How much Mortgage Can you Afford?
How Big of a Mortgage Can I Afford?
Not only does owning a home give you a haven for yourself and your family, it also makes great financial sense because of the tax benefits—which you can’t take advantage of when paying rent.
The following calculation assumes a 28 percent income tax bracket. If your bracket is higher, your savings will be, too. Based on your current rent, use this calculation to figure out how much mortgage you can afford.
Multiplier: x 1.32
Mortgage payment: _________________________
Because of tax deductions, you can make a mortgage payment—including taxes and insurance—that is approximately one-third larger than your current rent payment and end up with the same amount of income.
Slight variations in interest rates, loan amounts, and terms can significantly affect your monthly payment. For help in determining how much your monthly payment will be for various loan amounts, use Fannie Mae’s online mortgage calculators.
Credit Score Needed for Mortgage
Credit scores range between 200 and 800, with scores above 620 considered desirable for obtaining a mortgage. The following factors affect your score:
- Your payment history.
Did you pay your credit card obligations on time? If they were late, then how late? Bankruptcy filing, liens, and collection activity also impact your history.
- How much you owe.
If you owe a great deal of money on numerous accounts, it can indicate that you are overextended. However, it’s a good thing if you have a good proportion of balances to total credit limits.
- The length of your credit history.
In general, the longer you have had accounts opened, the better. The average consumer’s oldest obligation is 14 years old, indicating that he or she has been managing credit for some time, according to Fair Isaac Corp., and only one in 20 consumers have credit histories shorter than 2 years.
- How much new credit you have.
New credit, either installment payments or new credit cards, are considered more risky, even if you pay them promptly.
- The types of credit you use.
Generally, it’s desirable to have more than one type of credit—installment loans, credit cards, and a mortgage, for example.For more on evaluating and understanding your credit score, visit www.myfico.com.
Loan Types to Consider
Brush up on these mortgage basics to help you determine the loan that will best suit your needs.
- Mortgage terms.
Mortgages are generally available at 15-, 20-, or 30-year terms. In general, the longer the term, the lower the monthly payment. However, you pay more interest overall if you borrow for a longer term.
- Fixed or adjustable interest rates.
A fixed rate allows you to lock in a low rate as long as you hold the mortgage and, in general, is usually a good choice if interest rates are low. An adjustable-rate mortgage is designed so that your loan’s interest rate will rise as market interest rates increase. ARMs usually offer a lower rate in the first years of the mortgage. ARMs also usually have a limit as to how much the interest rate can be increased and how frequently they can be raised. These types of mortgages are a good choice when fixed interest rates are high or when you expect your income to grow significantly in the coming years.
- Balloon mortgages.
These mortgages offer very low interest rates for a short period of time—often three to seven years. Payments usually cover only the interest so the principal owed is not reduced. However, this type of loan may be a good choice if you think you will sell your home in a few years.
- Government-backed loans.
These loans are sponsored by agencies such as the Federal Housing Administration or the Department of Veterans Affairs and offer special terms, including lower down payments or reduced interest rates to qualified buyers.
Specialty Mortgages: Risks and Rewards
In high-priced housing markets, it can be difficult to afford a home. That’s why a growing number of home buyers are forgoing traditional fixed-rate mortgages and standard adjustable-rate mortgages and instead opting for a specialty mortgage that lets them “stretch” their income so they can qualify for a larger loan.
But before you choose one of these mortgages, make sure you understand the risks and how they work.
Specialty Mortgage Risks
Specialty mortgages often begin with a low introductory interest rate or payment plan—a “teaser—but the monthly mortgage payments are likely to increase a lot in the future. Some are “low documentation” mortgages that come with easier standards for qualifying, but also higher interest rates or higher fees. Some lenders will loan you 100% or more of the home’s value, but these mortgages can present a big financial risk if the value of the house drops.
Specialty Mortgages Can:
- Pose a greater risk that you won’t be able to afford the mortgage payment in the future, compared to fixed rate mortgages and traditional adjustable rate mortgages.
- Have monthly payments that increase by as much as 50 percent or more when the introductory period ends.
- Cause your loan balance (the amount you still owe) to get larger each month instead of smaller.
Common Types of Specialty Mortgages:
- Interest-Only Mortgages: Your monthly mortgage payment only covers the interest you owe on the loan for the first 5 to 10 years of the loan, and you pay nothing to reduce the total amount you borrowed (this is called the “principal”). After the interest-only period, you start paying higher monthly payments that cover both the interest and principal that must be repaid over the remaining term of the loan.
- Negative Amortization Mortgages: Your monthly payment is less than the amount of interest you owe on the loan. The unpaid interest gets added to the loan’s principal amount, causing the total amount you owe to increase each month instead of getting smaller.
- Option Payment ARM Mortgages: You have the option to make different types of monthly payments with this mortgage. For example, you may make a minimum payment that is less than the amount needed to cover the interest and increases the total amount of your loan; an interest-only payment, or payments calculated to pay off the loan over either 30 years or 15 years.
- 40-Year Mortgages: You pay off your loan over 40 years, instead of the usual 30 years. While this reduces your monthly payment and helps you qualify to buy a home, you pay off the balance of your loan much more slowly and end up paying much more interest.
Questions to Consider Before Choosing a Specialty Mortgage:
- How much can my monthly payments increase and how soon can these increases happen?
- Do I expect my income to increase or do I expect to move before my payments go up?
- Will I be able to afford the mortgage when the payments increase?
- Am I paying down my loan balance each month, or is it staying the same or even increasing?
- Will I have to pay a penalty if I refinance my mortgage or sell my house?
- What is my goal in buying this property? Am I considering a riskier mortgage to buy a more expensive house than I can realistically afford?
Be sure you work with a REALTOR® and lender who can discuss different options and address your questions and concerns!
Learn about the NATIONAL ASSOCIATION OF REALTORS® Housing Opportunity Program. For more information on predatory mortgage lending practices, visit the Center for Responsible Lending.
Reprinted from REALTOR® magazine with permission of the NATIONAL ASSOCIATION OF REALTORS®. Copyright 2008. All rights reserved.