One of the mistakes first-time home-buyers make is to put financial decisions into their mortgage broker's or bank's hands, borrowing as much as the institution will lend them. Take control of your finances and control you debt by determining an ideal percentage of monthly income to devote to your mortgage. Keep in mind that most mortgages do not include additional expenses you may incur with real estate ownership, such as taxes, insurance and maintenance.
Financial institutions use different methods of figuring out your monthly income, which then guides the percentage of income you use for house payments, also known a debt-to-income ratio.. A front-end ratio looks at your gross income and compares it with your house expenses. The Bankrate.com guide to mortgage basics recommends a 28 percent debt-to-income ratio from pretax income, underscoring the need to include the cost of principal, interest, insurance and taxes in that percentage.
If you have several types of debt, particularly debts with high interest rates, you may want to adopt a more conservative approach to determining the amount of monthly mortgage debt to carry. Use a back-end ratio that compares your gross income with all monthly debt expenses, including credit cards, student loans, legal payments, alimony, child support and condominium fees. Bankrate.com suggests a maximum of 36 percent debt-to-income ratio if you use this formula.
Certain exceptions apply when figuring out debt-to-income ratio. If you have other sources of income, or irregular income from interest or capital gains, you may be able to afford a larger mortgage than your debt ratio suggests. In addition, mortgages from the Federal Housing Authority and the Veterans Administration may follow a debt-to-income ratio, using the back-end ratio, of up to 41 percent.
No straight formula suits every financial situation. Rather than stick to a strict number, follow the advice of many financial experts, such as Dave Ramsey, and keep your housing debt as low as possible. He recommends putting 10 to 20 percent down on your home, keeping mortgage payments under 25 percent of your monthly net pay and using a 15-year payoff plan rather than the traditional 30-year mortgage. He adds that you should have a fixed-rate rather than an adjustable-rate mortgage.
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