You often hear people refer to their homes as investments. That's only half right. The primary purpose of a home is shelter. Yes, a house can be an investment, but if investing is your goal, the stock market demonstrates bigger long-term returns.
Homeownership feels satisfying, and you get a tax break on the mortgage. But ownership is not all wine and roses. When the roof or water heater leaks, you have to shell out money for repairs. A renter who loses a job can move out and find a cheaper place, whereas selling a home on short notice is costlier and vastly more complicated.
There are options between renting and owning: seller financing, lease with option to buy, and contract for a deed. But regular homeownership is the most common option. The first thing to figure out is how much house you can afford. For most buyers, that's another way of saying that you've got to figure out how much you can afford to borrow.
In general, mortgage lenders want your monthly housing payment to be 28% or less of your monthly before-tax income. For this calculation, your monthly housing payment includes the principal and interest on the mortgage, plus property taxes, mortgage insurance, and any mandatory hazard insurance. Lenders call this your housing expense ratio or front-end ratio.
Lenders prefer that all of your monthly debt expenses not exceed 36% of your before-tax income. These debts include your mortgage-related payments; your auto loan, credit card, and student loan minimum payments; your alimony and child support obligations; and the homeowner association fees. Lenders call this your debt-to-income (DTI) ratio or back-end ratio.
The recommended 28% housing expense ratio and the 36% debt-to-income ratio are general guidelines. Some borrowers, especially low-income homebuyers, can qualify for loans that allow higher ratios.
When you apply for a loan, you and the lender will need accurate estimates of how much you will pay every month for property taxes and homeowners insurance. In the next chapter, we will describe these and other key elements of the monthly mortgage payment.