From: Liz Pulliam Weston
Thirty years ago, first-time home buyers were often encouraged to stretch as far as they possibly could to buy a house. Back then, that advice made some sense but, today, it can be a recipe for disaster.
A too-big house payment can, at the very least, leave you with too little money for other goals: retirement, vacations, college funds for the kids. At worst, it can leave you vulnerable to foreclosure and bankruptcy. What’s more, you can’t count on your real estate agent, a mortgage loan officer, your friends and family or an Internet calculator to know what you can really afford. That’s a decision you have to make yourself after reviewing your finances, your future obligations, your goals and your gut. Yet many first-time buyers still find themselves pushed into mortgages that are bigger than they can handle, based on old-fashioned advice.
Here’s what’s changed in the 30 years (or more) since your parents bought their first house:
1. Inflation. Rapidly rising prices in the 1970s and early 1980s meant you could count on hefty annual raises. Today, you can’t rely on double-digit income boosts to make your mortgage payment less of a burden each year.
2. Two-income couples. A generation ago, single-income families were more common. If the breadwinner lost a job, the other spouse could go to work to save the house. With more two-income families needing both paychecks to make the mortgage payment, there’s no one on the sidelines to take up the slack — unless you put the kids to work.
3. The lending industry. Thirty years ago, it was pretty tough to get a mortgage for more than you could really afford. While lenders have learned their lesson after years of “liar loans’ and other easy-money tactics, they sometimes still push, knowing that the vast majority of their borrowers will do whatever it takes to pay their mortgage — even if it means trashing the rest of their financial lives.
4. Retirement. A much bigger proportion of the work force was covered by traditional, defined-benefit pensions 30 years ago — which means they didn’t have to save massive amounts of money on their own to have a decent retirement. Today, the onus is typically on you to carve enough out of your budget to fund 401k’s and IRAs.
So how much should you spend on a house?
The traditional way to calculate that is to add up all your income and make sure that your housing expenses — mortgage payment, homeowners insurance and property taxes — don’t exceed a certain amount of that total. The traditional limit, still used by many lenders, is 28% of gross monthly income. Some financial advisers recommend capping your outlay at 25%; others suggest stretching to 33% or more.
All that math making your head hurt? Here’s the short version: You’ll probably be most comfortable using the 25% lid. You may want to go even lower if:
1. You plan to have children. Kids can be expensive, and many couples discover they want to have the option of one partner staying home or working part-time once kids arrive. That’s tough to do if you need every penny of both incomes to make ends meet. If you really want to be conservative, do your calculations based on the income you think you’ll have post-baby.
2. You have an expensive hobby, like travel. Most homeowners are willing to put their wanderlust on the backburner to buy more house. If that’s not you, buy less house.
3. Your income varies considerably. Most American workers have variable incomes, thanks to the prevalence of overtime pay and bonuses (and, these days, pay cuts and reduced hours). If yours swings wildly from year to year, though, consider basing your calculations on your average earnings over several years or (even more conservative) on the minimum you expect to make.