The fourth step to borrowing SMART is: AMOUNT
This refers to how much SHOULD you borrow. As I am sure you know, there is a big difference in how much you CAN borrow versus how much you SHOULD borrow. If there was one problem to point at that was a major factor in leading to the Great Recession, it was this. Banks and lenders spent too much time telling people what they qualified for (eligibility) and little time helping them determine how much they could safely borrow given all of your other financial goals (suitability).
While I am on my soapbox, keep in mind that loan applications, and the typical qualifying process (Step 3 in Borrowing SMART) for most lenders, do not ask how much you pay in groceries each month, or child care, or on vacations. They do not factor in how much you should be saving each month for your future, or your ability to pay extra on that consumer debt you are desperately trying to eliminate (How to Prioritize Your Cash Flow). Most lenders and mortgage professionals (unfortunately) are not trained to consult with you on saving money for the holidays so you aren’t financing Christmas or still owing money (and paying interest) on a vacation you took last year!
When deciding how much to borrow, all of these questions should be discussed and factored in. It is also extremely helpful to understand some foundational money concepts, such as the true cost of borrowing, opportunity cost, the three-legged stool (safety, liquidity, and rate of return).
Imagine you just sold your house and have $1000,000 of net proceeds available for your next purchased. Most clients come in believing they should put all $100,000 toward the new house. Perhaps some of them should, but when diving in, many should not. When looking at the overall financial picture for many of my clients over he years, this decision of how much to and how much money to put down, really comes down to understanding the highest and best use of your cash.
Would it be better to use a chunk of that $100,000 to pay off consumer debt? How about jump starting little Johnny’s college savings?
Keep in mind, from a financial planning perspective, the purpose of your down payment is to achieve a monthly payment goal that you are comfortable with and is safely affordable. Anything beyond that, from a logical standpoint, is not always the highest and best use of your money. As always, I refer back to our 4-step cash flow priority model (How to Prioritize Your Cash Flow) when helping each individual client determine what is best for them and their future. What is right for you, may not be right for your friend or relative.
The real advice here is, take the time to create a plan. Find someone who understands that it’s not as simple as going online somewhere, getting pre-qualified, and going out and making an offer. That’s a severe lack of fiscal literacy in my opinion. And the best mortgage professionals in the industry will gladly help you through this important decision-making process. I know my Mortgage Advisors do.