate of what a bank may lend you for a mortgage.
Effective January 2014, the Consumer Finance Protection Bureau has mandated that a 43% debt-to-income ratio is the highest ratio can have and still get a Qualified Mortgage. A Qualified Mortgage is a category of loans that have certain, more stable features that help make it more likely that you’ll be able to afford your loan. And when you eventually apply for Mortgage Pre-Approval, that’s just what the Bank will do; It will tell the maximum amount it will lend you.
“Purchase or Refinance…I help families live comfortably and financially secure in their own home.” That’s what it says on my letterhead and that’s what I promise all my clients. So when John and Beth throw out a figure, I ask, “Does that include the mortgage payment, property taxes, home insurance, and mortgage insurance. How about maintenance costs? For them and all the others, we go back to basics.
The 43% ratio is based on borrowers gross before tax income and not net take home pay. It includes the mortgage payment, an escrow for property taxes, home insurance; and mortgage insurance (PMI); plus condo fees, debt payments, and alimony or child support if applicable.
Here’s the issue with these scenarios … The bank (and those calculators) aren’t telling you how much house you can comfortably afford. They’re only telling you the maximum they’ll actually lend you. Too often, I have seen First Home Buyers shop for homes at the top of their affordability range, only to find themselves in a difficult financial situation a few years down the road. A temporary job loss, a hike in property taxes (I could go on forever about this issue), a new car, orthodontics, can send homeowners financial situation spiraling out of control.
When I talk to First Home Buyers … we talk about these potential calamities and whether they might have to rethink How Much Mortgage I Can Afford if they had to squeeze their budget to make the monthly mortgage – or if one of these emergencies required them to take money out of the college fund to make ends meet. “It’s not up to me to decide How Much Mortgage I Can Afford,” I ask, It’s up to you to rethink your mortgage goals.”
Bottom Line: Home Buyers aren’t, by any means, required to take all the money a Bank offers to loan them. No one says you can’t buy a buy a $150,000 home even if you technically qualify for a $200,000 mortgage. But before you buy a home at all, consider how a mortgage payment – and other homeownership costs – will affect your budget. That way, you won’t wind up in over your head worried about making your house payment.