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For the last few years, it’s no secret that the housing market has been booming in many parts of the country. If you’re thinking of buying a home, it’s important to make sure you do not overspend and wind up feeling “house poor” with no room for fun vacations or savings for future goals. A house should be a place of comfort and stability, not a source of stress. In this blog post, we will discuss two stress tests that will help you consider how much house you can comfortably afford.
With interest rates at the highest they have been in the last 10 years, we have narrowed it down to two calculations to help ensure you do not overextend yourself.
It is important to note that often banks will approve you for over 2x the price of what we recommend, but just because they approve you does not mean you can afford it in the context of balancing living stress free today, while also achieving college savings, retirement savings, etc.
Stress Test #1: Percentage of Net Take Home Pay: The first calculation is taking 30% of your net take home pay, and ensuring that your payment (including principal, interest, taxes, and insurance) does not exceed this. For example, someone earning a gross income of $200k who would approximately have a net take home of approximately $10k/mo (after taxes, payroll deductions, and 401k contributions). In this example, the total mortgage payment should be within $3k/mo, which would be a mortgage loan of $350k – 400k based on a 5% interest rate, and assuming taxes of approximately 2% of the home value.
Stress Test #2: Multiple of Gross Income: The second calculation is simply taking gross income and multiplying it by 2. So again, if a family is earning $200k, the max mortgage limit should be at or near $400k.
Mortgage Terms: When it comes to length of mortgage, the 2 most common durations are 15-year and 30-year mortgages. In general, it is advantageous to take a longer-term mortgage when interest rates are low because although you will carry the debt for a longer period (and therefore pay more interest), it is likely that you will come out ahead if the lower payment allows you to save your money elsewhere. For example, a 15-year mortgage will have a higher payment than a 30-year, so you may not be able to dedicate funds to other savings such as your 401(k), Roth IRA, brokerage account, etc.
As with all aspects of financial planning, balance is crucial, and it is important that all pieces of your plan work together to support you and your lifestyle. We have found that sticking to these metrics will leave plenty of room in the budget for other goals, such as saving for college, saving for financial independence planning, and also spending on “fun things” like vacations, hobbies, etc. so you can enjoy life today.
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Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.