Sunday, December 26, 2004

Choose the right mortgage to avoid winding up 'house poor'

If mortgage payments absorb too much of your income, keeping up will be a struggle.
By Jim DeBoth
Special to the Orlando Sentinel

Owning a house is the American dream. For some people, however, it can become the American nightmare. How? By having the wrong mortgage.

When you shop for a mortgage loan, you know you need to borrow enough money to get the house you want to buy. You also need to have a payment you can meet every month. But if you take out a mortgage that leaves you unable to do anything except make your payments, you are considered "house poor." And it is a nightmare.

Being house poor is especially common among first-time buyers who don't realize how much more there is to owning a house than paying the mortgage.

Many renters have their utilities included in their rent: gas, electric, maybe even cable. Renters do not have to make property tax payments, either. In most cases, if anything goes wrong with the plumbing or wiring, if the roof leaks, or if a door or window needs replacing, it's the landlord's problem. And then there's homeowners insurance, or hazard insurance as it is sometimes called, and that costs a lot more than renters insurance.

Renters pay for all these items, but the costs are usually included in the rent. So, when they look at how much rent they pay each month, they tend to think that they can pay the same amount for a mortgage. They can, but only as long as they figure out how much all those "extras" will cost them every month, and how much they should be able to set aside as a reserve fund for when there's a problem.

When you buy a house, especially a first house, you also are buying a yard to maintain, which means you also might need all the equipment and paraphernalia associated with lawns, gardens, a swimming pool and so on. Many of these can turn into regular expenses. Before you buy any equipment, you should consider creating a budget.

One of the best ways to start working on a budget and get a handle on the size of the loan you should look for is to take a realistic look at your own finances. Lenders will look at your debt-to-income ratio. You can do that yourself to get a picture of where you stand financially.

The first question is how much do you spend on housing every month? If you're a renter, that would be the amount of your rent check. If you already own a home or a condo, it would be your mortgage payment including taxes, interest, insurance and principal, plus any applicable fees, assessments or homeowner association dues.

Most lenders believe you should be spending no more than 28 percent of your income on a mortgage payment. Other lenders are willing to stretch it to 40 percent.

Now add in what you spend every month for your regular debts, the bills you have to pay month-after-month. This includes credit cards, car loans, alimony and child support, and any other debts you will continue to have within the next six months or so. Most lenders say this should be no more than 8 percent of your gross income, but some will go as high as 10 percent. Now consider, how much do you spend on food, clothing, gasoline or other transportation costs? Are you going to be making a major purchase -- furniture, appliances? How often do you eat out? What do you spend on entertainment? How often do you go on vacation? What will that cost? What about medical expenses? How much of a cash reserve do you have in case something goes wrong? Are you planning to have children or do you have them already?

The way to avoid being house poor is by not borrowing more than you can afford to pay back and by finding a house that fits the reality of your budget. Just because a lender says you can use 30 percent or even 40 percent of your income on a mortgage doesn't mean you should. You have the final say on the amount you can comfortably borrow and pay back.

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