Mortgage size that fits you

Q: We have been saving to buy a house for several years and are now actively in the market. Our Realtor says that we can qualify for a mortgage payment of up to $2,500 a month and that we should look for a more expensive house.

I've heard the experts say that it's best to obtain the highest mortgage that a lender will allow, but we're just not comfortable with payments that high. We would much prefer to stay in the $2,000 range. We would appreciate your thoughts.

A: I may be in the minority, but I agree with you. I, too, hear financial advisers preach the advantages of carrying the highest possible mortgage, but I do not believe it's wise to make such a general statement.

The advantages of carrying a high mortgage are clear. Interest rates are at historical low levels. Mortgage interest is tax deductible. Therefore, a mortgage is an incredibly cheap way to borrow money.

For example, let's say you purchase a house and obtain a $200,000 mortgage at 7 percent. Since the interest paid is tax deductible, the after-tax rate that you're paying would be significantly lower. Assuming a 28 percent tax bracket, your after-tax interest rate would be less than 5 percent.

The argument for obtaining the maximum mortgage possible assumes you can earn more than 5 percent by investing the money in the marketplace.

It's not bad reasoning, and I will recommend a high mortgage in certain circumstances. But obtaining the maximum mortgage is a little more expensive.

Typically, the highest mortgage you are able to obtain will be 95 percent of the purchase price. In that case, you will have to pay a significant private mortgage insurance (PMI) premium, which is not tax deductible. There are ways of getting around PMI through a first and second trust combination, but recognize that the second trust interest rate will be higher than that for the first trust.

The primary reason I do not necessarily recommend that home buyers obtain the highest possible mortgage is that people have different objectives. They also have different spending habits and different levels of tolerance for risk.

The best thing to do when determining an affordable mortgage payment is to assess your situation: Determine your spending habits. Plan your savings objectives. Try to determine whether your household income is likely to increase or decrease in the future. Take into consideration future expenses such as education.

Once you have assessed the situation, you should have a good grasp of how much you can comfortably afford.

Henry Savage, president of PMC Mortgage in Alexandria, can be reached at 703/719-0099 or by e-mail (pmcmortgage@msn.com).

Article Source: The Washington Times