Urban Legend: Always Max Out Your Mortgage Loan

Keith L. Rucinski, CPA, JD
Chapter 13 Trustee
Akron, OH

house keys

You are looking to buy your first home.   You are eager to begin the preapproval process for a mortgage so you are able to make a bid on the home which is right for you.

As you work with a lender who reviews your credit history, your work history, your annual taxes, and your monthly income, you are overwhelmed by the paperwork. You turn to the lender and real estate agent for advice.   

You get good news.  You’re preapproved for a mortgage loan. Congrats!  The loan is for lot of money you’re not sure you can afford that much home.  The mortgage lender tells you not to worry, it is only 40% of your gross monthly wages. This sounds good – in theory.   

It’s time to pause.

Just because you’ve been approved for that amount, doesn’t mean that you should borrow that amount.   The mortgage loan amount you can afford should not be based on your gross wages. You, like everyone else, have to pay taxes.  On average, taxes (federal, state, and local) can be around 30 % of your gross wages.  (Gross wages is the amount you earn prior to all payroll deductions for taxes, benefits or wage garnishments.)

Here’s a better way to calculate it.

Starting with your gross monthly wages, multiply that number by 70%. That number should be close to your net wages (the amount you take home after paying taxes). This is the amount that you have to actually live on.

So, if gross wages are 100% minus taxes at 30%, subtract your preapproved mortgage at 40%, and you are left with 30% for your monthly expenses.   Expenses are typically groceries, utilities, gasoline, car payment, and student loans.

Can you live on 30% of your wages?  Probably not.

The amount of the preapproved mortgage often does not consider your individual monthly living expenses.  Many people who max out their loan amount to the preapproved limit often must subsidize their ongoing living expenses by using credit cards to buy everyday items like food, utilities, and gasoline.

Additionally, your mortgage loan may or may not include a monthly escrow for property taxes and insurance.  If not included in your mortgage that is another expense you will have to cover.  Given the continuing surge in home prices, many people are discovering that their property taxes are increasing (in some states, people are seeing increases over 30%).   Insurance rates in many states are also increasing due to natural disasters.  

Buying a home is exciting, but it can be costly and limit your ability to pay your living expenses if you max out your loan based on your gross income. 

Always check the number you can afford by starting with your net income and deducting your monthly living expenses. The amount left over is the amount you can afford. 

While it can be challenging to purchase a home in today’s market, the happiest homeowner is one who determines a manageable monthly mortgage payment. Remember, look at your net monthly pay and then back out your monthly expenses. That number is the magic number you should work toward.

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