You’ve just found the perfect house in the perfect neighborhood. Of course you’re excited, but don’t bite off more than you can chew with your mortgage. No matter how much you want that house, if you don’t bring in enough income compared with your expenses, you are either going to stress yourself out over paying your bills every month or lose the house to foreclosure.
To understand just what you can afford, you need to first figure your housing expenses. Housing expenses are your monthly mortgage payment, homeowners insurance and property taxes. Homeowners insurance and property taxes vary, but you can use a ballpark figure to give you an idea. The national average, as of 2010, for an annual premium for homeowners insurance is $481. Figure 1.5 percent of your home’s purchase price for your property tax. These combined housing expenses should not be more than 28 percent of your gross income, according to Bankrate.com. Calculate this by multiplying your gross annual income by 0.28. Divide that figure by 12. That is the most you can spend on your mortgage, insurance and taxes per month.
But the calculations don’t end there. You then need to figure out all of your other debt — your debt-to-income ratio — such as car loans, credit card debt and student loans. Your total debt-to-income should not exceed 36 percent of your gross income, according to Bankrate.com. Calculate this by multiplying your gross annual salary by 0.36. Divide that figure by 12. That is how much you should spend on all of your debts. So, if you can afford $1,000 per month on a mortgage, for example, based on housing expenses alone, if you have a heavy debt load in other areas, you might have to adjust your mortgage down to compensate. To illustrate just how important this 36 percent figure is, lenders extended this figure to 49 percent during the housing boom, according to Marc Roth in an article he wrote for “Bloomberg Businessweek.” After that, in 2008, the United States experienced a housing crash and a foreclosure crisis.
Realize that every household is different. You might be conservative. In that case, don’t spend all that you can afford on a house. You might want to have a cushion in case you want to quit your job when you get pregnant, for example. You also might want to figure in making an improvement to the house, such as that outdoor kitchen you’ve always wanted. On the other hand, if you are sure that you are not going to have kids or that your partner is guaranteed a raise and promotion once he becomes certified, for example, you might want to go ahead and spend more than the 28 percent figure. That puts you into the house you want to stay in without having to move.
Consider your down payment, too. It’s traditional to put down 20 percent of the price of the home. By doing so, you avoid paying private mortgage insurance, the extra insurance lenders require that protects them in case you default on your mortgage. You can use a mortgage calculator tool, such as the one on Bankrate.com, to help you determine just how much house you can afford.
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