As you get ready to start looking for a home, the first two thing you should do is to find a great Realtor who will look out for your best interests and second to get pre-qualified for a mortgage. It is important to find out how much you can afford to spend on a home so that you are confident that you are looking in the right price range and so that you can afford to buy that dream house when you find it.
When you make that mortgage application, the lender will decide how much money you can borrow. However, that doesn’t mean that you should take out a loan for the full amount. In fact, you may be surprised by how much the lender is willing to give you! In some cases, borrowing the maximum a lender will allow could leave you overwhelmed by debt.
How Lenders Decide How Much You Can Borrow
Lenders base mortgage decisions on several factors, including credit score and length of credit history, but the most important factor is a borrower’s debt-to-income ratio. This is the sum of all debts, including a mortgage, credit card minimum payments, and vehicle, student, and personal loans.
Most lenders want borrowers to devote no more than 28 percent of their gross income to a mortgage, property taxes, and homeowners and private mortgage insurance. They also generally want your total debt payments to be no more than 36 percent of gross income but they will allow up to 50 percent of your gross income to go to your total debt payments - and FHA can be even more "generous." This is an insane way to go into home ownership!
Reasons Not to Borrow as Much as You Can
A lender may approve you for a mortgage up to a high amount, but it might not make good financial sense to borrow all that money if your other, non-home-related debts are high. For example, if you have plans to renovate your home or your home will be expensive to maintain, that may throw your carefully planned budget out of alignment. You might have other expenses that take up a significant portion of your income, such as daycare costs, college tuition and medical bills.
Consider your long-term financial goals. If you have credit card bills you want to pay off quickly, you can pay more than the minimums due each month, but that might make your total debt payments too high to manage with a large mortgage. Consider your life style. You might be able to afford that big mortgage payment - but will you be eating ramen noodles for the next three years? Will you have to forego vacations and evenings out with friends because your mortgage payment takes all your disposable income? If you plan to buy a new car sometime soon, a car payment plus a high monthly mortgage payment could be hard to manage. If you want to set aside money for retirement or for your children’s college education, take those goals into account.
Don’t Take on More Debt Than You Can Handle
When shopping for a home, it’s easy to get carried away. That lender may be happy to lend you a big amound of money, but you don't have to take it all! Remember that you are going to be the one making the payments - not the lender! Just because you can borrow a large sum of money, that doesn’t mean you should. Look at your entire financial picture and make a responsible decision that will allow you to cover all your bills and live comfortably.
Finally, be sure to pick a Realtor who understands and respects your financial goals. Chances are there are a number of homes that will meet your wants and needs - and many of those will not break your bank. Don't get sucked into a bad financial decision by a Realtor who tells you that it is just a little more each month to get the house of your dreams! That Realtor isn't making your mortgage payment - you are!