How Much House Can You Afford?
Before you begin shopping around for home, you need to know what your budget is. To get an idea of how much house you can afford, you’ll want to factor in your household income, monthly debts, available savings for a down payment, and so on. Understanding your financial situation is essential because lenders tend to give out the lowest rates to people with high credit scores, substantial down payments, and low debt. You want to be confident knowing you can afford your monthly mortgage payments, even when surprise costs or emergencies come up. The good news is that interest rates are incredibly low right now, so this year is a great time to buy a house!
Start Crunching Numbers
To determine your budget, start by figuring out how much you (and your partner, if applicable) earn each month. Remember to include all income streams, including rental earnings, investment profits, and so on. Then you’ll want to write down your estimated housing costs and down payment. Make sure to include homeowner’s insurance costs, annual property tax, estimated mortgage interest rate, and the loan term.
Next, you’ll want to estimate your expenses. You’ll want to include all the money you spend each month, including bills, groceries, entertainment, and so on. Make sure you’re accurate with how much you spend because it determines how much you can reasonably afford for a mortgage. You need to be realistic about your monthly income and expenses because you don’t want to end up with a mortgage you can’t pay. It’s best to leave some breathing room for unexpected costs or emergencies that come up.
What is Your Debt-to-Income Ratio?
Your debt-to-income ratio (DTI ratio) is an important metric that the bank uses to calculate the amount of money you can borrow. This ratio compares your monthly income and your monthly debt. If your debt is high relative to your income, you’ll have a higher DTI. This number is significant to lenders because it shows your ability to take on more debt. The higher your DTI, the more difficult it will be to get a mortgage. Many lenders won’t give loans to those with a DTI above 43%. Your monthly expenses such as health insurance, internet, or gym memberships aren’t included in your DTI; it’s only your debt obligations such as rent, car payment, student loans, etc.
We recommend paying off as much of your existing debt as possible to qualify for a mortgage and get a good interest rate. By paying off your other debts, you’ll make room for a mortgage payment and be able to manage your monthly expenses even when adding the new cost of a mortgage.
DTI Formula: (Total Monthly Debt / Gross Monthly Income) X 100 = DTI percentage
Follow the 28/36% Rule
The 28/36% rule states that people should spend no more than 36% of their gross monthly income on total debt and 28% on housing expenses. Again, debt does not include monthly expenses like your Netflix subscription. It’s a tried-and-true home affordability rule that’s agreed upon by many financial advisors. This works as a great starting point to understand if your annual income is enough to cover a mortgage. The last thing you want to do is end up with a 30-year mortgage that’s too expensive for you.
Maximize Your Credit Score
Before you apply for a mortgage, it’s a good idea to get your credit score in order. You can check with one of the three big agencies, Experian, Equifax, or TransUnion (each agency gives you one free copy per year). You’ll want to review your report and check for any incorrect information or factors hurting your score. If you find mistakes, make sure to let the credit agency know as soon as possible. Be prepared to provide proof that the claims are inaccurate.
Maximize Your Down Payment
The bigger your down payment, the less money lenders have to give you, which means the lower your mortgage rates. The less risky you are to the lenders, the better your rates will be. While having a down payment of 20% or more makes you an attractive borrower, you can still get a new home with less cash on hand. If you put down less than 20%, you may have to pay private mortgage insurance (PMI), but this will go away once you’ve built up equity on your home.
But if you don’t have much saved up and you’re ready to buy, don’t be discouraged. You can always refinance later on at a lower rate (as long as the market conditions are favorable). If you plan on refinancing, make sure your credit score and finances are in excellent shape, so you have a good chance at refinancing quickly. The sooner you can refinance, the sooner you can trim down your monthly payments.
So, How Much House Can You Afford?
When figuring out how much house you can afford, know that your budget will be determined partly by your mortgage terms. In addition to calculating your current expenses, you’ll need to get an accurate picture of your loan terms. You do this a couple of ways. You can shop around and get multiple quotes from lenders, go through a mortgage broker, or try our mortgage number calculator!
Our calculator offers insights into how financial institutions view you as a borrower. You’ll learn about your overall strengths and weaknesses in the mortgage environment. Whether you’re a first-time homebuyer or your refinancing, knowing your mortgage number gives you an advantage when looking for a lender. You can skip the complex processes and intricate jargon and get your number immediately. Best of all, it’s completely free!