How Much of a Home Mortgage Can You Afford?
It seems that anyone who's still lucky enough to have a job can afford to buy a house these days. Thanks to low mortgage interest rates and housing prices, housing affordability is at an all-time high, according to the National Association of Realtors (NAR). The question is, what is affordable?
"How much can you afford?" is often called the key question that needs to be addressed before shopping for a home or mortgage. But a more important question is "How much should you spend?" The difference is important - just because you can manage a certain mortgage payment within your monthly budget doesn't mean you should spend that much.
What is an affordable mortgage?
The traditional guidelines say that you should be able to spend up to 28 percent of your gross (pretax) monthly income on housing costs - that includes your mortgage payment, property taxes and homeowner's insurance. You also need to figure in private mortgage insurance (PMI) if you're making a down payment of less than 20 percent, as well as condo or homeowner's association fees as well. All those are part of that 28 percent ceiling.
On top of that, it's recommended that your other monthly debts, including car payments, credit cards, student loans, child support and other obligations - total no more than 36 percent of your pretax income, when added on top of your mortgage payment.
Staying below the maximum
But do you want to pay 28 percent of your pretax income on housing each month? Current market conditions and mortgage interest rates allow you to buy a lot of home for your money. According to the NAR, a family earning he U.S. median income of $60,000 can afford the mortgage on a $280,000 home - more than half again as much as the U.S. median price. But that same family could also buy a median-priced home for about $180,000 - and have the difference available for other purposes.
Whatever you decide to do, mortgage calculators such as the ones here can make it easy to figure out your mortgage budget - just plug in the different numbers and they can tell you what your monthly payments will be and/or what you can afford. The challenge is knowing what some of those numbers are likely to be. You already know your income and current debts - but what are you likely to be paying for taxes, homeowners insurance, PMI and the rest?
Figuring your mortgage budget
Prevailing interest rates in your area are typically listed by local mortgage lenders and brokers on their web sites. Current 30-year fixed rates are running a little over 5 percent for people with good credit - about 720 or more. Figure on paying more if your credit score is lower - as little as 0.2 percentage points more if your score is only 10 or 20 points below the cutoff for prime rates, but as much as 1.25 - 1.50 percentage points or more if your score is in the lower 600s - and be prepared to bring a hefty down payment if you want to qualify.
Your property tax rate you can obtain from the assessor's office of the community where you're planning to buy - you can probably even look it up online, along with whatever formulas your state or municipality uses for calculating it - in Michigan, for example, taxes are based on the "State Equalized Value," which is about one-half the market value.
Remember too, that taxes can vary significantly from community to community, particularly between a township and a city, as well as within a single community if different school districts are involved.
Homeowners insurance averages about $1,000 a year, but varies widely around the country - ranging from as little as an average of $500 a year in Idaho to about $1,400 annually in Texas. Rates also vary depending on the price of your home and size of your deductable. Check with a local insurance agency for a ballpark estimate for a house of the price and size you're thinking of.
PMI is the insurance you pay on the mortgage if you have less than a 20 percent down payment. Figure on paying about one-half of one percent of the original loan value each year, based on 10 percent down, closer to 1 percent if you're putting down 5 percent or less.
You're going to have to pay condo or association fees if you purchase a condominium or another property where certain of the maintenance costs are covered. These can vary widely, so it's hard to predict what they might be when working out a housing budget. One thing to be aware of, though - they can increase over time, particularly if they start out at the low end, say $50 a month. Be prepared to budget for increases over the long term.
Utilities are often overlooked by first-time homebuyers, particularly if they've been renting a home where everything or nearly everything was covered. You can usually obtain information on previous gas and electric bills for a property you're interested from the utility company, and the real estate agent showing the property will sometimes offer it as well.
Many new homeowners are stunned to learn just how much more expensive it is to heat a big, old house than a smaller, newer, more energy efficient one - or cool a big, old house in a hot climate. Don't neglect it when planning your budget.
Other things to keep in mind
Finally, don't neglect future expenses when working out a budget. Many financial advisers recommend that homebuyers maintain a reserve fund equal to about 5 percent of the price of the home as a reserve fund against unexpected expenses, such as having to replace a roof, furnace or septic system, or just for emergencies in general.
Also, keep in mind other things that you want to be able to pay for down the road that aren't in your budget presently - like replacing a car, paying for college or starting a family. Don't assume your finances will automatically improve over time to pay for these things - that's how a lot of people who are presently in financial trouble ended up there.
Remember, just because traditional models say you can spend 28 percent of your pretax income on buying a house doesn't mean you have to do so. With so many great housing bargains available right now and mortgage rates so low, you can you can get a lot of home for your money. And with the economy the way it is, it wouldn't hurt to be a bit conservative with your budgeting.
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