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You, not the lender, should set size of mortgage
Dear Dollar Diva,
How do I figure out how much of a mortgage payment I can comfortably
afford, including taxes and homeowners insurance? I'd like to know
what monthly mortgage payments I can afford with a 30-year mortgage
vs. a 15-year mortgage.
Janet
Dear Janet,
The first question is the one that needs to be
answered. Once you figure out how much of a mortgage payment you
can afford, the next question is how much house will it buy? If
you want to pay the mortgage off in 15 years, you'll have to settle
for less house than if you're willing to stretch the payments out
over 30 years.
You may have to settle for less house with a 15-year
mortgage, but not that much less. Given a $25,000 down payment and
an 8 percent rate, the same mortgage payment buys a $255,000 home
over 30 years or a $200,000 home over 15 years.
But you have another option: Buy the $200,000 home
with a 30-year mortgage and pump up the monthly payments to get
it paid off in 15. Why would you want to do that?
- It gives you some wiggle room if you run into a
cash flow problem down the road.
- If inflation rears its ugly head, as it did in
the early '80s, instead of adding extra cash to the low-interest
mortgage debt, you could sock that money away in a safe, tax-deferred
investment that's indexed for inflation, such as U.S. Treasury
Series I savings bonds.
The debt-to-income ratio
Mortgage lenders use a debt-to-income ratio to determine how much
of a mortgage folks can afford. PITI is the term lenders use for
a mortgage payment that includes principal, interest, taxes and
insurance. The rule of thumb is: your total monthly debt payments
(PITI, credit cards, bank loans, and all other debt) divided by
your gross income should not be more than 36 percent.
Bankrate.com's "How
much house can you afford?" calculator has this formula
built into it. Plug in your numbers to get an idea of what a mortgage
lender will say you can afford.
You're in charge
Lenders are in the business of lending money, but you're the one
who has to cough up the monthly payments, rain or shine. You, not
your banker, should decide how much mortgage you can really afford.
Let's take a look at two potential homeowners with
the same income and debt burden:
- A single mother, who makes maximum payments to
her 401(k) plan, lives in a state with a hefty income tax, tithes
her church 10 percent and sends her two kids to private school.
- A single computer geek who lives in Florida,
has no 401(k) plan and no life.
The Diva doesn't think the debt-to-income ratio would
cut it for either of them.
To determine what you can afford for a mortgage, you
need to know what your monthly net income and expenses are. Separate
the non-negotiable expenses (debt payments, school tuition, tithes)
from the negotiable (clothing, vacations, recreation) so you know
where you can cut if you have to. The National
Foundation for Credit Counseling Web site has some excellent
budget tools to help you with this task.
Don't forget the other costs
If you can't afford to put 20 percent down, you'll
also have private
mortgage insurance (PMI) added to your monthly payments. And
don't forget the closing
costs and other expenses, such as moving, homeowner's association
fees and making the new place livable. If you know you're going
to be earning more money in the future, the Diva thinks it's OK
to stretch when buying a home; just don't stretch so far that you
break.
-- Posted: Dec. 2, 2002
 DOROTHY
ROSEN has a master's degree in finance, with a specialization in
accounting, from the Kellogg Graduate School at Northwestern University
in Evanston, Ill. Rosen has more than 15 years of experience in
the financial arena, serving in Illinois and Florida as a certified
public accountant, financial consultant, expert witness and educator.
She is owner of Dorothy Rosen, CPA, a public accounting firm that
serves individuals and small businesses.
-- Posted: Aug. 30, 2001 |
