If you are in the market for a new home, a major concern is buying a home that you like but also a home that you can afford. We all should cherish the right to owning our own home but we need to proceed with equal parts dream and hard financial thinking. We suggest a simple home affordability calculation to help you stay out of financial trouble when buying a home.
We only have to go back to a decade ago to recall how badly it worked out for so many people when the housing market crashed. Folks got into low-interest rate mortgages on homes that were really too expensive for them. Then two things happened at once. The five-year balloon on their mortgage expired and their interest rates went up. Suddenly these folks were paying twice and three times as much on their mortgage as before. The second thing was the collapse of the housing market in the Great Recession. The values of all those expenses houses fell precipitously at the same time many people lost their jobs. Unfortunately, these folks still owed the same amount of their mortgage and their payments had gone up.
This Will Not Happen To You
This is not going to happen to you because you are going to calculate how much you can afford to spend on a mortgage and therefore how expensive a home a home you can afford.
Twenty-five Percent and No More
Almost everyone who buys a new home gets a mortgage. They pay back the loan on their home and pay interest each month on the money they have borrowed. This is the mortgage payment. The payment also includes a payment for mortgage insurance and may include an installment on property taxes as well.
When you move into your new home and new life, it should be at least manageable and really should be a joy. When you set up financing, make sure that you will be paying no more than twenty-five percent of available take-home pay each month. Obviously, it is better to be paying a smaller portion of your income toward mortgage expenses but one fourth is tops. This is the first step of your home affordability calculation. The second has to do with how long you obligate yourself to make payments.
Ten, Fifteen, Twenty, or Thirty Years
One of the things that got folks in trouble a decade ago was that they signed up for a thirty-year mortgage with a really low-interest rate. That allowed them to buy a much more expensive home that they could otherwise afford. We noted how this worked out when it was a balloon payment and the bank could raise the rate after five years, and the housing market crashed sucking equity out of those homes, and the recession took jobs away. Most experts today suggest that you go with a 15-year mortgage with at least 20% down. By paying off your debt faster you will more quickly build up your equity in your home. And by choosing a home that allows you to do this your will guarantee that it will be yours for as long as you want to live there.