Just because you have the financial means to qualify for a mortgage, this does not mean you should accept the maximum loan possible.
If you are trying to determine the amount you can realistically afford it makes sense to get in contact with a lender for a pre-qualification quote or simply use one of the online calculators. But, even if you are approved for a specific amount, there is no need to apply for the full amount if it is likely to stretch the finances too much.
How much can I afford?
In the process of determining the amount you qualify for, most banks rely on a rule known as 28/36, which relates to a calculation based on income and maximum amount that can be repaid each month.
The 28 aspect of the rule relates to the front-end calculation and states that the monthly repayment of the mortgage, including insurance and taxes, should not be higher than 28 percent of the borrower’s pre-taxable income. The 36 aspect is the back-end and concerns the borrower’s complete debt profile, including student loans, credit cards, car loans, mortgage payment, or similar payments and should not be higher than 36 percent of the pre-tax income.
In certain situation, banks or other lenders may be willing to provide slightly higher limits. For instance, if your personal financial situation is in a position to meet several other requirements, the debt-to-income ratio can be increased to a figure like 45 percent. In this instance, monthly pre-tax earnings of $5,000 would make it possible to get accepted for a mortgage provided the total debt per month is not more than $2,250.
How to set a sensible budget
Buying a home for most people is likely to be their biggest lifetime investment. For this reason, it is essential to set a realistic budget and borrow what you can afford to pay back. A mortgage calculation of 28% of pre-tax earnings can be about 50 percent of the take home earnings.
Here are five tips to help decide on a sensible home purchasing budget:
1 – Other financial obligations
One of the major issues to consider when applying for a mortgage is other outstanding debts, which relates to car loans or credit cards. Even though the mortgage lender will look at other debts, they only generally take notice of the minimal monthly repayment. But making just the minimum payment each monthly is rarely sensible financial planning. For instance, a credit card debt of $30,000 with an interest rate of 18 percent and a minimum repayment of $500 per month can take up to 13 years to pay back in full. Plus, the amount paid back over this time frame will be in the region of $75,000. By not stretching the finances with a high mortgage payment it is possible to clear the debts with high interest rates much sooner.
2 – General expenses
In addition to the major financial obligations, there are various other expenses that do not feature in the qualification step. In the process of evaluating a debt, lenders are more interested in the finances that appear on a credit report, such as bank loans or credit cards. General expenses are wide-ranging and can be classified as:
- Eating out
- Food shopping
- Fuel/other travel costs
- Insurance polices
The debts that appear on the credit report are just one aspect of your financial obligations. A full breakdown of all expenses should be carefully examined before committing to a mortgage.
3 – Home ownership costs
Home ownership also has a variety of additional costs such as insurance and property taxes. In many cases these costs have the tendency to increase year-on-year, which puts more strain on the finances. Plus, there is the issue of repairs and maintenance. Without keeping a little back each month it is certain to be a strain to cover the cost of repairing a leaky roof or replacing the broken down heating or air conditioning system.
4 – Extra for emergencies
Saving a certain percentage of the income each month is a sensible and practical thing to do, especially if an emergency situation should arise. Plus, there is a need to put aside a certain amount of money for your retirement. Based on data provided by the Federal Reserve, it is believed that about 50% of American adults are not in a position to cover the cost of an unexpected bill in the region of $400 without borrowing from a family member or using a credit card. Living paycheck to paycheck can put a lot of strain on property owners.
5 – Personal expenses
Make sure to understand the difference between the home essentials and the wants. For instance, it will be nice to install a steam shower, a home theater room, en-suite guest rooms, and an outside pool, but in reality this should only be done when the finances are already in place without needing to rely on credit or using all the savings. Personal wants are better added to the home when the personal finances make it possible.
Spend the borrowed money wisely
Getting approved for a mortgage is much the same as taking on the responsibility of any other dept. Even if you have a credit card limit of $25,000 there is no reason why you should immediately go out and spend that full amount. While you might have the means to spend that amount of money it is never a sensible approach to managing the finances.
But a sensible approach isn’t always taken when it comes to buying a new home. Instead, many would-be property owners made the decision to invest as much as the banks will agree to lend. This approach should only be taken if there is a justifiable reason to invest as much as possible on a home. Overall, it is essential to carefully consider the finances and only invest what you can sensibly manage each and every month. For many people it benefits to lower the initial investment in the property to ensure there is more income to use on other essential or personal expenses.