Owning a home can be a smart move on many levels, especially from a tax perspective. But if you're planning to apply for a mortgage in 2017, don't make the same mistake countless homeowners have already fallen victim to: taking on too much house.
Can you really afford that mortgage?
According to a MacArthur Foundation report, between 2011 and 2014, 52% of Americans had to make at least one major sacrifice to keep up with their housing costs -- sacrifices like taking on credit debt, working a second job, delaying retirement savings, and cutting back on healthcare. If you're not careful about how much you borrow, you could easily wind up in debt, foreclosure, or both.
Though foreclosure rates have dropped in recent years, in 2016, there were still about 379,000 homes foreclosed upon across the country, while 479,000 properties entered the early stages of the process. Furthermore, if you're spending an inordinate amount of money just to own your home, you'll have less disposable income for other things, be it food, transportation, healthcare, or unexpected expenses that inevitably arise. And while some people are willing to rack up credit card debt to hang onto their homes, it's a move that could set off a vicious cycle and wreck your finances irreparably.
Taking on too much of a mortgage could impact your retirement savings too. As a general rule, you should aim to put away 10% of your salary (or more) for the future, but if your housing costs eat up too much of your income, your nest egg could easily take a hit. Taking on too large a mortgage is a dangerous move that could hurt you in more ways than one, so before you get in over your head, think about what you can really afford and make sure your mortgage payment falls within that limit.
How much should you be spending?
In 2015, almost 12 million households spent more than half of their income on housing, which is borderline reckless. While there are sometimes exceptions, most people should limit their housing costs to 30% of their take-home pay. To be clear, that 30% figure includes your mortgage payment, property taxes, and homeowners' insurance, all of which are relatively fixed costs that you know to anticipate off the bat.
According to ValuePenguin, the average annual homeowners' insurance premium in the U.S. is $952, and it's estimated that the average American household pays $2,127 a year in property taxes. Now these are just averages, and in some parts of the country, you might easily face property taxes that are five times as high. But we'll go with these numbers to give you a basic idea of how much you ought to be spending.
Let's say that after contributing 10% of your salary to a retirement plan, you bring home $6,000 a month. This means that your mortgage, property taxes, and homeowners' insurance shouldn't exceed $1,800 a month. If you're like the average family and need to spend $256 per month on property taxes and insurance, it means your mortgage payment shouldn't exceed $1,544. If you live in a part of the country where property taxes are much higher, you'll need to adjust that figure downward as necessary.
Of course, if you're able to keep your housing costs below that 30% threshold, even better. The less you spend on housing, the more money you'll have for life's other necessities -- and the less likely you'll be to wind up in debt.
Don't forget these additional costs
While that 30% of income limit includes the obvious costs of owning a home, it doesn't factor in maintenance, which, if you're like the average homeowner, can be anywhere from 1% to 4% of your property's value per year. So if you own a $300,000 home, you should expect to spend between $250 and $1,000 per month on maintenance alone. Now that's a pretty sizable gap, so you'll need to apply some logic when working out your budget. If your home is older and in relatively poor shape, assume your costs will hit the higher end of that range. On the other hand, if you own a newer property with recent updates, you might not spend as much.
Furthermore, the 1% to 4% range is meant to cover typical maintenance and repairs. But if your furnace goes kaput or your roof needs to be replaced, you can bet your costs will well exceed that upper limit. That's why it's important to have emergency savings in place before you sign a mortgage. Once you own your home, you're responsible for all of the costs involved, and without that safety net, you could run into trouble even if your mortgage payment itself is relatively low.
Tempting as it may be to buy that giant house with the sprawling yard, taking on too much of a mortgage could compromise both your short-term and long-term financial security. You're far better off keeping your housing costs low and giving yourself as much financial flexibility as possible.