Before you start falling in love with a home, it is important to understand the difference between a mortgage you can afford versus the mortgage that is right for your financial situation. Just because you can afford something doesn’t mean you should buy it!
There are multiple factors that make up how much house you can afford. Lenders will be evaluating:
Your household income is the total amount of money earned by every working member of a single household. This includes salaries, wages, retirement accounts, investment returns, and welfare payments.
Monthly debts are payments you make back to a lender or creditor for money you have borrowed. Some examples of monthly debts are credit card payments, rent, student loans, auto loans, alimony, and child support.
Tip: Lenders will use your debit-to-income ratio to determine your ability to make payments and repay the money you have borrowed. As a general guideline, lenders prefer a debt-to-income ratio lower than 36%, with no more than 28% of that debt being your mortgage. The lower your debt-to-income ratio the better. Below is the formula for debt-to-income ratio (DTI).
DTI = Total of Monthly Debt Payments / Gross Monthly Income
Available Savings for Down Payment and Closing Costs
Most people say that you need to put 20% down to buy a home. While that is a good percentage to shoot for, most of the time it is not realistic. A majority of the time, home buyers are only able to put 6%-12% down. The right amount will depend on your financial situation and the programs you might qualify for. A 20% down payment is a good goal to shoot for though, because it will eliminate the need for mortgage insurance.
Your Credit Profile
The amount of debt you owe, and your credit score, influence the way a lender views you as a borrower. These factors will aid in determining how much money you can borrow and the interest rate you will receive.
Other factors to keep in mind:
- How much are YOU comfortable with?
When deciding how much money you are comfortable spending for a mortgage payment each month, there are rules of thumb that can help you decide. The most common is the 30% rule. This rule states that you should not spend more than 30% of your income on housing costs each month. Just because this rule of thumb exists, doesn’t necessarily mean it is the best for you. Take a realistic look at your finances and what 30% of your income represents. If you feel like this is a stretch in order to make monthly payments, the 30% rule isn’t best for you. Maybe spending 20% of your income on housing costs would make more sense and reduce potential stress
- Other housing costs
Remember, buying a home isn’t limited to your monthly payment. There are other costs associated with buying a home, including:
- Property taxes
- Homeowners insurance
- Repair and maintenance costs
- Utility costs
Many people forget to include the extra costs that come with home ownership when deciding how much they can afford.
Remember financial goals
Keep in mind the financial goals you are working towards. Saving for a vacation? Looking to grow your retirement funds? Don’t let the excitement of a new home make you lose sight of the long-term financial goals you have set for yourself.
Buying a home is a big commitment. You have to be prepared to repay the loan over an extended period of time, so you want to make sure you can afford your payments long term. Before making the big decision, sit down, look at your finances, and evaluate where you want to be. Take the time to test drive your possible new mortgage payment for a few months to make sure it fits your budget. Don’t forget about your other expenses and financial goals, like retirement, that you are working towards. The last thing you want is to become house poor. Buying a house that you can actually afford will allow you to be a lot less stressed in the long run.
If you're ready to start seriously looking at your options for home-ownership, do your research first. ALLIANCE offers free financial education for everyone, including online coaches to help make big decisions easier. Check out the Banzai "What Mortgage Can I Afford Coach" by clicking HERE.