| Regardless of where you live, how much you earn or what type of house you are shopping for, as soon as you find out how much the seller is asking, your first reaction might be something like, “Wow! That's expensive!” Your initial assessment is correct. With prices rising quickly, particularly in areas like New York and Boston, even starter homes can carry hefty six-figure price tags. Your next reaction is likely to be, “Can I afford that?” |
| Generally speaking, most prospective homeowners can afford to mortgage a property that costs between 2 and 2.5 times their gross income. Under this formula, a person earning $100,000 per year can afford to mortgage between $200,000 and $250,000. But this calculation is only a general guideline. Ultimately, when deciding on a property, you need to consider a few more factors. First, it's a good idea to have an understanding of what your lender thinks you can afford - to gain a precise idea of what size of mortgage their clients can handle, lenders use formulas that are much more complex and thorough. Secondly, you need to determine some personal criteria by evaluating not only your finances but also your preferences. Lender's Criteria: Debt-to-Income Ratios From a lender's perspective, your ability to purchase a home depends largely on the following factors: Front-End Ratio The front-end ratio is the percentage of your yearly gross income dedicated toward paying your mortgage each month. Your mortgage payment consists of four components: principal, interest, taxes and insurance (often collectively referred to as PITI). A good rule of thumb is that PITI should not exceed 28% of your gross income. However, many lenders let borrowers exceed 30%, and some even let borrowers exceed 40%.Being House Poor: a Personal Decision To be house poor means that the costs of paying for and maintaining your home take up such a large percentage of your income that you don't have enough money left to cover other expenses. As grim as that sounds, many people choose to be house poor because they believe that it's wise to purchase the most expensive home that they can afford, regardless of how far they have to stretch. Their theory is that, over time, their income will increase as a result of raises and promotions, making that expensive mortgage a smaller and smaller percentage of their monthly expenses. Clearly, those who choose to be house poor have their own set personal criteria determining what kind of home they can afford. Personal Criteria The decision of whether or not to be house poor is largely a matter of personal choice - since getting approved for a mortgage doesn't mean that you can actually afford the payments. So in addition to the lender's criteria, consider the following issues and set some decisive factors of your own: Income When contemplating your ability to pay a mortgage, ask yourself the following questions: Are you relying on two incomes just to pay the bills? Is your job stable? Can you easily find another job that pays the same or better wages if you should lose your current job?Beyond the Mortgage Buying a new home is an exciting adventure. But many prospective homeowners, caught up in the thrill of searching for their dream house, forget to pause and consider the financial responsibilities of homeownership. While the mortgage is certainly the largest and most visible cost associated with a home, there are a host of additional expenses, some of which don't go away even after the mortgage is paid off. Smart shoppers would do well to keep the following items in mind: Maintenance Even if you build a new home, it won't stay new forever, nor will those expensive major appliances, such as stoves, dishwashers and refrigerators. The same applies to the roof, the furnace, the driveway, carpet and even the paint on the walls. If you are house poor when you take on that first mortgage payment, you could find yourself in a difficult situation if your finances haven't improved by the time your home is in need of major repairs.Think Before You Buy The cost of a home is the single largest personal expense most people will ever face. Prior to taking on such an enormous debt, take the time to do the math. After you run the numbers, consider your personal situation, and think about your present and future lifestyle into the next three decades. Make an informed decision, and be sure to purchase a home that you can afford without compromising your future. |
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