Determing Your Value
How much home can you afford? This is such a great question. The home you choose to live in is really a lifestyle choice. It has so much to do with the day-to-day and the quality of your life. But it’s important to bear in mind that the debt – the house payment is also a lifestyle choice – and finding balance is vital.
A Common Mistake
Most people when they are deciding how much house they can afford will go to a bank or a mortgage lender and simply ask – “how much can I afford?” This is a mistake. Banks will tell you how much you can borrow which is different then what you can afford. They’re not financial planners looking to help you create a happy life. Their simply telling you how much money you would be eligible – based on current lending rules – to borrow. The balance between quality of home and debt is not something they’re prepared to help you determine. They are simply telling you how much you’re eligible to borrow.
The debt, the amount of money that you pay each month, either individually or as a family, in order to afford that home has a great deal to do with the course of your life from that point forward. It affects the decisions that you make, the amount of free time that you have, and the amount of work that you have – that responsibility to that income. So if you’d like to start a business – well you have a debt that you made a commitment to when you bought the home. That is why it’s important, when you’re stepping back to see how much you can afford, to take a broader look at where you see your life going and where you’d like it to go and make a home and the debt that goes with it fit into your image of that dream life.
So What’s the First Step?
So the first step still would be to go to a lender and find out how much you’re eligible for – if you qualify for a loan and how much. Now that’s the maximum amount that you can borrow. Your investigation then will work down from there. I can tell you that most people borrow as much as possible. We’ve all seen a lot of beautiful homes and many people are willing to sacrifice for luxury. That’s a choice that you and they get to make. And it’s very seductive to go look at homes with wonderful luxurious features – large yards, views, pools, and patios. It’s remarkable the level of luxury that exists in most American homes.
However, in addition to the amenities in the home, it’s important to step back and think what are the qualities of life that you are looking to pursue. Would you like to start a business? Would you like to do volunteer work? Or spend more time camping with your family? How do you want to live? Most people, once they are given the budget from a lender, will actually go on the home search to try to get as much house as they can with that amount of money. However, try to step back, to think about what matters most and the balance you hope to find in your life. Remember, in addition to living with that home you will be living with that mortgage payment. They are all part of your future lifestyle.
Let’s Look at the Numbers
Right now, for conventional loans, you can borrow about 33% of your gross income for a house payment. That includes principle, interest, taxes, and insurance. Up to 43% of income can be debt. This would include the home, car payment, credit card, student loans – other payments that you have. On FHA loans, it is 29% for housing debt and 42% of gross income for all debt – including student loans, car, credit card debt, and so on. These are the guidelines that lenders follow in how much you can borrow. That doesn’t mean that’s how much you can afford.
How much you can afford is a much more personal decision. In fact, it’s not a bad idea to meet with a financial planner and discuss your financial future. The different things you have coming up – whether it’s family, major purchases, retirement – explore all the other financial components that make up your life. I’ve asked a lender that I have a great deal of respect for – Roy Macey – what he’d recommend for borrowing guidelines as a suggestion. In fact, I think the question I posed was, “If it was your daughter, what would you recommend to her?” His recommendation was spending 25-30% – at most – of your normal wages. This means no overtime, no bonus, and no extra income that can inflate it that may or may not be there at some future point – 25-30% of normal wages. He also recommends that revolving debt not be more than 10% of your gross wages. Revolving debt is credit cards, your car, and student loans.
This is a tall order – but it’s a great piece of advice. If you can keep your debt under control – in particular, both housing and revolving debt at manageable levels – you’ll be surprised at how great life can be. A beautiful home is wonderful thing but so is financial freedom. Managing debt is one of the most important barriers to financial freedom.