afford vs borrow

The Difference between How Much You Can Afford and How Much You Should Borrow

afford vs borrowThe housing market continues to pick up steam in 2014 with a number of new buyers entering the market for the first time.

Many if not most of these buyers will not have the cash reserves on hand to pay for a new home all at one time. This is where borrowing comes in. An affordable home loan can make the dream of owning your own home possible.

Depending on your income, credit score etc. the amount of money that you will be approved to borrow is going to vary. And just because you’re approved to borrow a certain amount doesn’t necessarily mean that it’s financially wise to take out a loan for that maximum amount.

Buying a Home

When you begin the process of buying a home for the first time, mortgage companies will examine your debt-to-income ratio to determine how much you can borrow. Mortgage banks look to make sure that no more than 36% of your monthly income is going to pay debts.

In order to calculate your monthly payment threshold you take your annual salary multiply that number by 0.28 and then divide by 12. So, if you make $100,000 a year then you would have a monthly mortgage threshold of $2,333. This is a pretty good rule of thumb that will serve most people well.

Most people most of the time won’t be teetering on the verge of foreclosure. What’s important to consider is what is unique to your own financial situation. Just because you make enough now to be able to afford a home loan at a certain price doesn’t mean that you’ll be able to continue doing this well into the future.

A number of factors could come together that would make paying back a home loan at a certain price prohibitively expensive. If, for example, you take out an adjustable rate mortgage, then your monthly mortgage payment could go up according to market conditions. Inflation is also going to drive up the cost of nearly everything that you purchase on a day to day basis.

Necessities such as food, energy and clothing are all bound to get more expensive the more time goes by. In other words, just getting by with the same amount of money is going to become more difficult. Another important factor to consider is job security. It’s worth considering how likely it is that you’ll be able to do the same job and earn the same wage or higher well into the future. Moreover, how much would you be earning if you had to switch careers in order to adapt to the changing job market?

These are all issues worth considering when deciding how large of a loan you should take out. No one has ever been seriously harmed by being too financially secure and by having too much money stored away in their savings account. Choosing the size of the loan you want to borrow is a combination of understanding what’s unique about your financial situation, planning for the future, living comfortably and taking on risk.

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