Navigating the current home-buying frenzy can be daunting as homes sell in a matter of days with contracts often above their asking price. With the difficulty in removing emotion from financial decisions, it’s hard to imagine all these purchases are fueled by financially rational decision-making. In fact, the moment you start picturing your furniture in a prospective home or envision throwing a summer evening barbeque on the outdoor patio, you’ve already formed a subconscious attachment to that property. One of the key ways we walk with you on your journey is through objectivity: the ability to serve as an unemotional voice in your financial decisions. So, what are some basic principles to help you avoid turning the American dream of homeownership into a potential financial nightmare?
Calculate an appropriate mortgage debt-to-income ratio
Mortgage lenders rely on debt-to-income ratios as an indicator of an individual’s ability to handle monthly mortgage payments, and so should you. Generally, a debt-to-income ratio of 28% or less is considered acceptable. To find the maximum you should consider paying monthly for a mortgage, simply multiply your gross monthly income by .28.
Even if you don’t plan on paying your real estate taxes and insurance through an escrow account, the maximum monthly payment calculated should include these expenses as part of what is known as PITI (Principal, Interest, Taxes, and Insurance). It’s important to note that 28% is considered a maximum ratio. An appropriate debt-to-income ratio for your situation may look quite different.
Avoid paying for insurance that doesn’t protect your family
Purchasing a home with at least 20% down not only lowers future payments but allows you to avoid purchasing Private Mortgage Insurance (PMI). PMI is insurance you pay for to protect the lender – not you – which alone makes it an expense worth avoiding. Realistically, though, PMI can add several thousand dollars to your mortgage expense each year you are required to carry it.
Re-evaluate the insurance that does protect your family
Thomas recently wrote about the “insurance inertia” trap, and home buying is certainly an ideal time to avoid this trap by re-valuating your current disability and life insurance needs. If others depend on your income, a mortgage represents a large financial obligation they may need protection from if death or disability prevents you from being able to make future payments.
Taking a few moments to create a financial home buying plan and establishing clear parameters for what you can reasonably afford, will help keep you from the pitfall of paying an emotion-fueled premium for your home.