How Much Should You Borrow When Buying a Home?

When you’re in the market for a new home, it can be tempting to stretch your budget in order to buy a place that has all the features you want. But doing so could cause money trouble for you and your family.

Emily Holbrook, director of personal markets at Northwestern Mutual, says homebuyers can get into trouble by borrowing too much. “Some people have unrealistic expectations about what they can afford,” she said. “They have a vision in their heads of their dream home, and they don’t understand all the hidden costs of homeownership that they need to factor into their budget.”

Holbrook believes it’s critical that buyers spend time figuring out what they can truly afford to make sure that they don’t end up in over their heads. “When you become cash-strapped by borrowing too much,” she said, “it affects your ability to invest in your future and save for your other goals. It can also make people feel trapped since they often have to cut back on hobbies, travel or other things that matter to them.”

Here are some things to consider before making an offer on your dream house:

HOW TO DETERMINE THE TRUE COSTS OF HOMEOWNERSHIP

When Holbrook was shopping for her first home, she calculated the cost of her mortgage and assumed that the expense of owning a home would be close to the amount she was already paying in rent. But once she added in all the other expenses involved in homeownership, the monthly cost nearly doubled.

A lot of people mistakenly believe that if they're approved for a certain mortgage amount, then they can afford to borrow it.

"New homeowners don't always understand the hidden costs that come along with owning a home," said Holbrook. “They don't factor in things like home repairs, maintenance, homeowners' association or condo fees, utilities, property taxes, private mortgage insurance, home insurance and all sorts of other costs."

Not taking these costs into account meant that Holbrook might have taken on a mortgage that would have significantly stretched her budget. That's why she believes it's critical that you sit down with a calculator and add up all the costs in order to get a true idea of how much homeownership will cost you.

THE AMOUNT YOU’RE APPROVED TO BORROW MAY NOT BE WHAT YOU CAN AFFORD

A lot of people mistakenly believe that if they're approved for a certain mortgage amount, then they can afford to borrow it. But that's not true, says Holbrook.

"What a bank may feel comfortable lending you might be very different from what you can actually afford," she said. "Lenders don't know all of your expenses. They're looking only at the types of expenses that are going to show up in your credit report. They don't know what kind of daycare expenses you have, if you're paying private school tuition or whether you're supporting aging parents."

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Lenders also don't know about your other goals or financial priorities, like whether you want to start a business in a few years or you're saving to send your kids to college. "You're the one that has to make the mortgage payments," Holbrook said. "You have to make sure you feel comfortable with those payments."

How much you should borrow on your home is an individual choice. You might make the same amount as your friend; but if you have different expenses, goals or priorities, then the ideal amount to borrow could be completely different.

Even common advice, like spending no more than 25 to 30 percent of net income on housing costs, might not apply to you if it doesn't fit with your current and future lifestyle and goals. Since buying a home is a long-term investment, make sure that the costs will fit your financial situation in 10 or even 30 years' time.

If you're unsure how much you can afford, Holbrook suggests that you sit down with a financial professional who can go over your financial situation and help determine how much to spend.

FEEL CONFIDENT IN YOUR CHOICE

Shopping for and buying a home is often a stressful and busy time, but taking the time to think about mortgage affordability and ensuring that you don't end up borrowing too much will set your family up for future success.

"Being house poor," said Holbrook, "can lead to a great deal of conflict in the household and the inability to do many things as a family that you enjoy." But when people borrow the right amount, they end up feeling confident rather than stressed, according to Holbrook. "They feel assured that they can achieve all their financial goals — not just their goal of homeownership," she said.