Leave a cushion for uncertainty in your mortgage calculations

December 20th, 2012

Two seemingly contradictory pieces of news came out in mid-December. First, the Bureau of Labor Statistics announced that the Consumer Price Index declined by 0.3 percent in November. Then, less than a week later, mortgage finance company Freddie Mac announced that 30-year mortgage rates had just risen by 5 basis points, to 3.37 percent.

Deflation usually signals lower interest rates

Normally deflation, as indicated by the drop in the Consumer Price Index, would be conducive to lower interest rates. However, since many economic indicators play all at once, short-term signals are often erratic. This type of uncertainty is characteristic of mortgage rates and financial planning in general. You can use a mortgage calculator to make a very precise measure of your payments under a given set of conditions, but the accuracy of those conditions is always subject to some doubt.

For example, when using a mortgage payment calculator to determine how much you can afford to pay for a house, you should be sure to leave room in your budget as a cushion against the following uncertainties:

  1. Mortgage rates. Not only do mortgage rates vary from week to week, but there are also differences from region to region and from lender to lender. And mortgage rates, of course, also depend on the borrower's individual circumstances. Until you have a signed loan agreement, don't count too heavily on a particular mortgage rate.
  2. Mortgage interest deduction. Negotiations to avoid the fiscal cliff have introduced many possibilities, and one involves something Americans have come to take for granted -- the tax deductible status of mortgage interest. Just the fact that eliminating this deduction has been put on the table is a reminder that nothing is untouchable, especially over a time period so long as a 30-year mortgage term. So, when budgeting for your mortgage, you would do well to aim for a payment you could afford even if the loan interest were not deductible.
  3. Payroll taxes. The temporary reduction of payroll taxes may not be extended as part of a fiscal cliff deal, so make sure you are planning on payments you can make with your take-home pay after this tax goes back up.

Leaving a cushion for uncertainty in your mortgage calculations is a prudent idea, because uncertainty is the one variable you can always count on.

Posted By :

Richard Barrington has earned the CFA designation and is a 20-year veteran of the financial industry, including having previously served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc. Richard has written extensively on investment and personal finance topics.

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