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Can You Really Afford that House?

Buyers so often get their hearts set on a home whose asking price is just outside of their budget. Rather than shopping for another home, buyers will go to great lengths to find a way to purchase the home, financially over-extending themselves in the process. As a result, the home that the buyers once wanted so desperately turns into a financial albatross, and some buyers may even end up facing foreclosure. Fortunately, this predicament is completely preventable when you figure out your housing budget constraints ahead of time. Read on for tips on how to decide if you can really afford that house you have your eye on.

Misleading Approval Decisions

Homebuyers usually end up fettered to houses they can�t afford because their mortgage lender approved them for a larger loan than they were really qualified to handle. This is especially common with homebuyers with excellent credit. Lenders tend to be very generous with mortgage loans when the borrower has a high credit rating. However, buyers need to distinguish between the size of the loan for which they can get approved and the amount of house they can actually afford. Almost always, these two figures are vastly different. For this reason, you should not base your housing budget on the amount of money your lender is willing to give you. Instead, you need to come up with your own figures, and we�ll tell you how in the following sections.

Setting Limits

When determining how much house you can afford, you should focus primarily on two ratios: your housing ratio and your total obligation ratio. The housing ratio represents how much of your gross monthly income will be spent on housing expenses, such as mortgage payments, taxes, and insurance. Ideally, your housing ratio should be below 28%. You will also need to figure out your total obligation ratio, or the amount of your gross monthly income that you spend on all of your financial obligations. These obligations include housing expenses as well as credit card payments, auto loans, child support payments, and so on. In other words, your total obligation ratio is a reflection of the amount of your income devoted to debt. Your total obligation ratio should be below 36%.

Budgeting Conservatively

The limits for your housing and total obligation ratios mentioned above are the standards set by lenders. In many cases, these limits tend to be too high, especially for consumers with significant amounts of debt. To make sure you are able to comfortably afford your home, you should aim for much lower ratios. For example, some financial advisers recommend keeping your housing ratio at about 20% to give yourself more of a cushion. Similarly, if you want to budget conservatively, your total obligation ratio should not be higher than 28%. Adhering to these smaller limits will help you buy a house you can actually afford without putting an undue strain on your budget.
National Rate Averages

Mortgage Rates

Product Rate
5/1 yr ARM 3.147%
1 yr ARM 3.299%
15 yr fixed 3.221%
30 yr fixed 3.815%

Home Equity Rates

* Updated Jun 8, 2012