Only a lender can tell a homebuyer how much they can spend on a house. But you don’t have to spend that much, and probably shouldn’t. Everyone needs some wiggle room – especially if you’re a first-time buyer.
Broker Steve Godzyk in Manchester, New Hampshire recently had a client who didn’t heed that warning, and she’s likely to be sorry. A single mother of two, she told Godzyk that after paying the house note, she’s left with no money to have fun or go anywhere with the kids.
During the house hunt, she’d insisted on searching at the top price her lender said she qualified for. When Godzyk asked why she wouldn’t buy in a lower price range so she would have money left over after paying her mortgage, she replied, “The loan officer said I can buy a home at that price, and I will.”
House Poor Far from Rare
Being “house poor” is no fun, and it doesn’t take long for a dream house to become a nightmare. And Godzyk’s client appears to be far from alone in shooting for the moon.
A new report from mortgage analytics firm Black Knight found that 1 percent of all loans taken out in last year’s first quarter were delinquent within six months. Sure, 1 percent doesn’t sound like a lot in the greater scheme of things, but that’s the most since 2010 – and an increase of more than 60 percent over the past two years.
Here’s more proof some buyers are biting off more than they can chew: In another recent study, Clever Real Estate, a site that matches buyers with agents, found that 35 percent of mortgage complaints submitted to the Consumer Financial Protection Bureau in 2018 were from people who were struggling to pay their mortgages, suggesting they were overextended.
It’s even happening in the rental sector, according to Zumper, a leasing platform, which said a third of all Millennials spend more than 30 percent of their incomes – the standard measure of affordability – on rent.
How Lenders Set Limits
Lenders base their decisions about the maximum they will lend on several factors. Credit scores are key, but they also give heavy credence to your debt-to-income ratio, or DTI, which is calculated by dividing your total monthly debt expenses – like vehicle, credit card and student loan payments – by your gross monthly income.
Generally, lenders won’t approve mortgages for people who spend more than 43 percent of their income on recurring monthly payments. But that cutoff “is hardly a steadfast rule,” said Clever Real Estate research analyst Francesca Ortegren, who found that 15 percent of the loans written in 2018 were to borrowers above that ceiling.
Indeed, Middletown, Connecticut, mortgage broker George Souto said some conventional lenders will go up to 50 percent, while those pushing government-backed FHA financing will go as high as 55 percent.
Don’t go that high, though. Why? If you add the cost of your new mortgage to your monthly debt load, it leaves little or nothing for utilities, maintenance, food, gas, clothing, school supplies and all those other things you spend money on, month in and month out – items your lender doesn’t pay any attention to when calculating your DTI.
“This is an insane way to go into homeownership,” Lise Howe of Keller Williams Capital Properties in Washington, D.C., warned recently on the ActiveRain real estate site. “A lender may approve you for a mortgage at a high amount, but it might not make good financial sense to borrow all that money.”
How to Help Your Clients
To help your clients avoid debt overload, start by encouraging them to pick their lender carefully. . You want them to deal with professionals who have their best interests at heart. And make sure to keep your clients’ practical interests in mind.
“There are agents who will test [clients’] discipline,” said Barbara Todaro of RE/MAX Executive Realty in Franklin. “If your pre-approval reflects a large number, they’ll start their showings with that luxury home, and everything else will look like a fix-and-flip.”
New Lenox, Illinois, mortgage broker Gene Mundt agreed.
“A good lender fulfills a larger role than someone who facilitates a mortgage,” he said.
Another good step is to suggest your client prepare two budgets: one so they know exactly what they are spending now, and the other so they’ll know what they’ll be paying once they buy a house. That way, they won’t be giving their lender the power to determine how much you can spend on your house.
Some items will shift, of course. If they are paying renter’s insurance now, for example, they can forget that number – but they should include an amount for homeowner’s coverage in the second budget. It’s required, as is mortgage insurance. Some of these costs can be included as part of their monthly house payment, but they add substantially to an amount above and beyond principal and interest.
Make sure they include everything, from cable and internet bills to their cellphone. And allow amounts for food, entertainment, transportation and whatever else they can think of. Later, if they decide to lower some of these expenses or dump them entirely, they can. But at least they’ll know going in what they have going out.
Making these lists will take some time, but it’s well worth it. Budgeting allows borrowers to determine their own fates, advises Ortegren. It’s “a simple way to avoid overspending,” she said.
Lew Sichelman has been covering real estate for more than 50 years. He is a regular contributor to numerous shelter magazines and housing and housing-finance industry publications. Readers can contact him at firstname.lastname@example.org.