05 Jun Can I afford a bigger home?
Q. I’m thinking of buying a bigger house. I have no debt except for the mortgage on my current house. How can I decide what I can afford, or would I be better off just saving my extra money in a non-real estate investment?
A. The decision to move to a larger and more costly home isn’t just about the money.
Before you get the finances, you should consider your reasons for a move. You mention the home as a real estate investment, but it’s not clear if you would move so your family could have more space or a nicer place to live, or if it’s just an investment idea.
It’s important to consider how moving to a bigger home would impact your ability to achieve other major goals, such as a comfortable retirement, said Jim Sonneborn, a certified financial planner with RegentAtlantic Capital in Morristown.
He said you should ask yourself if you’re already saving enough to make that retirement dream a reality, or if the additional housing expense could cause you to work longer than you may otherwise have wanted to.
“Understanding how much you need to save of your annual income in order to have a large enough nest egg in place for retirement is critical before you potentially make a significant change in your housing expense,” he said.
If you are on track with your savings rate to ensure sufficient retirement cash flow, then how you spend the rest today is a matter of balancing your discretionary spending according to your family’s priorities, he said.
“If there is enough available to afford that larger house and that would be a desirable use of your earnings, than it just may make sense,” he said. “As your expenses increase, be sure to make adjustments to your `rainy day’ fund that would be called upon for the unexpected event such as a job loss or temporary disability.”
As you get deeper into the process, you need to consider not only the costs of buying a new home, but also the costs involved in selling your current home, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway.
Now on to what you can afford.
McCarthy said there are two ratios that mortgage lenders look at when determining if a borrower can afford the mortgage they are requesting.
The first is a housing debt ratio, which all housing costs (principal, interest, property taxes and insurance) divided by gross monthly income. The ratio must be less than 28 percent, he said.
Then there’s your total debt ratio, which is all monthly debt payments, including housing costs, divided by gross monthly income. This must be less than 36%.
He offered this example: If you earn $50,000 a year, the maximum amount for monthly housing-related payments at 28 percent of gross income is $1,167. ($50,000 x 0.28 = $14,000, divided by 12 months, equals $1,166.67 per month.)
Next you deduct the monthly amount of property taxes and homeowners insurance to determine the amount of principal and interest you can afford.
When you have the mortgage amount, add it to the amount you intend to use as a down payment to determine the total price you can afford to pay.
“Mortgage lenders also look at the loan-to-value ratio (market value of home divided by mortgage requested),” McCarthy said. “Anything below 80 percent loan-to-value and you will probably face a harder time getting approved, higher interest rates, and potentially paying private mortgage insurance (PMI).”
So should you stay put? That depends on where all the numbers land. If you’d like more help, consider a free money makeover with NJMoneyHelp.com.
Email your questions to .
This story was first posted in June 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.