When you apply for a mortgage, a lender will decide how much money it’s willing to give you to put toward the purchase of a house. That doesn’t necessarily mean that you should take out a loan for the full amount. In some cases, borrowing the maximum a lender will allow could leave you overwhelmed by debt.
How Lenders Decide How Much You Can Borrow
Lenders base their mortgage decisions on several factors, including credit score and length of credit history, but the most important factor is a borrower’s debt-to-income ratio. This is the sum of all debts, including a mortgage, credit card minimum payments, and vehicle, student, and personal loans.
Most lenders want borrowers to devote no more than 28 percent of their gross income to a mortgage, property taxes, and homeowners and private mortgage insurance. They also want total debt payments to be no more than 36 percent of gross income. If your debt-to-income ratio is higher than these limits, a lender may reject your application or approve you for a loan at a high interest rate.
Reasons Not to Borrow as Much as You Can
A lender may approve you for a mortgage up to a high amount, but it might not make sense to borrow the full amount if your other, non-home-related debts are high. For example, if you have credit card payments that, when combined with home-related expenses, would put your total debt payments over 36 percent, you could find yourself struggling to meet all your obligations. You might have other expenses that take up a significant portion of your income. For instance, daycare costs, college tuition and medical bills could make it impossible for you to afford a high mortgage payment, even if a lender offered it.
Consider your long-term financial goals. If you have credit card bills you want to pay off quickly, you can pay more than the minimums due each month, but that might make your total debt payments too high to manage with a large mortgage. If you plan to buy a new car sometime soon, a car payment plus a high monthly mortgage payment could be hard to manage. If you want to set aside money for retirement or for your children’s college education, take those goals into account.
Don’t Take on More Debt Than You Can Handle
When shopping for a home, it’s easy to get in over your head. Just because you can borrow a large sum of money, that doesn’t mean you should. You probably have several other current and future expenses that could affect your ability to manage mortgage payments. Look at your entire financial picture and make a responsible decision that will allow you to cover all your bills and live comfortably.
This article is intended for informational purposes only and should not be construed as professional or legal advice.