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Balancing What the Bank Says You Can Afford and What You Can Really Afford

Written by Ilyce Glink on November 26, 2010 in Real Estate  |   18 comments

Balancing What the Bank Says You Can Afford and What You Can Really Afford How much can I afford to spend? That might be the most asked question among homebuyers. Just to make it extra confusing, the answer to that question depends very much on…

Balancing What the Bank Says You Can Afford and What You Can Really Afford

How much can I afford to spend?

That might be the most asked question among homebuyers. Just to make it extra confusing, the answer to that question depends very much on whom you ask.

A mortgage lender might approve you for one amount, based on a conventional debt-to-income (DTI) ratio, while you’ll get more money if you go for an FHA loan with higher DTI limits or for an FHA 203K loan, which qualifies you for up to 125 percent of the sales price if work needs to be done to bring the property up to code.

At the same time, it might be that none of those amounts is what you’re comfortable spending each month on your mortgage payment, real estate property taxes, and homeowner’s insurance premium.

My friend Ellyn faced this question some years ago. When she went to buy her first property, her lender qualified her for an amount that was three times as much as the rent she was paying. She thought that amount seemed dangerously high and asked me to take a look.

For a conventional loan (one that meets the guidelines set forth by Fannie Mae and Freddie Mac), a lender will allow you to spend 28 percent of your gross monthly income on your mortgage, taxes, and insurance, and up to 36 percent on your total debt. If you don’t have any other debts (school loan, car loan, or credit card debt, for example), you can spend up to 36 percent on your mortgage, taxes, and insurance.

At the time, Ellyn was earning about $50,000 per year, and the rent on her apartment was less than $400 a month. But her lender qualified her to spend about $1,170 on her mortgage, taxes, and insurance, which was 28 percent of her gross monthly income of $4,166.

However, Ellyn’s take-home pay was far less than her gross monthly income. She was bringing home about $2,300 per month after paying federal and state income taxes and her 401(k) contribution. The lender qualified her for a nearly $1,200 per month payment, which, along with her $400 in school and car loan payments, meant she was spending about $1,600 per month on her debts, leaving her with only $700 per month for everything else.

She asked me what I thought, and I told her that just because the bank says you can afford a payment doesn’t mean you really can. Whether the payment is affordable depends on your other monthly expenses and what you’re willing to give up for homeownership.

Homebuyers often forget that buying a home means you take on not only monthly mortgage, tax, and insurance payments, but also assessments (for a condo or co-op) and ongoing maintenance costs, which can add up.

In Ellyn’s case, she was planning on continuing her postgraduate studies and didn’t want to give up traveling, going out, and, most important, saving for retirement. She decided to spend less on her house payment and started shopping around for a less-expensive house.

Figuring out how much you can afford to spend on a house means thinking about your lifestyle and your debts, not just what the bank says you can afford.

Ilyce R. Glink is the author of several books, including 100 Questions Every First-Time Home Buyer Should Ask and Buy, Close, Move In!. She blogs about money and real estate at ThinkGlink.com and at the Home Equity blog for CBS MoneyWatch.

READ MORE:

4 Tips for Buying a HUD Home
Buying a New Home? Here Are 5 Things Your Builder Won’t Tell You
Reverse Mortgages: What’s New
Zero Down Home Loan Options

18 comments

  1. geazelle says:

    I'm talking to an investor on Philippine real estateand was shocked about the difference between bank and what you really can afford. It's a large scale of difference.

  2. Editor, Equifax Personal Finance Blog says:

    Comment from Tammy at ActiveRain:

    excellent points. I try to get my buyers to look at homes about $10,000 under their max if they can. Most first time buyers are like a kid with a credit card and think the max IS how much they GET to spend.

    http://activerain.com/blogsview/1994362/balancing-what-the-bank-says-you-can-afford-and-what-you-can-really-afford

  3. Editor, Equifax Personal Finance Blog says:

    Comment from Deborah at ActiveRain

    Oh isn't that the truth! Many of my clients don't want to go to the maximum that they can afford!

    http://activerain.com/blogsview/1994362/balancing-what-the-bank-says-you-can-afford-and-what-you-can-really-afford

  4. Editor, Equifax Personal Finance Blog says:

    Comment from Stan at Active Rain:

    And that is a well shared honest opinion ilyce is right. don't get in over your head because you want something beyond your limits. You need to consider the potential of those homes you can afford or hold off till your in a better position (though the second choice could cost you if the market changes)

    http://activerain.com/blogsview/1994362/balancing-what-the-bank-says-you-can-afford-and-what-you-can-really-afford

  5. Editor, Equifax Personal Finance Blog says:

    Comment from Patrick at ActiveRain

    Ilyce,

    Great info and still another facet of our job to inform our clients in their journey!

  6. Editor, Equifax Personal Finance Blog says:

    Comment from Jordon at ActiveRain:

    Good solid advice for buyers! Thanks!

  7. Editor, Equifax Personal Finance Blog says:

    Comment from Brad at ActiveRain:

    Ilyce,

    Thanks for this down to earth look at finance. It's a concern that so many really don't know what they are doing when it comes to family finances. some Newlyweds don't have the experience or often maturity to manage five or six digits in a budget. Some folks are getting along by "dumb luck" budgeting and some do very well. When some come to the lender's office and this expert/professional says that they can afford $XXXX every month, who are they to say this expert is wrong. They recognize that they could make changes in spending that would be better for them… and commit to the loan.

    One problem is that they don't make those expert prescribed changes or don't live by them once started.

    Read your linked post and have subscribed to your AR blog. Good information well presented.

  8. Editor, Equifax Personal Finance Blog says:

    From Ellie at ActiveRain:

    Ilyce, thanks for the good read. In times like these, this is excellent advice. I like to see my clients enjoy their new home without financial stress.

  9. Editor, Equifax Personal Finance Blog says:

    Comment from Charita at ActiveRain:

    So many times buyers just look at that monthly payment as the deciding factor when there is so much more to consider. Not only that, buyers have a tendency to want to purchase at the max that the lender say they will lend (which is not always a good idea particular if the buyers are first time homebuyers). That may be the frugality in me, but I don't ever want to max myself out and I wouldn't advise others to do it either.

  10. Editor, Equifax Personal Finance Blog says:

    Comment from Claudette at ActiveRain:

    Of course this isn't as bad as it was during the peak. Banks would push people out to buy much more than they should have been doing. But, it still holds true that the person buying the home should decide on what they are comfortable with for a monthly payment, not the bank.

  11. Editor, Equifax Personal Finance Blog says:

    From Doug at ActiveRain:

    I am always happy to hear from buyer clients that say…"i'm qualified for 250 but i want my payments to be around a 200k purchase price. those are the responsible buyers. it makes me nervous when we are right up against the buying limit.

  12. Editor, Equifax Personal Finance Blog says:

    From Richard at ActiveRain:

    I have owned five homes, with the first one having been purchased in 1976. I've always made it a rule to determine how much home I can afford after looking at my own budget and lifestyle. As such I have always considered what lenders and real estate agents have told me as guidelines.

  13. Editor, Equifax Personal Finance Blog says:

    From Steven at ActiveRain:

    I always tell buyers to work it backwards from what they can really afford to comfortably pay per month then figure out what price home that equals. 25-30% of you NET take home income is pretty much all your house payment should be. It makes for fun living.

  14. Editor, Equifax Personal Finance Blog says:

    From Frank & Sharon at ActiveRain

    Ilyce, our buyers rarely buy what the bank says they can afford and they are well aware of the HOA and other community fees that go along with their homeownership. Excellent post on this topic.

  15. Editor, Equifax Personal Finance Blog says:

    From John at ActiveRain

    New homeowners need to exercise financial discipline. It can be tempting to buy a lot of new things for the home (or a new car to decorate the driveway), but consumer debt can quickly put them in a perilous position.

  16. Editor, Equifax Personal Finance Blog says:

    From Patricia at ActiveRain:

    310,946 Points 1 Featured Post

    Smart buyers don't want to spend the max of what "the bank " says they can afford. They'll look at those homes that "they know they can afford" I'm always impressed with these smart people. The banks and lending institutions were telling people they could afford more than what they really could afford. That's part of why we are all in this lousy economy today.

    Patricia/Seacoast NH & ME

  17. Editor, Equifax Personal Finance Blog says:

    From Chris at ActiveRain:

    Hi Ilyce — I really try to counsel first-time home buyers to really know their income and expenses in great detail, using a spreadsheet or some other program and track where their money goes, and to really budget, know that there may be an additional 1-2% of the purchase price in maintenance costs per year, budgeting for replacement reserves of major systems, etc. As well as budgeting for change in lifestyle, potential relocation, job loss, school, retirement, etc., and to live under their means so they aren't stressed. It's a sobering conversation but an important one.

  18. Editor, Equifax Personal Finance Blog says:

    From Bernadine at ActiveRain:

    I also caution buyers to buy below what the bank says they can affort and try to only show them houses that fit that criteria.


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