Myth: As a general rule, you should spend no more than 2.5 times your annual income for your house.
Facts: This measure is not very helpful because even in this depressed housing market, that ratio may be too low for many areas of the country. On the other hand, a number of Americans ignored all the rules and wound up in big trouble with houses they really could not afford.
A good rule of thumb when purchasing a house today is to look at the monthly mortgage costs compared with your gross monthly income, says Lawrence Yun, chief economist for the National Association of Realtors in Washington. Generally, the total cost of the monthly mortgage—escrow, insurance and mortgage payments—should not eat up more than 25 to 30 percent of your gross monthly income. Yun says many of the homeowners who are in trouble today took out adjustable-rate mortgages with low initial rates that are now escalating, “and their monthly housing costs are 40 or 50 percent or more of their monthly incomes.”
Barbara Basler is a senior editor on AARP Bulletin staff.