As we ponder how to solve the crises in the housing market, maybe this is the best time for the homeowners of the near future to consider the question posed above.
While lenders must assume some responsibility for this problem, so must the homeowners who simply bought more house than they could afford.
So, how do you know how much house you can honestly afford?
It's pretty simple, actually: just calculate your mortgage payments and compare to your monthly gross income.
Most of your payment will go toward loan principal and interest, also called "P+I," but is also likely to include amounts for property taxes and homeowner's insurance. If you plan to make a down payment of less than 20% of the home purchase price, you will also have to add an additional amount for private mortgage insurance ( PMI). Lenders require PMI to insure against the higher risk of default that occurs with loan-to-value (LTV) ratios greater than 80%. ( An LTV of 80% is equal to a down payment of 20%.)
Next, determine your housing ratio. To do this, divide your total monthly payment by your monthly gross income.
The ratio should not be more than 28%. So, if your total monthly payment is $1400, your monthly gross should be at least $5,000.
Next, you'll want to find your debt ratio, which is the sum of your total monthly payment, loans, credit cards, etc., divided by your monthly gross income. This should not be more than 36%, or $1800 if you gross $5,000 monthly.
These ratios are used by mortgage lenders as guidelines and change over the course of economic cycles.
If possible, you might limit your search to homes that allow you to obtain a conforming loan. For 2008, the conforming loan amount for Fannie-Mae and Freddie Mac-sponsored loans is $417,000. For Alaska and Hawaii, the limit is $625,500. A conforming loan allows you to avoid private mortgage insurance if you make a down payment of at least 20% on the home purchase price.
If your mortgage loan is conforming, you will likely have an easier time finding a lender than if the loan is non-conforming. (A non-conforming loan is called a "jumbo" loan.) Generally, interest rates on conforming loans are lower than on non-conforming loans.
How much house you can afford also depends on the amount of your down payment. If you don't have one saved, consider these alternatives:
- Obtain private mortgage insurance.
- Federal government mortgage-financing programs.
- Borrow against the value of your investments.
- Borrow from your employer-sponsored retirement plan.
- Withdraw funds from an individual retirement account.
- State government housing programs.
Don't forget to add in closing costs (generally, from 3-6 percent of the purchase price), including fees to process, review and you're your loan; Fees for legal and appraisal services, credit review and title search, insurance and moving expenses.
You will also have moving expenses, but you may be able to write these off (IRS Form 3903). If you move to another region of the country, you may also face a change in the cost of living. To compare the cost of living between cities, you may wish to visit the ACCRA Cost Of Living Index.
Those are the basics. For advice on your specific needs, consult a mortgage lender or financial adviser.
Gary Mancuso Oak Park Homes River Forest Illinois
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