Calculating Your Risk Tolerance When Purchasing a Home

 

When you’re planning to buy a home—whether as a first-time home buyer or as a seasoned pro—deciding how much you can afford is a critical initial step. Once you know that, you’ll be able to find a mortgage tailored to fit your style.
But figuring it out takes more than knowing your debt-to-income ratio. Real estate is an investment, and you need to know your risk tolerance when investing.
Are you conservative, aggressive or somewhere in the middle? Here’s how to tell your real estate risk tolerance.

Income Level

Start by taking a look at your income level.
If you make a higher income, you can afford to be an aggressive borrower, with up to 41% of your monthly take-home pay going toward your debts and 36% going toward housing expenses.
If your income falls in the middle to lower range for your area, an aggressive plan may not work for you.
Let’s use 41% debt ratio as a benchmark.
If you make $60,000 per year, that’s $5,000 per month. A 41% debt ratio means that $2,050 is committed to monthly debts—before groceries, taxes, health insurance, utilities, beer, etc. Most folks will eventually get into trouble if they do this.

Financial Stability

How you make your income also factors into the equation.
If you have a steady base plus windfall income from bonuses, commissions or stock options, then the windfall income could be used as your ‘rainy day’ bucket, and pushing your debt ratio to 41% makes sense.
On the other hand, if your work is steady—but you don’t see a promotion or raise in your future—a moderate financial plan would suit you better.
And if you’re self-employed, a conservative approach is best.
If someone is self-employed or on 100% commission, unless they have a superb, steady track record, they should always be conservative.

Saving Habits

Before you apply for a mortgage, take a hard look at how much you have—or haven’t—socked away.
If someone is a good saver, they may be more comfortable with them pushing the debt-ratio envelope, because I know they can manage tight months.
If you don’t have large cash reserves in your savings account, you’ll save yourself trouble later on by choosing a conservative mortgage.

Age

Your age is also an important deciding factor.
If you’re younger, purchasing your first home, have many years of work ahead of you and feel like you’re in line for pay increases and promotions as you go on, choosing an aggressive plan may make sense. You’ll put more toward your debts and mortgage payments each month—but you’ll be able to build up equity faster.
However, if you’re nearing retirement or already retired, this strategy may not work.
If you’re looking at retirement, you shouldn’t be using your current income to calculate your debt ratios—you should be using your projected retirement income.
This lower, more stagnant income might be better suited to a conservative financial approach.

Bringing It All Together

Once you know what type of borrower you are, realtor.com®’s Home Affordability Calculator can help you see what your mortgage and monthly expenses may look like.
By plugging some basic financial information into the calculator and selecting your borrowing type, you’ll be able to see an estimated monthly payment breakdown—including principle and interest payments, property tax, home insurance and mortgage insurance.
Use this tool to help you manage your real estate risk tolerance.

You should definitely speak to a mortgage professional as this blog just provides guidelines.  Contact me today and I can put you in touch with some great mortgage people!