How Much Mortgage Can I Afford?
Rent is Crazy
Can I afford a mortgage? There’s got to be another way, right?
The cost to rent a place is going up like crazy, and it makes you think…
“I could probably just buy a place for as much as I’m paying in rent!”
And then a tidal wave of reality comes crashing down on you as you realize that this is a huge step, a huge decision for you and your family.
There’s a lot of information online, but how can you believe any of it because it all sounds either incomplete or so general that it’s hard to tell if it’s applicable.
I hope to put things into a context here that helps you to sort through the positives and negatives of investing in real estate.
I’m going to try to not bore you with the same old song and dance that typically accompanies this topic of conversation, but the facts remain facts, and they have to be a part of the conversation.
We’ll call that part of the article the four pillars of homeownership.
Can I Afford a Mortgage?
The question of whether or not you can afford a mortgage is not always just a simple financial decision. There are a lot of factors that go into assessing risk, analyzing reward, and using leverage that you need to consider.
Everyone is going to have different tolerances for risk, and everyone has a unique personal and professional situation that will heavily influence your experience.
One of the most important qualifying indicators is your debt to income ratio. Here’s a simple way to calculation your DTI:
Calculation for Debt to Income Ratios
Your DTI is calculated by your Gross monthly income divided by your monthly liabilities as reported on your credit report. In some cases, you may have income from sources that cannot be documented properly to count towards qualifying income.
If your income is other than W2 income, you want to make sure your loan officer knows. Even if more than 25% of your income is commission or bonus or 1099. Make sure you talk to a professional, not one of these big box lenders.
FHA is going to have 2 DTI limits. The front end debt to income ratio is your housing payment only, and that maximum is 46.99%. The back end debt to income ratio includes your monthly liabilities, and that maximum is 56.99%
Conventional has only one DTI limit, which has recently moved to 50%, and includes all of your housing and liabilities as a percentage of your gross monthly income.
Four Pillars of Home Ownership
The four pillars of home ownership are simply solid, foundational facts about the benefits of owning real estate. It’s not enough to simply compare owning to renting, that’s apples and oranges.
In most cases, your dollar for dollar payment on a mortgage payment will most likely be higher that the payment on a rent check. There’s so much beyond the amount on the check that should be considered when you’re thinking about buying a home.
Pillar 1: Fixing Your Housing Expenses
Where I live, in Orange County, California, our local paper is predicting a 9.4% increase in rents in 2018. This brings us to one of
The first “get to the point” reason for owning real estate is that you will fix your housing expenses. In many areas of the Country, rent is as much, if not more than a mortgage payment.
Pillar 2: Tax Benefits of Ownership
Perhaps one of the most interesting of the benefits of converting your mortgage payment into an investment in your future, is the tax benefits associated with homeownership.
If you have not owned a home before, you may take a tax deduction for:
- Interest paid on a mortgage against your primary residence
- Property taxes paid on your primary residence
Take Home More Money: After consulting with your CPA or tax preparer, you should have a conversation about adjusting the pay check withholding with your employer to take home more money each month.
Pillar 3: Forced Savings
This is a little covered topic, but I think that it’s one of the strongest arguments for the long-term benefits of financial planning.
Owning real estate has the unique benefit of offering two different ways of earning money every day you drive up the driveway to your home. Let’s take a look at both of these wealth building income streams.
Safe and Secure: Every month when you make your mortgage payment you are actually paying yourself! Each month, you will pay part of the payment towards the interest of the loan, and a portion goes toward the principal, or balance of the loan.
As you make your mortgage payment each month, you are paying down your loan. The safety and security come from the fact that even if your home doesn’t appreciate, you’re benefiting every month.
Play the Equity Market: Of course there are things that you can do to improve the value of your home, but for the most part, the value of your home is what someone would pay to live in a similar home in your neighborhood in the future.
To error on the side of being very conservative, you can use a 3% equity growth per year. If you wanted to be aggressive when considering your ability to afford a mortgage, use a 5% growth in equity every year.
Adding your principal reduction and equity growth together, and your net worth increases in most months. Of course, if home values decrease, then you’re playing the market, and you’re subject to the future value in your local market.
Pillar 4: Leverage
Leverage is probably one of the most powerful tools you can use when investing. Essentially leverage means that you invest a very small amount, like 3% to 5% of the purchase price, and you own an asset worth tens to hundreds of thousands of dollars.
All you have to do to protect this investment is to continue to make your payments on the loan.
Even if your home doesn’t appreciate one dollar over 30 years, your $15,000 investment (5% of $300,000) has given you a return of $285,000!
Where else can you invest $15,000 and get a return of $285,000 with almost no risk? I say there is almost no risk because this is assuming that your home’s value does not increase one red cent in 30 years.
What are the chances of you seeing no equity growth in 30 years? I’m going to go out on a limb and say that it has never, and never will happen.
Are You Using a Mortgage Credit Certificate?
This is a secret weapon that few loan officers will tell you about, or know about, in my experience anyways.
A mortgage credit certificate may be available in your State or County, and you should research it. An MCC is the gift that keeps giving for as long as the term of the original loan*.
Here’s how it works:
- Let’s say you have a mortgage credit certificate at 20%
- This means that your taxable mortgage interest deduction is reduced by 20%
- This 20% now represents a dollar for dollar tax credit (not deduction) for as long as you own the home*
Let’s use the numbers in Pillar #4: Leverage
- Purchase price is $300,000
- You have a 5% down payment
- The loan amount is $285,000 on a conventional loan
- Your interest rate is 4%
- Your annual mortgage interest tax deduction is $11,400 (interest paid on loan)
- Your taxable income is reduced by 80% of your total $11,400 interest deduction
- The Mortgage Credit Certificate is 20% of your interest deduction
- $2,280 (20%) goes directly toward paying taxes that are owed. If you usually get money back at the end of the year, now you’re getting more back, simply for being a home owner.
* terms and conditions of your local MCC program may vary, this is just an example of an MCC program we have in California.
In some States, you can only apply for a MCC at the time of the purchase of your first home. So if you are not aware of it, imagine the thousands you would be losing in tax breaks over the live of your loan.
Why don’t you hear more about mortgage credit certificates? My only guess can be that they require a little extra paperwork by the lender, and nobody gets paid from you getting a tax credit
Starting Off on the Right Foot
Using the right loan officer to get pre-qualified for your home loan is the absolute best way possible to find out what your can afford as a mortgage payment.
Choosing the right loan officer, and assuming that this loan officer is working for a great lender or broker, is the absolute key to having a hassle free first time home buyer experience.
You want to go with those seasoned professionals that still exists out there, that get much of their business from referrals and cannot afford fancy TV or radio ads or sports stadiums.
Feel free to reach out if you would like an introduction to a loan officer that can help in your State. I have a close group of expert lender friends that cover all 50 States. They know what they’re doing, and they’ll treat you like their only client.
You can reach me by clicking on the Questions? prompt. Or you can leave a comment or question as described below.
Getting Your Questions Answered
All lenders are not created equal. Most of the readers that find this site because they’ve been researching solutions to challenges, and have been told 10 different things by 10 different loan officers.
We’ve created this resource to help you sift through the endless opinions and articles that may, or may not directly answer your question correctly.
There are several ways to ask questions, and get expert opinions on this website.
- Submit a Question: On the bottom of this page, you’ll see a prompt that allows you to ask questions. These questions come directly to me and are answered very quickly.
- Leave a Comment: Below every article is the option to leave a comment or question. We see these comments and questions in real-time and the always answered, usually pretty quickly.
In addition to researching your questions and providing you with expert advice, I can also introduce you to a lender friend that I know has experience with your specific situation and can help.