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💡 Question: “I’m looking for a house, and I got preapproved for a LOT more than I thought I could afford. I’m nervous about spending it all. Help!”
If you’re not old enough to remember 2007, let me refresh your memory. It’s when mortgage lenders screwed the proverbial pooch by getting people into homes they couldn’t afford.
It caused a temporary market crash, and many people lived in homes that were way too expensive for them.
The story’s moral is simple: Your approved mortgage amount isn’t necessarily what you can afford.
Instead, it’s the risk the bank will take on you.
That’s it.
Do not, under any circumstances, let the bank convince you to spend more than you’re comfortable with just because you’re approved for it.
That’s a one-way street to Debtville.
Here’s what to do instead.
How Much House Can You Afford?
I won’t lie, your approved mortgage amount can be insanely deceiving. Looking at all those zeros makes you believe you can afford a more expensive house than you thought.
If you spend it all, you could find yourself “house poor,” meaning the majority of your income will pay for your house without much left over for saving and investing.
That’s a BAD position to be in.
Never let the bank decide how much house you can afford.
There are better ways to determine that.
Two ways to determine how much house you can afford
#1: 2.5x gross annual salary rule
As a general guideline (and to make the math easy), you can generally afford a house that costs up to 2.5x your gross annual salary (gross means before taxes are removed).
If you earn $100,000 a year, you can afford a $250,000 home.
Note that this is only a general guideline. It’s a simple calculation to put you in the ballpark of what you can safely afford.
You might feel comfortable buying a more expensive home if your spouse also works. Again, use this as a guideline, not a hard and fast rule.
#2: 28%/36% rule
This is a slightly more complex way of determining how much house you can afford. Here’s how it works.
No more than 28% of your gross monthly income should be spent on housing expenses and no more than 36% on total debt, which includes other debts such as credit cards, auto loans, etc.
Your housing expenses include everything in your mortgage, including the principal, interest, taxes, and insurance. Everything. Many mortgage lenders consider this before approving your mortgage.
If your gross monthly income is $5,000, it’s best not to take a mortgage higher than $1,400/month, as that’s 28% of your monthly salary.
When in doubt, be conservative. Especially in our inflationary market, playing it safer right now is probably the best bet.
Summary: If you’re uncomfortable spending the whole mortgage amount, DON’T SPEND IT. Spend less, bank as much as you can, and you’ll build more wealth than 80% of the people in your neighborhood.
See you in your inbox on Saturday,
– Steve
