When you are buying a home you can't always rely on your loan officer to tell you what you can afford. The fact is that what you can qualify for and what you are comfortable with can be two very different things. To find out if you are truly comfortable with a potential monthly payment there are a few things that you should do...
Develop a Realistic Budget
You should develop a monthly budget and write down every single monthly cost and include a contingency fund of 10% for the unexpected. After the mortgage payment, do you still have enough to put some into savings? into an emergency fund? Are you going to have to cut out cable/Internet, eating out, or other luxuries that you can't do without? If you are uncomfortable with your answers, look for a different house.
The Industry Standards
You could also use the standard "housing ratio" and "debt to income ratio" which underwriters use to determine whether the payments are affordable. Those standards are that you shouldn't spend more than 28% of your gross monthly income on your mortgage payments and that you shouldn't be spending more than 41% of your gross monthly income on your mortgage payments along with other monthly debts (e.g. car payments, credit card payments, student loans, etc.)
It's possible to get approved if your ratios are higher than these standards, if you have very good credit or a large down payment for example. But unless you live very frugally it's likely that you will struggle with a mortgage payment that high.
Account for all increases!
you need to look at your current housing expenses and take into account all of the increases that you will see if you buy a new home. You will need to ask yourself at least these questions...
- How much more is the new mortgage payment (including hazard insurance and property taxes) vs. our current rent payments?
- How much more or less will the utility bills be?
- How much do we need to set aside each month for potential home repairs? (Studies show that you will pay 3.5% annually of the purchase price for a new home and 4.5% for an older home)
- Is there an HOA fee that we need to account for?
*You also need to find out how much more of a tax refund you will get because mortgage interest is tax deductible.
The Eight Hour Rule
If you have taken all of the above steps and passed there is still one more test that you need to be aware of. You can always fall back on the eight hour test to determine whether you will be comfortable with a new mortgage payment. If you find yourself reaching for the Tylenol PM at 2 am, chances are that you will not be comfortable with your new mortgage payment.
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