Buying a home can be a stressful experience for many people. Often, when you qualify for a mortgage, you are committing to pay for between 15 and 30 years. This is generally the largest financial commitment that most people make. A home is also the largest investment for most American families and is considered the key to building wealth. However, a 2008 mortgage crisis demonstrated that a home mortgage can be a very poor investment indeed if you cannot afford the payments.

How Much Should You Borrow?

When determining how much you should borrow, you must consider two major factors. First, you need to look at your income. No matter how wonderful a deal a house is, it is a poor deal if you cannot afford to comfortably make the monthly payments. If you are used to renting, you will also need to account for other costs, such as property taxes, insurance and utilities you didn't pay for as a renter. Second, you need to consider how much you can qualify for based on the appraised value of the house, your down payment and credit score. Even if you can afford a mortgage, the bank will have to determine that you can qualify for it before they will give it to you.

Income and Mortgage Amounts

Conventional wisdom says that for a home to be affordable, your monthly payments for housing should total no more than 30 percent of your total gross income. This is the amount you earn before taxes. Gross income is used to calculate mortgage payments because mortgage interest is tax deductible. To determine your monthly housing cost, find out what interest rate you will likely qualify for if you apply for a mortgage. Use this to factor in the monthly mortgage payment. Add an estimated cost for property taxes (most real estate listings list the proper taxes associated with the home), insurance (calling an insurance company can give you ballpark figures) and utilities (ask the current seller) what they are paying. Once you arrive at the monthly cost, compare this to your gross income to see whether you can afford the mortgage.

Home Value

You should typically borrow 80 percent of the appraised value of the home you are willing to borrow. This means you will need to come up with the other 20 percent of the money to buy the home from your savings. This down payment provides you with some instant equity in your home to protect you in case real estate prices fall. Many banks require some type of down payment, although alternative financing can certainly be arranged if you simply cannot qualify for a down payment. Taking an 80-20 loan (which means you are borrowing the down payment in a second mortgage) is one option. If you put down less then 20 percent of the value of your home and borrow 80 percent on a single loan, you will have to pay Private Mortgage Insurance, or PMI, so some buyers will use this type of 80-20 financing in an effort to avoid paying PMI insurance. Using HUD or other government lenders is another.

Source:

Mortgage Insurance Companies of America: How to Buy a Home With a Low Down Payment

HUD: Common Questions from First-time Homebuyers