How Much Should You Mortgage Your New Home

If you’re selling your home to “size up,” you might be taking on more debt to do so. Common investment wisdom used to be: the housing market always goes up so you want to stretch for good real estate. But the Case-Shiller Index and the housing crash of 2008 taught us that this isn’t always the case.

Now, financial planners will tell you it’s more important to buy a house you can comfortably afford. If you’re using a mortgage to pay for your home, you’ll need to consider more than the maximum loan amount for which you qualify.

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Down Payment

How much are you able to put toward your down payment? Hopefully, you’ve built up some equity in your current house so that when you sell it, you’ll have a good chunk of cash to reinvest. Because the less money you put down, the higher your home mortgage will be. The higher your home mortgage is, the riskier it is, and the riskier a home mortgage, the more expensive.

If your down payment is less than 20% of the purchase price, your lender will require you buy private mortgage insurance (PMI) which can add up to 1% of the loan amount every year. Your interest rate will most likely be higher as well and the higher the interest rate, the higher your monthly payment.

If you live in an expensive area or haven’t been able to save up enough cash to cover a 20% down payment, there are lending sources that will loan up to 97% of the purchase price for people who qualify. But just because a lender is willing to give you that much money, it doesn’t mean you can afford to take it.

Debt to Income Ratio

What other debt do you have? If you have good credit, lenders will often give you a loan that, when combined with your other debt, reaches to 40% of your gross monthly income level (i.e. your income before taxes, insurance, and retirement are subtracted). But that doesn’t leave a lot of room for saving after all of your other monthly expenses to get taken into account.

Financial advisors usually recommend keeping your monthly debt payments (other than your home mortgage) to no more than 7% of your net monthly income (i.e. your income after taxes, health insurance, and retirement are subtracted). They also recommend keeping your total cost of housing to no more than 28% of your net monthly income. That 28% must include your mortgage payment, taxes, homeowners’ insurance, PMI (if applicable), and maintenance.

So if you have the maximum debt financial advisors recommend, your total monthly debt payments would equal 35% of your net monthly income.

In order to get an accurate idea of how much your monthly housing costs will be, you need to get good estimates of your monthly tax and insurance payments. You can find the property tax rates for your city or county on the city or county website, and you can call a few insurance companies to ask about their rates for homeowners.

Prepare a Budget

While 80% loan-to-value and 35% debt-to-income ratios are good guidelines, they won’t give you all the information you need to make a decision about your mortgage. For that, you’ll need to do a monthly budget.

Take your total net monthly income and subtract your fixed costs which include all costs that are the same each month. They include expenses like rent, home mortgage payments, car payments, student loans, school tuition, childcare costs, and anything else that isn’t easily adjusted. Then subtract variable costs like groceries and utility bills and discretionary costs like gym memberships and restaurants.

After taking all of your expenses into account, how much can you afford to spend on that monthly mortgage payment without making major changes to other areas of your life? Conversely, are there expenses you can cut down or cut out in order to afford the home you’ve always wanted?

Whatever your decision, you should keep your ideal monthly mortgage payment in mind when you shop for loans. The loan officers might try to convince you that you can afford more than would be responsible (the more money you borrow, the more money they make), so be upfront and firm with how much you want to pay each month. A lender might even offer a lower interest rate or waive the PMI to get your monthly payment in line with where you want it.

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