Once you’re pre-approved for your mortgage, you’ll know how much the bank will allow you to spend on a house. It’s important to realize, however, that just because the bank may have approved you for a certain amount doesn’t necessarily mean that you can afford that amount.
A fairly major flaw in the mortgage process is that the bank looks are your gross income, not at your net income. As you might recall from the previous post in this series, during the interview process, the bank will look at your gross monthly income (that’s before income taxes, too) minus minimum monthly payments that are required on any obligations you have and then work with that total as the basis for your loan. For example, if your gross pay is $36,000/year, that works out to $3000/month. Subtract from that your car payments (for this example, we’ll use $500), and minimum payments on any credit card or other balances you carry (we’ll say the total minimum payment is $200). If you do the math, you’ll see that leaves us with an income of $2300.
With that $2300, the bank will figure out the price of house that you can afford. The flaw comes, though, from the fact that they don’t take into account that you may want to pay more than the minimum on your credit cards. You may want to pay a bit more on your car payment, or you may have major medical expenses to deal with. There’s a whole realm of possibilities that could suck money out of you that the bank doesn’t take into account.
So, moral of the story is to budget and figure out exactly how much you can afford to spend on a house payment (don’t forget property tax, homeowners insurance and Private Mortgage Insurance – PMI – if you’re putting less than 20% down). In many cases, this will be pretty close to your pre-approval amount; in many other cases, however, you’ll find that you can’t really afford to spend what the bank is telling you that you can. Keep that in mind.