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Whether you’re buying your first home or your fifth, being approved for a larger-than-expected mortgage can be exciting and even a bit intoxicating. But qualifying for a big loan isn’t the same as being able to afford it — and you don’t want your biggest asset to ruin your finances.
Before you sign up for a mortgage, ask yourself how much house you can afford.
Many financial advisors and consumer advocates recommend that you borrow less than you qualify for. These are a few of the reasons why.
- You’ll Lower Your Risk of Missing a Payment
If your housing costs are on the edge of what you can afford, the odds of not being able to make payments in the event of an economic emergency or a job loss is much too high. The COVID-19 situation, which was very unexpected, has shown us all how fast even a stable income can be impacted.
And missing a mortgage payment can have a domino effect on your finances. If you are at risk of missing a payment you are at risk of being in default, risk of ruining your credit and risk of foreclosure, which would wipe out your investment in the home.
To ensure that the home you’re considering is within your budget, take all housing costs into account, including your mortgage payments, property tax payments, insurance premiums, maintenance costs and, if applicable, homeowners association fees.
- You’ll Be Prepared for Emergencies
Life can be rough. You might lose your job or face a medical emergency that drains thousands from your savings. See, again, 2020 and COVID-19. You might have to move before you’re able to build significant equity in your home.
Getting a smaller mortgage than you qualify for will allow you to stash away extra money so you can handle hardships.
Experts advise keeping enough money in your savings to cover six months of living expenses. You should also be saving for life after retirement.
- You Can More Easily Afford Other Costs
Part of the fun of owning a home is filling it with things you want and need. If you have children, you might need to set aside money for their education. And let’s not forget the costs of fixing a leaking roof or a busted water heater.
If you have to make other debt payments—say, on credit cards, or auto or other loans—it’s in your best interest to opt for a smaller monthly mortgage payment, and put your savings toward these expenses.
- You Can Avoid Using Your Home Like an ATM
When less of your monthly budget is taken up by the mortgage, you’ll have more disposable income and be less tempted to use a cash-out refinance—the process of replacing your current mortgage with a larger one and pocketing the difference—to buy a new car or pay off credit card debt.
A cash-out refinance can be risky because you’re putting your home on the line. If you miss a few credit card payments, you won’t lose your home. It’s another story when you can’t make higher mortgage payments after a cash-out refi.
A Good Mortgage Borrowing Rule of Thumb
So how much should you borrow? Your debt-to-income ratio—the percentage of your pretax income that goes toward mortgage and other debt payments—is one way to figure out how large your loan should be. Professionals say 28 percent is a safe target, though lenders often allow borrowers to go much higher.
You can also use a mortgage calculator to see what you might pay each month.
In some cases, it does make sense to borrow what you qualify for. If you have a high income, plan on staying in your home for at least seven years, are buying in a competitive market or have sky-high rent payments, there is some flexibility in the 28 percent rule.
But if you can go lower than 28 percent, you should. That way, you’ll be more likely to feel comfortable—financially and otherwise—living in your new home.