Goodspeed: How much home can you buy?
QUESTION: How do you assess how much home you can buy?
ANSWER: That’s a good question. When people buy a home, the temptation is to buy as big a home as they can possibly afford.
To do this, they go after a mortgage with the lowest possible monthly payment. This can be a mistake, especially in a rising interest rate environment like we have now.
In order to get the lowest possible monthly payment, people can make some bad choices. There are many what I call mortgage gimmicks out there, such as an interest-only loan that offers borrowers a low frontend monthly payment. But the shoe always drops and when it does, your payments can escalate dramatically.
Even a traditional adjustable rate mortgage (ARM) can be a bad choice in a rising rate environment. They also help people get into a home by giving them a lower rate for the first year, three years, five years – whatever the term. After the term expires, the rate “adjusts” with the market. When it adjusts up, so does your monthly payment.
The theory behind an ARM is that your income will grow and/or your home will appreciate in value so you will be able to afford the higher monthly payments. But like all theories, it may not prove true.
In the market we have now, I think you need to be conservative. Rates are rising and you should not depend on appreciation to bail you out of a bad mortgage. This is what happened during the housing crisis a decade ago.
Be very conservative when you take out a mortgage. I think a fixed rate product is a good idea. Your payments will be higher than an ARM or interest-only loan and you may be able to afford less house, but less can be more especially if more house leads you to financial ruin.
It’s also important to remember that buying a home comes with many more expenses than just your monthly principal and interest payment. If you are renting right now, part of your rent payment goes toward many housing expenses, such as maintenance and upkeep and property taxes that you will be assuming yourself as a homeowner. These costs are not included in your monthly mortgage payment, but should be part of your overall housing budget estimates.
Other expenses you should budget for as a homeowner include mortgage insurance (if your down payment is less than 20 percent of the purchase price of the home), utilities, homeowner’s insurance, snow removal, garbage removal, lawn care, condominium association fees (if you buy a condo). And don’t forget closing costs and moving expenses.
It’s important to keep all these other costs in mind when you plug in your gross monthly income and gross monthly debt into those “affordability” calculators. Going after the lowest monthly mortgage payment and the biggest house that payment will buy you is not the best choice.
Linda Goodspeed is a longtime real estate writer and author of “In and out of Darkness.”