How Much House Can I Afford Based on My Income?
A home purchase is a major financial commitment and many buyers find themselves caught up in the process; forgetting to be mindful of their budget. Searching only for homes that fit your budget will prevent you from being let down when a home you’re interested in just isn’t attainable. The amount of home that you can afford depends directly on what you are able to qualify for with a lender.
The 29/41 Rule
When your application is being reviewed, lenders will calculate your DTI or debt-to-income ratio. Your DTI is the amount of debt you have to pay down each month divided by your monthly gross income. This is how lenders determine how much more debt you can comfortably take on. The 29 is used to represent your housing expense ratio. The cost of your mortgage includes interest, principle, real estate taxes, home insurance, HOA fees (in some cases), mortgage insurance (when applicable) and should not exceed 29% of your gross monthly income. The 41 represents your total DTI. Your debt (student loans, credit cards, etc.) should not exceed 41% of your gross monthly income. In order to calculate your DTI, simply divide your monthly debt amount by your gross monthly income. The percentage should be 41% or less. It is good to know this information before you waste your time applying for a mortgage loan you are not very likely to be approved for.
Terms & Interest Rates
A mortgage term is defined as the amount of years you have to pay back your mortgage loan. Your monthly payment amount depends upon the term you select. Mortgage terms are typically anywhere from 15-30 years. The longer your term, the less you will have to pay each month, although some buyers prefer higher payments so they can pay off their debt faster. Interest rates should also be considered when weighing a home purchase. Interest rates are decided by the lender and can either be fixed or adjustable. Fixed interest rates will remain the same throughout the duration of your loan while adjustable rates can change at any time. Credit scores are a major determining factor in this area. If your credit isn’t very good, you will likely have a higher rate, and therefore a higher monthly payment. Interest rates have an immense impact on a buyer’s ability to afford a home and can be the difference between closing on a home you love and having to continue your search.
What Do You Have in the Reserves?
How much do you have in your savings right now, and how long could you sustain a mortgage based solely on that? If you lose your job or cannot work for some other reason, you want to be prepared. Set aside enough to where you could make your payments for two months if you were to become unemployed. Lenders will need to have a look into your finances, and they will be trying to ensure that purchasing a home won’t completely drain you financially. This is why you should try to set aside as much as you possibly can so that after all buying costs are covered, you will still have your mortgage cushion.
What About the Down Payment?
It is a common misconception that buyers need to put down 20% in order to purchase a home. However, upon qualification for an FHA loan for example, you can put as little as 3.5% down as long as your credit score is 580 or above. This is a great option for buyers who need to move urgently and don’t have as much wiggle room with their cash. It is worth mentioning that a higher down payment on a conventional loan will lower the interest rate; the more you offer up front, the less of a financial risk it is for the lender. Rates are decided by lenders based on your FICO Score and how much you put down upfront, so if your score is not very high and you can afford to put down 20% or more, this will work in your favor. Not to mention, putting down more than 20% will eliminate the need for you to purchase mortgage insurance, which would be an additional monthly cost added onto your already increased expenses. These are all very important factors to be considered when calculating what you can afford. Lenders look at a variety of factors to decide whether or not a borrower is worth taking a financial risk on. This is why it is a good idea to not stray outside of your budget, lenders want to see that you are able to take on the debt of a mortgage and still be financially stable.