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Chapter 8: Problem 20

Describe how to determine what you can afford for your monthly mortgage payment.

Short Answer

Expert verified
The affordability of a monthly mortgage payment is determined by calculating the monthly disposable income (which is the total income minus all non-housing expenses) and using a mortgage calculator. By adjusting the loan amount so that the calculated mortgage payment equals the disposable income, one can determine the maximum affordable monthly mortgage payment.

Step by step solution

01

Determine the Monthly Income

This is the first step and it involves adding up all sources of income that the individual receives in a month. This could be salaries, business profits, rents, investments, etc.
02

Determine the Monthly Expenses

The second step involves adding up all monthly expenses excluding housing cost. This would include food, transport, insurance, utilities, personal care, entertainment, etc.
03

Calculate the leftover income

Subtract the total monthly expenses from the total monthly income. This will give the monthly disposable income that could potentially be used to service the mortgage.
04

Determine the interest rate on the mortgage

Obtain the prevailing interest rate on mortgages from the relevant financial institution. This is important because it affects the amount that can be borrowed and hence the affordability of the mortgage.
05

Calculate the affordable monthly mortgage payment

After knowing the monthly disposable income and the interest rate, you can use a mortgage calculator. The calculator requires the loan amount, loan term, and the interest rate. The loan amount should be adjusted until the calculated monthly payment equals your disposable income.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Monthly Income Calculation
Understanding your monthly income is crucial when you're planning to take on a mortgage. To calculate it, aggregate all your earnings such as wages, business income, rents, and investment returns. It's not just about how much you make annually, but rather what your net income looks like on a monthly basis after taxes are taken out. For those with variable incomes, it may be helpful to find an average by looking at the past six months to a year. Consider also any seasonal variations that may affect your income to ensure you're not overestimating your financial capabilities.
Monthly Expenses Tracking
Keeping track of your monthly outgoings provides clarity on how much you can afford for a mortgage. To start, list all non-housing related expenses like groceries, transportation, insurance premiums, utility bills, and leisure activities. This step is not just about knowing your total expenses, but also about recognizing spending patterns and identifying areas where you could potentially cut back. Budgeting apps or simple spreadsheets can be useful tools in monitoring monthly expenses and ensuring that your calculations are as accurate as possible.
Disposable Income
Disposable income is the amount of money you have left after all monthly expenses have been paid. It's essential to be realistic about your living costs before allocating what's left to a mortgage payment. A common mistake is to overestimate this figure, leading to financial strain. Be sure to incorporate a buffer into your calculations for unexpected expenses. Ultimately, knowing your disposable income helps in making an informed decision about how much you can comfortably spend on a mortgage each month.
Mortgage Interest Rate
The mortgage interest rate significantly impacts the affordability of a home loan. It dictates how much you'll ultimately pay for borrowing money. The lower the rate, the less interest you'll pay over the life of the mortgage, making the loan more affordable. It's vital to shop around and compare rates from different lenders since even a slight difference can have a substantial effect on your monthly payment and the total cost of the loan. Keep in mind that your credit score, down payment size, and loan term can all influence the interest rate you're offered.
Mortgage Calculator Usage
A mortgage calculator is a helpful tool in determining what you can afford. By inputting the loan amount, loan term, and interest rate, you can estimate your monthly mortgage payment. Adjust the loan amount in the calculator to match your disposable income. Remember to consider additional costs like property taxes, home insurance, and potential homeowners' association fees when using the calculator. These tools often provide an amortization schedule, which can help you see how each payment affects the principal and interest over the term of the loan.

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Most popular questions from this chapter

In Exercises 11-18, a. Determine the periodic deposit. Round up to the nearest dollar. b. How much of the financial goal comes from deposits and how much comes from interest? $$ \begin{array}{|l|l|l|l|} \hline \text { Periodic Deposit } & \text { Rate } & \text { Time } & \text { Financial Goal } \\ \hline \$ \text { ? at the end of each year } & 6 \% \text { compounded annually } & 18 \text { years } & \$ 140,000 \\ \hline \end{array} $$

If an investor sees that the return from dividends for a stock is lower than the return for a no-risk bank account, should the stock be sold and the money placed in the bank account? Explain your answer.

In Exercises 11-14, use the formula $$ A=\frac{P\left[\left(1+\frac{r}{n}\right)^{n t}-1\right]}{\left(\frac{r}{n}\right)} $$ Round all computations to the nearest dollar. Suppose that you drive 40,000 miles per year and gas averages \(\$ 4\) per gallon. a. What will you save in annual fuel expenses by owning a hybrid car averaging 40 miles per gallon rather than an SUV averaging 16 miles per gallon? b. If you deposit your monthly fuel savings at the end of each month into an annuity that pays \(5.2 \%\) compounded monthly, how much will you have saved at the end of six years?

a. Suppose that between the ages of 22 and 40 , you contribute \(\$ 3000\) per year to a \(401(\mathrm{k})\) and your employer contributes \(\$ 1500\) per year on your behalf. The interest rate is \(8.3 \%\) compounded annually. What is the value of the \(401(\mathrm{k})\), rounded to the nearest dollar, after 18 years? b. Suppose that after 18 years of working for this firm, you move on to a new job. However, you keep your accumulated retirement funds in the \(401(\mathrm{k})\). How much money, to the nearest dollar, will you have in the plan when you reach age \(65 ?\) c. What is the difference between the amount of money you will have accumulated in the \(401(\mathrm{k})\) and the amount you contributed to the plan?

Make Sense? In Exercises 47-53, determine whether each statement makes sense or does not make sense, and explain your reasoning. By putting \(\$ 10\) at the end of each month into an annuity that pays \(3.5 \%\) compounded monthly, I'll be able to retire comfortably in just 30 years.
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