How Much House Can You Afford?

Mary asked ALMC – How do I know how much house I can afford?

When your parents bought their first home they were likely encouraged to stretch as far financially as they possibly could. Today, potential homebuyers are still pushed into mortgages bigger than they can handle based on this old-fashioned advice. However, there have been several changes that have occurred over the past 30 or so years that now make this practice dangerous to the dream of home ownership:

Cessation of inflation. Rapidly rising prices in the 1970’s and early 1980’s meant you could count on hefty annual raises. Today, you can’t rely on double-digit income boosts to make your mortgage payment less of a burden each year.

Predominant two-income couples. A generation ago, it was much more common to have one breadwinner in the family. If they lost their job, the other spouse could go to work to save the house. Today, it is more likely that both spouses must work to support the household, leaving no one on the sidelines to pick up the slack if needed.

Greater necessity for retirement planning. 30 years ago, a larger portion of the workforce was covered under traditional, defined-benefit pensions. Therefore, they didn’t have to save massive amounts of money on their own to have a decent retirement. Today, it is up to you to make sure you are prepared by sufficiently funding your 401(k)s and IRAs.

So what can you afford? The more conservative in the mortgage industry suggest capping your total outlay for mortgage payment, homeowners insurance, property taxes and mortgage insurance (if you need it) at 30% of your gross monthly income. They also recommend that when you add this amount to your total debt payments, you don’t exceed 41% of your gross monthly income. If your total debt will push you over this amount, you should consider paying off some debt before you purchase a home, or reducing the size of the mortgage you are considering.

Keep in mind that 30% is just a guideline, and every situation is unique, so factor in special circumstances. You may want to go lower than 30% if you plan to have children, have an expensive hobby you don’t want to give up, or if your income varies considerably. You may, however, be able to stretch beyond 30% if you’re relatively debt-free, you don’t have to worry about contributing to your retirement, or you know your income will climb steeply in coming years.

Ultimately, you have to decide what will work for your situation. At the very least, a too-big house payment will leave you with too little money for other goals: college funds, vacations or retirement. At worst, it can leave you vulnerable to foreclosure and bankruptcy. Don’t rely on your realtor, loan officer, family or friends to tell you what you can actually afford. You have to make that decision yourself, based on your finances, your future obligations, your goals and your risk tolerance.

Meet Cheryl!

About Cheryl

As a successful business owner and community leader, Cheryl Braunschweiger is known and respected for getting things done with a degree of skill and enthusiasm that bring out the best in those around her - colleagues, clients and friends. The name of her business, ALMC Mortgage, reflects Cheryl's philosophy and personality. She says it stands for All Loans Must Close –a reflection of her determination to do whatever it takes to serve her clients. Cheryl has been in the mortgage lending business for 20 years. Read More About Cheryl
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