1 Big Mortgage Risk to Avoid in This Crazy Market

You could really end up regretting this mistake.

The real estate market today is definitely not the most favorable one for borrowers. There's a serious shortage of homes available for sale, and housing prices have repeatedly hit new recent highs in most parts of the country. Many properties are also selling very quickly.

This type of red-hot housing market can be really frustrating if you are looking for a home. And unfortunately, it can sometimes lead borrowers to make the mistake of stretching their budgets and taking out a mortgage that is larger than they can comfortably afford. Here's why that's a mistake.

Make sure you know how much house you can truly afford

Unfortunately, with housing costs so high and homes so hard to come by, many borrowers may end up stretching their budgets in order to be able to get into a home.

Lenders will approve borrowers for a loan based on their debt-to-income ratio (DTI). This looks at total monthly debt payments relative to monthly income. Typically, mortgage lenders allow borrowers to go as high as a 38% debt-to-income ratio (including the mortgage), but some permit them to take on much more debt. In fact, for certain kinds of mortgage loans, it's possible that a borrower could get approved with a DTI as high as 50%.

But an approval for a large loan doesn't mean that it's actually affordable for you during the entire payoff time -- especially given your financial goals and future plans. If you opt to take out the largest allowable mortgage so you can make a competitive offer in today's seller's market, you could end up really regretting it if it turns out making the loan payments isn't comfortable for you.

Rather than allowing the frenzied market to prompt you to make a choice that you will end up regretting, it's a good idea to know in advance how much house you can afford.

Set your maximum mortgage loan limit yourself based on the amount you are really sure you are comfortable paying each month. And when you decide how large a mortgage payment you are willing to make, consider all of your other expenses as well as financial goals, such as early retirement or paying for college.

Once you have set a maximum monthly mortgage payment for yourself, you can work backwards from there and see what size loan will come within your budget. A mortgage calculator can help you figure out your total monthly payment. That should shape your home buying choices.

For example, if you decide you simply aren't comfortable with paying more than around $1,000 per month for your mortgage loan, then the maximum amount you should be borrowing is around $250,000 (assuming you qualify for a 30-year loan at a rate somewhere around 3.125%).

After you've figured out the mortgage loan amount you're comfortable with, you can calculate how much money you have for a down payment. Then start shopping for homes you can afford with the money you're putting down and the maximum loan amount you're willing to borrow. Stick only to searching for homes that are within that price limit so you aren't tempted to up your budget just to get into a property during a seller's market.