How to Choose an Affordable Mortgage

Hello, and welcome to Your Money 2.0. I’m
Thomas Fox, Community Outreach Director of Cambridge Credit Counseling. Homeownership
has long been the American Dream, and the housing boom at the turn of the century gave
many individuals what seemed like the perfect opportunity to make that dream a reality.
Unfortunately, a combination of exotic mortgage products and an unprepared public led to the
largest housing crisis in decades. The first steps in avoiding a repeat of this awful period
in our history is for prospective homebuyers to understand exactly how much house they
can afford, and how much it will take to maintain ownership in the years that follow. First, it’s important to develop a realistic
understanding of how much of a mortgage you will qualify for. This is dependent on two
specific ratios that we’ll discuss in a few moments. Second, and perhaps more important,
you have to determine just how much of a home you really need. Lenders will qualify you
based on current underwriting procedures, not necessarily on what you can afford. The
burden falls on you to understand exactly the size of the mortgage payment you can make
month after month, year after year. For instance, when determining affordability, lenders typically
base their calculations on your gross monthly income. As you know, your gross income represents
earnings before taxes and other deductions are taken out. For example, if you were to
earn $50,000 a year, your gross income each month would be around $4,100. However, depending
upon your tax bracket, your net income can be very different. In this scenario, your
tax obligation would be approximately $8,600 annually, which would make your monthly net
income $3,376. That’s a big difference. Furthermore, there are other aspects of affordability
that your lender probably won’t take into consideration. Do you pay for childcare? Do
you pay child support? If you have any obligations that aren’t considered debts, yet you have
to pay them each month, this can dramatically change your ability to maintain a mortgage
payment. Therefore, creating a realistic budget is the very first step in understanding what
you can afford. When determining affordability, it is highly recommended that you contact
a HUD- approved housing counseling agency, such as Cambridge Credit Counseling Corp.,
to participate in pre-purchase counseling. Not only will this help you figure out what
you can afford, but your counselor will also discuss other expenses that you’re likely
to incur, further challenging your ability to maintain your mortgage payment. So, how do lenders determine how much of a
mortgage payment you can bear? There are two commonly used calculations. The first is a
borrower’s housing ratio, which is the percentage of your gross monthly income that can be used
to make monthly house payments. This would include principal, interest, taxes and insurance.
Our previous example featured a gross monthly income of $4100, so let’s base our calculation
on that. In that situation you would t see the ake the gros your you an e-mail in an
agency’s is s monthly income and multiply it by the recommended 28% of income that should
be used for such an expense. Different loan programs may allow for different housing ratios;
however, we’ll focus on the more traditional approach. So, we take our $4100, multiply
it by 28%, and we come up with $1,148 – the monthly mortgage payment the lender believes
you can sustain. Lenders also take a second look by adding
into their equation any other household debt that exists, including credit card debt, car
loans, college loans, and so on. After the debt is added, the optimal debt-to-income
ratio for sustainability is 36%. Again, there are different loan programs that can accommodate
higher ratios, but we’re focusing on broadly accepted practices. Okay, now we take the
gross monthly income, $4100, multiply it by 36%, and come up with $1476. This amount would
be the maximum recommended amount of all debt payments, including your mortgage payment. In some instances, these numbers may indicate
that an individual is mortgage ready, and on their way to homeownership. However, these
numbers can also indicate that you might not be ready to own a home — just yet. In many
cases, although the bank believes you can sustain a payment, your instinct may tell
you this is not necessarily the case. Therefore, it’s important for you to establish a workable
budget, a realistic plan for homeownership, and take some time to speak with a housing
counselor to make sure you’re on the right path. Well, that’s it for this edition. We welcome
your feedback and ask for your thoughts and suggestions by e-mailing us at [email protected]
Thank you for watching. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.

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