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Taking on too high a mortgage is dangerous. If you do so, you risk not only falling behind on your payments, but struggling with other bills as well. That, in turn, can damage your credit score and, in a more extreme scenario, put you at risk of losing your home to foreclosure.
But these days, Americans are borrowing more money than ever to buy homes. The average home purchase mortgage amount reached $375,000 last week, according to the Mortgage Bankers Association. That's the highest number since they began their survey in 1990.
Why are buyers borrowing so much? It's simple -- because they have to.
Limited housing inventory and low mortgage rates have driven home prices up, and today's buyers need higher mortgages to compensate. But stretching yourself to take on a higher mortgage than you're comfortable with could have serious consequences. If you're going to buy a home today, proceed with caution.
How to know you're taking on too high a mortgage
Clearly, the higher a mortgage you take on, the more it stretches your budget thin. But how do you know you're crossing the line?
As a general rule, your monthly housing costs should not exceed 30% of your take-home pay. If you bring home $3,000 a month after taxes, that gives you $900 to spend on your monthly mortgage payment. But to be clear, that $900 shouldn't just cover principal and interest on your loan. It should also cover your:
- Property taxes
- Homeowners insurance costs
- Private mortgage insurance (PMI), if you're subject to it
- HOA fees, if you buy a home that's part of a homeowners association
The reason to lob these expenses into that 30% limit is that they're all predictable, recurring, and unavoidable. On the other hand, you don't have to count things like maintenance and repairs in that 30%. The reason? Those are variable, and you can't always know what they'll cost.
For example, you may go months without anything in your home breaking, only to have a pipe come loose that costs $250 to replace. You don't need to set aside $250 every month for something like that. Rather, that type of expense will likely come out of your emergency fund. When we say your housing payment shouldn't exceed 30% of your take-home income, we're talking about the expenses you know you're on the hook for.
How much of a loan can you swing?
If you're in the market for a home and aren't sure how much mortgage you can afford, use this helpful calculator to figure it out. But be careful if you're considering a mortgage that's higher than the loan amount you initially expected to take on. A big reason buyers are borrowing so much right now is that limited housing inventory has caused home values to skyrocket. Chances are, if you sit tight and pick up your search again in four to six months, you'll have more homes to choose from in a more comfortable price range, and that could, in turn, leave you with a lower mortgage to pay off.