There's no question that we're borrowing more, and there's also no question that credit is one of the best things about living in the modern world. So, like Goldilocks, you want to borrow just the right amount and nothing more.
So how much debt is the right amount?
The criteria that mortgage lenders use to decide who can get a loan are an important guideline. You can usually get a fixed-rate, 30-year mortgage if your mortgage principal and interest, property taxes, and property insurance don't cost more than 28 percent of your gross monthly income (PITI). Also, regular monthly costs like PITI, car payments, credit card debt, school costs, etc. can take up to 36% of your gross monthly income. Also, other loan programmes like FHA, VA, and adjustable-rate financing often let you borrow more money because they have less strict requirements for who can get a loan.
But no matter what kind of mortgage financing you think about, the real question should not be how much you can borrow, but how much you can comfortably borrow. In other words, being smart about money is important.
"Financial sanity" is an expression that doesn't really mean anything. What makes sense for the Webbers may not make sense for the Johnsons. We all make different amounts of money and have different interests, preferences, and costs. With this information, you might ask, "What makes the most financial sense for me?"
The answer looks like this: If you live from paycheck to paycheck, if your monthly costs are a burden, if your savings are small or non-existent, and if you don't have health insurance, it's time to rethink your debt burdens.
The richest person I've ever met was someone who started with nothing and gave jobs to more than 50,000 people "Saving is the key to being financially stable, and saving that first $10,000 is the hardest thing you'll ever have to do. From there on, it's easy."
In other words, it's not impossible to fail the financial sanity test even if you make a lot of money. Every bankruptcy court has rooms full of people who once made a lot of money and had a lot of debts. One day, the math didn't work, and the big houses and cars had to go.
So how do you get started saving?
Literally, the first thing to do is to open a savings account. The nice people who give you checking accounts and credit cards will also be happy to hold your savings.
Step two is to look for every penny and dime you can find.
The economics of saving is like gravity: when small things come together in one place, they make a big difference. Here's an example: Imagine that you usually spend $2.50 a day on small things like coffee, candy, or whatever. Instead, you put the money in an account that gives you 6% interest on it. What happened? You'll have almost $77,000 in your account after 30 years.
There are lots of ways to save money, but let me suggest one that makes sense. Look at your debts. Choose the one with the smallest balance, like a small card with a $25 monthly payment. Save money and pay it back. Then find the next debt that you still owe that has the smallest balance. You now have an extra $25 a month that can be put toward the second bill. Put money aside and pay off the second loan. With the second one, you might be able to save $50 a month. After you pay off the second debt, you'll have an extra $75 a month to put toward the third debt.
There are other steps to take during this process. Take your lunch to work. Own one car (hard in some areas, but not impossible). Collect your change at the end of the day and deposit rolls of coins every month or so. Eat out, but not all the time. Don't use credit cards. Pay your bills on time and in full to avoid late fees and keep your credit score high.
As this process goes on, you'll see a number of interesting things happen.
First, it gets easier to borrow money for real estate as debts go down and qualification scores go up.
Second, when you have better credit, your interest rates go down, which can save you a lot of money. If you have good credit and save 0.5 percent on a $300,000 mortgage, you'll save nearly $1,500 in the first year of the loan.
Third, "savings" are not taxed.
If you owe $1,000 each month on credit cards and car payments, you can't use that money until after taxes are paid. Depending on your tax bracket and where you live, you might have to make $1,300 or $1,400 to get that $1,000 in cash. If you pay off your bills and don't have to pay that $1,000 a month, Uncle Sam doesn't raise your taxes, and you get a huge raise.
When you talk to lenders about how much you can borrow, keep in mind that if you have good credit, you can probably get as much as you need or even more. But you should also think about how important it is for your own financial health to save. If you can buy a home, pay your regular bills, and save 5 or 10 percent of your gross monthly income, the chances are high that borrowing won't be too much of a burden for you now or in the future.
