Is It Time To Downsize Mortgage Debt?

downsize mortgageQuestion: We want to buy a first home. We have a joint income of $80,000 a year and no debts of any kind. A loan officer says with $25,000 for the down payment and closing costs we could get a $250,000 mortgage. We have the cash but our problem is the monthly cost: $2,000 — a figure made high by mortgage insurance and very steep flood insurance premiums (as much as $5,000 a year because of where we live). Is now the time for us to buy a home?

Answer: You get tremendous marks for saving money — that $25,000 up front — plus you have no debts. That’s terrific. You no doubt have a very high credit score for the simple reason that you have a solid income, savings and no payments to miss.

Before going further let’s consider this idea: A lot of people are borrowing less than they can afford, they’re electing to downsize mortgage debt and you can too. According to the Federal Reserve, mortgage debt in 2010 amounted to $9.915 trillion versus $9.380 trillion at the end of 2014.

Now let’s see why so many buyers and borrowers are down-sizing their debt:

You earn $80,000 a year. That’s $6,666 a month. Less taxes and Social Security you bring home perhaps $4,650 in cash per month. In other words, $2,000 is equal to a little less than 31 percent of your $6,666 monthly gross income — but it’s nearly 43 percent of your spendable cash income. A $2,000 monthly mortgage payment plus utilities — a separate but additional cost — would mean at first glance that you have few dollars for anything beyond housing expenses.

However, with mortgage interest, mortgage insurance and property tax deductions your income tax bill would drop significantly. That would make the monthly expense of ownership much more tolerable — but there is still a hard $2,000 monthly cost. A job loss or fewer hours could quickly drive you into foreclosure — as might new and additional expenses. A job opportunity elsewhere could be lost if you cannot sell or rent the house for enough to cover costs.

How To Save On Home Buying

There are several ways to make this picture more attractive.

  • Buy a less expensive house. This would mean a smaller mortgage and related costs.
  • Put at least 20 percent down plus closing costs. This would eliminate the need for private mortgage insurance plus you would have a far-smaller loan amount.
  • Buy in an area which does not require high-cost flood insurance. Ask insurance agents for a local flood map. Be aware that as a condition of having and keeping a mortgage the lender can require that you maintain flood insurance. At the same time, flood insurance costs can rise in the future, further straining your budget since coverage is required regardless of cost.
  • Buy a fixer-upper. This would give you a low monthly cost and because you would live at the property you could do much of the work yourself. Given that you have jobs this is not easy but it is a way to build equity. Once repaired you could then stay, sell or rent the property as you prefer.

As you consider these issues review your credit report and clean up any factual errors or items that are out of date. For a free credit report, go to AnnualCreditReport.com.


Syndicated originally to newspapers nationwide by Content That Works. Revised, modified, expanded and updated. Posted with permission.

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