How Much Can You Afford?

Rent Vs. Mortgage

Mere numbers don't tell the whole story. Many lenders tout the idea that mortgage payments can wind up costing people less than renting. Renters look art this sort of claim and think "Well then, why couldn't I be a homeowner?" Although it is true that in a good number of cases mortgage payments can indeed cost less than some rental payments it is imperative to remember that a mere mortgage payment is not the whole picture. There are so many other costs associated with owning a home; there are property taxes to pay, homeowners insurance to keep current, and don't forget that when something breaks in a house you own then it's your responsibility.

Renters can merely call their landlord to get things fixed; homeowners need to dig into their own pockets. So when you are budgeting for your mortgage payment be sure to take into consideration the fact that your mortgage payment will be merely a portion of the monthly cost associated with owning a home. You should be able to put money away every month for a repair fund, and you should also be able to pay for any additional insurance, such as flood insurance, without it causing a big trauma to your bank account.

Mortgage is considered "good" debt. Something odd happens when you become a homeowner…suddenly creditors and chomping at the bit to finance you for whatever credit you want. It is as if having a mortgage payment on your credit report suddenly makes you a viable credit risk. Although it is true that there is something kind of cool about being able to check "own" instead or "rent" on credit applications you need to make sure that you don't get carried away. Every new credit account that you open after you purchase your home has the potential to drive you deeper into debt. Sure, a mortgage is considered an acceptable debt and the vast majority of homeowners in the United States carry a mortgage on their home, but you still need to use caution when using this to your advantage.

Renters can just walk away. When renters sign a lease they enter into a legal commitment to stay in a residence for a certain number of months or years. If they break the lease and are unable to find a replacement tenant they are then obligated to pay the amount of money in rent that they would have paid if they had kept the lease.

Homeowners, on the other hand, do not necessarily have a cut-and-dry method of egress like renters do. If a homeowner walks away from a home and a mortgage obligation then they will face foreclosure. The home will be auctioned off to the lowest bidder, and the previous owner will still be legally obligated to pay any deficit owed to the bank. This means that if your home is foreclosed on with a mortgage balance of $100,000 and then the auction yields a buyer who bids $75,000 then you are still obligated to pay the deficit of $25,000, even though you no longer reside in the home. There is simply no walking away from a home when a mortgage is attached.

Don't stretch yourself. If you're looking at your potential budget and you notice that there will be very little money left over each month then you need to lower your expectations in a home. You don't want to stretch yourself too thin and you need to make sure you will have an abundance of cash left over each month, otherwise you are just asking for trouble to knock at your door.

It is hard to think in a practical way when you find a home, which you adore. You might find yourself trying to finagle your budget to make it work. You might even talk yourself into believing that you can cut some corners or temporarily take on a second job. You shouldn't let your emotions rule you when you are figuring out what you can afford. Now is the time to think in a practical manner so you don't find yourself in a tight situation down the road.

Don't Trust The Bank

What's a debt-to-income ratio? When applying for any sort of loan you will probably hear the term "debt-to-income ratio" mentioned more than once. Lenders don't necessarily set out to make this a mysterious term, but they use it so often than many times they don't think to explain it to the borrowers. Your debt-to-income ratio tells the lender how much of your monthly income is tied up with recurring financial obligations. Lenders use this ratio to tell them if you are in a financial position to take on more debt.

Figuring out your debt-to-income ratio is quite simple. First, figure out the total monthly amount of all your recurring bills. Car loans, student loans, and credit card payments are the sorts of things you should include here. Don't include rent because they are looking for your debt-to-income ratio as it will relate to a new mortgage payment, not how it looks right now. After totaling up all your monthly obligations, subtract this sum from your total monthly income. You can generally use your pre-tax income since that is how most lenders look at the ratios. Take this new number and divide it by your monthly income. This gives you your debt-to-income ratio.

For example, a person who makes $5000 a month and has $2500 in monthly debt will have a debt-to-income ratio of .5, or 50%. Incidentally, this is a pretty high ratio and most credible lenders would not write a mortgage in this instance. 35% debt-to-income ratio is usually the highest "A" lenders like to see. "A" lenders are those who have low interest rates and who also do not charge many junk fees. If at all possible, you should attempt to get a mortgage through this sort of lender; it will save you a lot of money in the long run.

Each lender has its own acceptable ratios. As a general rule, the credibility of the lender will define what sort of debt-to-income ratio they will accept. Lenders who are the most well regarded and who are able to offer attractive interest rates without tacking on ridiculous fees and penalties tend to lean more towards borrowers who have low debt-to-income ratios.

Unscrupulous lenders, those who have terribly high interest rates and who hit their borrowers up with penalties and fees on a regular basis, are generally much less concerned about a potential borrower's debt-to-income ratio. Unscrupulous lenders are simply out to get as many mortgages as they can, and therefore will accept borrowers who probably shouldn't be buying a home to begin with due to high monthly bills or a seriously bad credit history. As a general rule, if a credit union or bank turns down a borrower for valid reasons but a relatively unknown lender leaps at the chance to finance a mortgage for the same borrower then it may be that the lender is hoping to charge excessive interest rates and otherwise unnecessary fees.

They don't know all your monthly obligations. When mortgage lenders look at your debt-to-income ratio all they usually see are the monthly payments, which show up on your credit report. They may ask for additional information such as any child support payments you're making, but most lenders simply assume that utilities and such do not represent a huge dent in your monthly paycheck. Now take into account all the things you pay for on a monthly basis: phone bill, cable bill, electricity, car insurance, groceries, and anything else you shell out your hard earned money for. When you take all these items into account it should become obvious to you that even if the bank joyfully declares you financially ready to purchase a home you really need to sit down and make a budget, which includes all your current financial obligations in addition to a proposed mortgage payment.

If you simply can't make the numbers work then that is a pretty good indicator that you either need to wait a while to purchase a home or instead look towards a lower price range (and thus a lower monthly payment). Naturally it can be hard to have a lender tell you that they're ready to loan you $200k for a home but then you realize that the most you can manage is $130k. Don't let the bank decide your financial fate though; you will more than likely regret it later when you find yourself consistently lacking the money you need to pay your bills.

Mortgage Isn't The Only Cost

Ask about utilities. Certain factors affect what sorts of utility payments a house faces on a monthly basis. High ceilings are harder to heat and cool, a big window facing the morning sun can heat up a house really quickly in the summer, and certain appliances can be a real drain when it comes to electricity. It is not rude to ask to see some recent utility bills from the sellers because this can give you an accurate portrayal of what you may be paying for utilities if you purchase the house. Although it is true that every family uses utilities in different ways it is better to know what is generally spent at each house. If you find two houses that you equally like it may come down to which one will cost you less on a monthly basis, and if the mortgage amount is the same the only difference may be monthly utility bills.

What is PITI? PITI is an acronym for Principal, Interest, Taxes, and Insurance. You will hear this term quite a bit when researching mortgage loans. PITI is the total monthly amount you will need to pay. When a lender quotes you a monthly mortgage payment you need to find out if that figure includes interest and taxes, or if they are merely referring to the principal and taxes. It would be a shame to assume that the number was for everything only to find out that it isn't so when your first payment is due. You need to be sure to have a solid understanding of what sort of monthly payment you are getting yourself into so that you can budget accordingly. You should also be aware that taxes and insurance can change from year to year, so even if you have a fixed rate loan your monthly payment might still increase each and every year.

Does anyone purchase a home with cash anymore? Although this practice has become a bit of a rarity, it still happens. If you happen to have the ach you need sitting in a savings account to purchase a home then you still need to decide if using cash is in your best interest. If buying a home will completely obliterate your savings then you don't want to use cash. If, however, you have enough money saved up to where you can purchase a home outright and still have a sufficient savings to cover emergency expenses for a decent number of months then it may be a good idea to avoid financing. Some people rationalize using financing since the interest paid on a mortgage is tax-deductible, but when it comes right down to it this is faulty logic. Why even pay the interest to begin with if you don't have to?

When you purchase a home you are making a major financial decision. There is so much more to buying a home than simply making a monthly payment. You need to realize that you are obligating yourself to a monthly payment for a very long time, and if for one reason or another you think there may come a time when this payment will not be feasible to make then you should think twice about taking on a new home. If you have checked all the facts and figures, though, and it looks like you can afford a house payment along with all the other expenses involved with homeownership then proceed with caution to the next step: finding a lender to finance your mortgage.

On the next page we talk about the various methods of Acquiring Financing.