While owning a home can be a smart move from a tax perspective, statistics show it can also lead to one of the biggest mistakes of the year. Many consumers fall victim to taking on too much house.
Between 2011 and 2014, 52 percent of Americans had to make at least one major sacrifice to be able to keep up with their housing expenses, according to a MacArthur Foundation report. The major sacrifices include: taking on credit debt, working a second job, delaying retirement savings, and cutting back on healthcare. Carelessness about how much you borrow to purchase your home could potentially lead to things like foreclosure.
While foreclosure rates have dropped from recent years, there are still a significant amount of victims throughout the country. In 2016, there were about 379,000 homes foreclosed upon throughout the country. However, 479,000 home still began the early stages of foreclosure.
Taking on a mortgage that is far too high for your budget could affect other areas of our financial life as well. As a rule of thumb, you should put away at least 10 percent of your salary for the future. However, if things like your mortgage are eating up all of your income though, you are unable to do this.
In 2015, almost 12 million people spent more than half of their income on housing. Consumers should limit their housing expenses to 30 percent of their take home pay, according to Pantagraph.
Lenders actually have their own rule of thumb when it comes to determining how much house you can afford. Lenders use what is called the 28/36 rule to determine how much you can spend each month on your mortgage, including principal, interest, taxes, and insurance.
The “28” is the front-end ratio. This says that your mortgage cannot exceed more than 28 percent of your pre-tax income. The back-end ratio, “36”, says that your total monthly debt payments, including your mortgage, cannot exceed 36 percent of your income.
While these numbers are not set in stone, they are a rule of thumb typically used by lenders. Many lenders will still lend with a debt-to-income ratio of 45 percent.
For examples, if your salary is $100,000 per year and you have a total of monthly debt payments of $800 per month, then you could buy a $558,700 home with your debt-to-income ratio being at 45 percent. This calculation assumes that you put 20 percent down.
Buying a home allows you to start earning equity, just avoid buying too much home.