How Much House is too Much
If you’ve never heard the phrase “buy too much house” before, it’s a good one to be familiar with. Buying too much house means you buy a more expensive house than you can afford. Sure, you may be able to make the minimum monthly payment and the lender approved you for the loan so you’re good to go, right? Wrong! It’s very possible to be approved for a home that’s more expensive than you really should be buying. The difficult thing about this is that it’s very subjective; you can’t just throw out blanket rules that are the definitive measurements of how much house you can afford. While there are guidelines that can be laid out, and there are definitely indicators of whether you’re buying too much house, only someone intimately familiar with your finances (as you hopefully are) can know for sure if you are buying too much house.
You Are Your Own Master
No one is responsible for this besides you. The loan officer is not there to tell you how to spend your money, and plenty of loan officers will tell you they’ve closed on plenty of loans that they would never have done if they were the borrower. Why? Because it’s not the loan officer’s job to tell you how to manage your money. You’re a big boy or girl and you can make your own decisions. Unfortunately that means that we all need to have a clear understanding of what we’re getting ourselves into when we buy a house, and we need to know the guidelines and red flags to keep us from getting more than we can really afford. This responsibility to both learn about how to know if you’re buying too much house and to choose not to do so is yours and yours alone, so take it seriously. Plenty of responsible people got hit hard when the recession hit, but the ones that got hit the hardest were people who bought too much house in the first place.
Your Debt-to-Income and Other Signals
There are a few things to look at that can help you know how much house you can afford. The first one is your Debt-to-Income ratio, abbreviated as your DTI. You will not usually get approved by a lender if the addition of the proposed monthly payment brings your DTI higher than 41%, though there may be some exceptions. That said, 41% is a pretty high DTI, and if you’re flirting with that line, that’s a really good indicator of buying too much house. 35% is much better, and 30% is where you start to be in really good shape. Now, we’ll talk about this more in-depth in a bit, but choosing a 30-year fixed because the 15-year brings your DTI close to 41% would not be a great decision. Other signals include how much credit card debt you have – your DTI only incorporates the minimum payment on your cards, which will result in a large amount of interest over time, so you’ll want to evaluate how much credit card debt you have and how quickly you can pay it off. You also want to look at how stable and reliable your income is, and whether it’s likely to get larger, go lower, or stay the same. Are you in the sort of position where it’s likely your hours will be cut as employers comply with Obamacare? Those signals are less concrete but all help to paint a clear picture of what you can realistically afford.
The Effect of the 30-Year Fixed
The 30-year fixed is a very divisive thing in the mortgage industry – many (like this author) look at the 30-year fixed as a poisonous viper that’s out to get borrowers and ruin the potential wealth that buying a house can bring. Others look at the 30-year fixed as the door that has opened up homeownership to literally millions of families who would not have been able to afford it otherwise. Regardless, the 30-year fixed can easily lull borrowers into buying more house than they can afford. Why? Because the monthly payment drops so much on a 30-year that all of the sudden the DTI is fine, the income is fine, and borrowers can suddenly qualify for the house they want. While this can work out just fine, and has for many people, this can also be a recipe for disaster, and is a good way to buy more house than you should be. If you can’t qualify for the loan on a 15-year fixed, chances are you shouldn’t be buying that expensive of a home. It may seem rough, but you’ll accrue equity much, much faster on a 15-year fixed so you’ll actually be able to save up a big down payment to pay down the balance on a more expensive home more quickly.