Monday, February 22nd, 2010
When we apply for a mortgage we should always have some idea as to how much we can afford to borrow, and our capacity to repay the mortgage. Knowing how much we can afford is vitally important because nobody would like to lose their house or investment property to foreclosure. When we ask ourselves the question of ‘how much can I borrow for a mortgage’ it will be highly dependant on two major factors:
1.) The interest rate charged on the mortgage
2.) The amortization, or length, of the mortgage.
When it comes to lenders or banks deciding upon the amount and rate of the mortgage loan, they will certainly look into the financial background of the borrower.
Lenders are typically looking to satisfy themselves of the Three C’s of credit – Including the capacity to repay the loan, along with the credit history and the character of the individual. These factors can be determined initially by looking at the credit score, and secondly by calculating several ratios before the determination of how much credit they can grant to the borrower.
The Real Cost of A Mortgage
When one decides to buy a house, there are several payments that must be paid on time in addition to the actual mortgage payment. These other payments should always be included when we ask ourselves the question ‘How much can I borrow for a mortgage’?
Such additional payments consist of home owners insurance, property tax and home owners association fees. When these are all added to the mortgage payment, they comprise a more realistic cost of home ownership. In addition, add this to your other anticipated monthly expenses and this is one of the ways to estimate how much you can really afford when you apply for a mortgage.
Private Mortgage Insurance – PMI
This might be another expense that could alter how much mortgage we can afford. Private mortgage insurance, also known as PMI; is an additional cost that must be added if you are not able to afford 20% of the homes price paid as a down payment. In such a case, you will need to purchase private mortgage insurance in order to protect the bank’s investment in your high ratio mortgage.
Front-End Ratio
The front and ratio is the comparison between the monthly mortgage cost-which includes insurance, real estate taxes, private monthly insurance with your total monthly income. Generally mortgage costs are given to make up between 26% to 29% of your monthly income, in this case your monthly maximum repayment amount would be $840. This is another analysis you can use in answering the How much I can borrow for a mortgage question.
Back-end Ratio
When your total income is compared with your total debt payments, this is called back end ratio. This, more comprehensive, ratio includes credit card debt and college loans, and any other debt you have. It can make a total of up to 33 to 40% of your income.
For example, if your bank sets 35% as the limit, and you have a monthly income of $3000. In this case your total debt paid in a month would be $1,050. If you pay $400 as a monthly student loan, you would then have a maximum of $650 left from your income which can be used to repay the mortgage loan.
Credit Score
If you have a good credit score, the banks may increase the limit of the above ratio calculations because your history of repayment cements the bank’s faith in your credibility. Once the ration is determined, all the aforementioned characteristics and calculations help both the borrower and lender in deciding how much credit is really affordable for the borrow.
As you can see, answering the question ‘How much can I borrow for a mortgage’ is not as easy as we might think. There are many variables that lenders take into consideration and we must fully understand those variables in order to determine how much mortgage we can really afford. It’s just not as easy as some online mortgage calculators would have you believe!
For more information on Mortgages, check out my Mortgage Survival Guide For the First Time Homebuyer!
Posted in Investor Education | 2 Comments »
Wednesday, March 19th, 2008
There is but one constant in building wealth and that is to spend less than you earn. If we boil it right down to the simplest of forms, you can never be rich if you spend more than you make.
How Much To Save?
Every financial book out there will throw out a number or percentage of your pay that you should save and invest for retirement etc. but there is no magic number that works for everyone.
Some have said that saving or investing 20% of your income is a great amount and this is attainable by most folks if they make the correct lifestyle choices.
Some have loftier goals, such as Trent over at the Simple Dollar, who recently advises newly graduated workers to save 50% of their take home pay! While that may seem unattainable, let’s look a little closer at the idea.
Buying Freedom
If you are reading this blog, then you are looking to make more money, save more money, or find a way to retire earlier. Now that we have agreed on that point, let’s examine another point.
When I recently wrote about automatic savings accounts like ING Direct and why I believe they are essential, I also mentioned that they are useless unless there is a goal attached to it. The reason that they are useless without a goal is that there is really nothing stopping you from spending that money unless the reason that you are saving it is stronger than your desire to fulfill your “need” for immediate gratification.
For most of us, saving 50% of our income seems unrealistic. I’ll admit that it seems daunting to me at the moment as I am expecting my first child in a few weeks (kids are expensive pregnant wives are expensive).
Making Choices
The amount that we save really just depends on our choices. This is no secret, but it has been the basis for many successful personal finance books, from the Automatic Millionaire to the Wealthy Barber, it’s really all about choices.
I made the choice to save more than 50% of my income for nearly two years as I saved in order to write that big cheque that paid off my $40,000 in student loans less than a year after leaving college.
What was the trick?
I lived like I was still in school (I was still in school for one of those years, but working full-time too).
Back to the conversation at hand.
We must have a certain level of income to provide us with shelter, food, water, and clothing; everything else is optional.
The Options Make The Difference
The optional items that we choose to purchase with our disposable income are what make the difference in our wealth. Again, a simple concept that has sold many millions of books.
The optional items that we choose in order to increase our comfort cost us money. That is the surface of the conversation. However, when we look deeper into what it is really costing us is time/freedom.
The argument for saving 50% of your income translates into buying one year of freedom for each year worked. In addition to this, the effects of compounding also come into play.
For each year that we save and invest 50% of our income, we are earning more and more freedom – assuming we keep our expenses at the same level relative to inflation (annual salary raise).
Going Overboard
This example is very extreme and may be viewed by some as going overboard. However, it does prove the point that it was intended to make.
At some point in your quest to save more money, you will reach a crossover point where you begin sacrificing your basic lifestyle for savings. This is not healthy either because you can never tell what tomorrow will bring.
I believe that each person or family must find that delicate balance between a comfortable and enjoyable lifestyle and the emotional and psychological benefits of a secure financial future. I am sure you will agree that this is much easier said than done.
How To Start Saving
The way I started automatically saving money was to set up a separate high interest savings account to which I began having automatic transfers made on each pay day. I have since kept increasing that amount as I find new way to make more money or spend less. Some months I am able to increase the transfer by just a few dollars, while other months I find ways to make a significant increase in the automatic transfers.
Try it out for yourself and see how far you can push yourself and just how much you can save when you are consciously thinking about it.
If you don’t already have a high interest savings account, you can sign up here at ING. They even offer sub-accounts so that you can compartmentalize your savings. I have a sub account strictly for the new baby and another for funding my brokerage account. I find that sub-accounts make it easier for me to organize my saving goals.
There is no “one size fits all” solution, but I hope that this example will help you to find yours!
Posted in Saving Money | 2 Comments »
