When it comes to credit, remember what your mother said: Just because you can doesn’t mean you should.
Maybe you’re preapproved for a mortgage loan that’s much bigger than you anticipated. Or you’re offered a new credit card that comes with a big, fat credit limit.
It can be easy to get swept up in the moment and take the offer. But just because you’re granted the credit doesn’t always mean you can afford it.
Whether it’s a credit card, car loan or mortgage loan, the approval for new credit doesn’t take into account your lifestyle, other monthly expenses and what you can actually afford.
So, how do you figure out your limits to avoid biting off more than you can chew?
When it comes to mortgage loans, the rule of thumb is to borrow no more than 2-1/2 times your gross annual income, according to Katie Palmer, a lending consultant at Dupaco’s Manchester branch.
Here are some other factors to consider:
- Look into the future. Especially if you are a younger borrower, look at your five- and 10-year plan. Will you need to purchase a new car soon? Are there wedding bells or children in your future? “If they’re newly married or single, they may not take into account a family down the road,” Palmer says. “Those expenses will have a huge impact on a budget. Will they be able to afford that mortgage payment when they have those future expenses?”
- Revisit your monthly budget. If you haven’t done so, create a monthly budget. You need to know where your money is going to determine whether you can afford another payment obligation. Consider keeping all of your receipts for a two-month period to see how you’re actually spending your money. A Dupaco MoneyMakeover also can help you get a clearer understanding of your total financial picture. “I’m always amazed at how few people write down their budget each month,” Palmer says. “When they start to write it down, they realize how much money is going out the window that they could be using to save for a car or a home.”
- Take a practice run. Make pretend payments before you sign for the real deal. For example: If you think you can afford an extra $500 car payment or $700 house payment, start putting that money aside in a savings account to see if that truly will be affordable, Palmer suggests. If it becomes too difficult to save that extra amount, you know that you need to revisit your budget, consider a smaller loan or hold off on the purchase.
By Emily Kittle