When buying a home, most homeowners don’t look at their total mortgage debt to determine how much they can afford. After all, you are paying off your mortgage over a 15 or 30 year period and as such looking at the total amount you are borrowing does not provide an accurate reflection of what you will actually pay, since this bottom line number does not factor in the interest payments which can sometimes add up to hundreds of thousands of dollars.
Instead, when considering how much mortgage debt you can afford to take on, most perspective homeowners look at their monthly payments. This method of determining your price range can be a good method of deciding how much mortgage debt to take on, but it can also lead to problems if you try to use alternative financing to afford a larger house than you should be buying.
Mortgage Debt and Fixed Rate Mortgages
Within the mortgage industry, a fifteen or thirty year fixed rate mortgage has long been the standard. With this conventional method of financing, your payments are fixed for the duration of the time it takes to pay off the mortgage. As long as you make those payments on time and do not refinance, you will be able to pay off your mortgage in between fifteen and thirty years.
When using this method of financing, you can determine how much mortgage debt to take on my looking at your monthly payments and comparing them to your income. This is an effective method of determining an appropriate amount of mortgage debt because your payments never change for the life of your loan.
To determine how much mortgage debt you can afford, simply calculate your gross income. This is the amount you make each month before deductions, such as taxes, are taken from your check. You can determine this number by dividing your annual salary by 12. Your monthly mortgage payment should not exceed a set percentage o this debt.
While experts disagree somewhat on the percentage, in general your monthly mortgage payment should be somewhere in the range of 25 to 33 percent of your gross monthly income. Therefore, if you make $50,000 per year, you can afford to pay around $1160 per month as a mortgage payment, provided you don’t have significant other debts. This $1160 per month should cover the amount you pay to the bank to service your mortgage loan, as well as property taxes and homeowners insurance.
If you have lots of other debts, you have to take those into consideration when determining how much mortgage debt you can afford to take on. Your total debt payments, including your mortgage, should need exceed between 36 and 40 percent of your income. If your mortgage payment plus your debts will be larger than this number, you should consider paying down or paying off your other debt before buying a home.
Mortgage Debt and Other Financing Methods
When considering other methods of financing, such as adjustable rate mortgages or balloon mortgages, the standard formula of looking at monthly payments versus monthly income does not work, since your payments are not standard or fixed. Your payments can rise sharply with these types of mortgages, so you must leave yourself a very comfortable cushion of cash between the amount you are paying each month and the mortgage payment to account for rising interest rates.
While many homeowners opt not to do this, instead choosing alternative financing to buy a home they cannot fully afford, this can lead to an inability to pay your payments if you are unable to refinance when interest rates rise. This sort of borrowing was a contributing factor in the mortgage crisis of 2007 and 2008 and can lead to foreclosure.
Deciding How Much Mortgage Debt to Take On
While stretching to buy a home can seem appealing, it can also be a risky financial proposition. If possible, it is best to be conservative in the debt you take on. If you want to buy a bigger house, instead of borrowing more, simply save a larger down payment in order to protect your investment.
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