28% = The Share of Your Pretax Monthly Income That Should Go Toward Housing Costs
Why this target: During the housing boom, many people laid out unrealistic amounts of their gross income (sometimes 45 percent or higher) for their monthly mortgage payment, real estate taxes, and home owner’s insurance. And everyone knows how that turned out (see: foreclosure crisis). These days many banks have tighter lending standards, meaning they may not lend to someone whose housing payments are liable to exceed the benchmark of about 28 percent. (Some experts say that up to 38 percent of pretax monthly income is a reasonable target.) If you want a home that takes you over this limit, it won’t be easy to get a loan: Typically, you’ll need a minimum credit score of around 740 and a down payment of 10 percent or more, says Carolyn Warren, the author of Homebuyers Beware ($20, amazon.com).
How to hit it: Use a mortgage calculator to estimate your costs (try the one at Bankrate.com). If you’re just over the 28 percent mark, shrink your monthly costs by making a larger down payment and signing up for a high-deductible home owner’s policy, which could reduce your premiums by 25 percent. You could also lower your mortgage interest rate by paying “points” to a lender up front. (A point is 1 percent of the total loan.) You’ll pay heftier closing costs, but your monthly outlay will be smaller.