How Much Mortgage Can I Really Afford?

Determining How Much Payment You Can Afford + Factors that Affect Affordability

By

Matt Lyons

on

Jan 21, 2021

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Buying a home is one of the biggest purchases someone will make in their entire life. Because homebuying is such a big purchase, it’s important to reflect back on your own finances and determine whether or not you should continue moving forward with the process. To start off, you can do some quick calculations that will give you more of an idea of how much you can truly afford based on your income. It’s recommended by financial advisors to not spend any more than 25% to 28% on a mortgage payment, so you can add up your total household income and multiply it by .28.

For example, if your total income each month is $4,000, you can multiply that number by .28 which will get you to $1,120. Besides income, there are a couple other factors that go into deciding how much mortgage you can afford. These factors include:

  • Cash reserves: The amount of money you have available to cover the down payment and closing costs. This can be used from your savings, investment, or another source.
  • Debt: It’s important to look at debts when deciding how much money you have to spend towards the mortgage. Debts can include credit cards, car payments, student loans, and other utilities. 

Importance of Credit Score

Credit score is one of the major components that can influence your chance of qualifying for a mortgage loan. A better credit score will result in lower interest rates, so it’s a good idea to work on improving your score before speaking with a lender about a loan. You can check your credit every year completely free, by contacting one of the national credit reporting agencies that include Experian, Equifax, and TransUnion.

Debt-to-income Ratio

A debt-to-income ratio (DTI) is a comparison of your monthly income to your monthly debt. A lower DTI will improve your chances of qualifying for a mortgage loan, and you should aim for a DTI lower than 43%. You can calculate DTI on your own by dividing your total monthly payments by your total monthly income (before taxes). For example, let’s say your monthly expenses add up to $1,400 a month and your monthly income is $4,000. You would calculate DTI by this calculation:

$1,400/$4,000= 0.35 or 35%

Deciding on a Down Payment

Down payments can be beneficial when trying to spend less money on a home over time. Making a bigger down payment will result in a lower amount needed to be borrowed from a lender. Other benefits could include better mortgage rates, lower monthly payments, and maybe even a shortened loan term. 

Along with some of these benefits, a higher down payment will also build up equity in your home faster. If a down payment on a conventional loan is less than 20%, you will have to pay for PMI (private mortgage insurance). You can expect the yearly cost of PMI to be around 1% of your outstanding loan balance, and the fee will be added to your mortgage payment each month. 

Starting a Budget

Once you have an idea on numbers such as your DTI and how much money you might want to put towards a down payment, a good idea might be to start some sort of a budget. Just because you can afford to spend a certain amount of calculated money each month, doesn’t make it a good idea. When determining a budget, you should keep these monthly expenses in mind:

  • Total monthly household income
  • Estimated monthly mortgage
  • Homeowners insurance
  • Utilities
  • Car payments
  • Student loans
  • Average credit card payments
  • Home maintenance costs. Common home maintenance costs will include new furniture, repairs, services such as lawn care, homeowners association dues, or appliance maintenance.

Another common method of budgeting is the 50/30/20 rule. 50% of your money each month will go towards your needs, 30% of your money will go towards your wants, and 20% of your money could go towards savings or paying off any outstanding debts. A general rule of thumb is that your mortgage and debts should not exceed any more than 36% of your total income. 

Get Prequalified and Preapproved 

If you’re not sure about how much money you can borrow for a loan, a good idea is to get conditionally approved or prequalified for a mortgage. A prequalification will give you an initial estimate into how much you’re able to borrow based on your income, employment, along with bank and credit information. If there’s a house you already have in mind that you want to buy, you should work towards getting preapproved. This is more of an in depth process, but worth it if you’re serious about purchasing your dream home!

Before you contact your lender about a preapproval, you should make sure that you have these financial documents:

  • W-2s for the past two years
  • Pay stubs for the last month
  • Bank statements for at least two months
  • Balances on any retirement or investment accounts
  • Monthly debts. This might include things like car payments, student loans and credit cards
  • Divorce documents including child support and alimony

Once you have done the calculations and gotten more of an idea where you stand financially, you can decide whether or not you’ll be able to purchase a home. If you’re not already in the financial position you thought would be in, take the time to work on a budget, increase your credit score, and ultimately save up enough additional money. Good luck on your home buying endeavors!

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