HOW MUCH HOUSE CAN I AFFORD?
One of the biggest questions you will have when it comes to starting your home buying process is ‘how much house can I afford’. Well, this and ‘will I qualify for a mortgage’? Without knowing the answer to this questions, it’s hard to know where to start looking.
To know for sure what you will qualify for, you must talk to a lender. A lender will get some detailed information from you, and make a determination of how much you will be approved for, in addition to educating you on what kind of loan is right for you.
I understand that as a potential first time homebuyer you may just want to gather a bit of information. You might not be ready to talk to a lender…talking to a lender almost feels like you are committing yourself to the process, so it’s a bit overwhelming just starting out.
If you are just wanting to get a general idea of what you might qualify for, here are some basic guidelines to help you figure this out.
In general, lenders don’t want your mortgage payments to go over 35%-40% of your monthly gross income. So if you have a monthly gross income of $3500, your mortgage payments shouldn’t exceed $1225 – $1400.
You also need to consider is that your TOTAL monthly debts (including your mortgage) shouldn’t exceed 45%-50%. In some cases, some lenders will allow up to 55% debt-to-income.
So how does this apply to the real world?First, you need to figure out your debt-to-income ratio:
To do this you need to add up your monthly debt payments. Your monthly debt is defined as anything that is considered a loan of some sort. For example, the monthly debt that is taken into consideration would be your car loan, student loans, credit cards, alimony, child support, any type of long term payment terms that you have. What is NOT included in your long term debt is items like your current rent, utilities, gym memberships, wine of the month clubs, or any type of membership program.
Monthly debt divide by your Monthly Gross Income (your income before deductions and taxes) = Debt-To-Income Ratio
For Example: Let’s say that you have a car payment of $300/mo, student loan payments of $300/mo and a minimum credit card payment of $50/mo . That is a total of $700/mo in monthly debt payments. Now, let’s say that you make $3500/mo gross income (before taxes and all deductions).
$700 (monthly long term debt payments) / $3500 (monthly gross income) = 0.20 or 20%
In the example above the current debt-to-income is 20%…pretty good.
Estimating what you would qualify for:
Let’s take two different examples to showcase how the same situation can have different results depending on the type of loan you choose/ qualify for. This equation will be:
Step 1: Gross monthly income * the maximum debt-to-income ratio = Total dollar amount of debt that a mortgage lender would qualify you for
Step 2: Take your monthly long term debt payments – Total dollar amount of debt you would be allowed = The maximum amount your mortgage payment could be
Here are two examples (We’ll use the same numbers from our example above.):
In this example we’ll say that we qualify for and are doing a conventional type loan that allows us up to 50% TOTAL debt-to-income ratio.
Step 1: $3500 (total gross income) *.50 = $1,750 (This total amount has to include our mortgage payment AND our current monthly debt payments).
Step 2: $700 (currently monthly long term debt) – $1,750 (the maximum amount of long term debt that we are approved for) = $1,050
So In the example above we would qualify for a mortgage payment up to $1,050.
For this example, let’s say that we are doing a loan that allows us to have a maximum debt-to-income ratio of 43%…using the same numbers above:
Step #1: $3500 * .43 = $1,505
Step #2: $700 – $1,505 = $805
So in the example above we would qualify for a mortgage payment up to $805.
You need to know everything that is included in a mortgage payment:
When we talk about a mortgage payment, this includes the following costs: your principle payment, interest, homeowners insurance, property taxes, mortgage insurance (required if you don’t put 20% down), and any monthly associations fees, if applicable (such as monthly condo fees). All of those items make up your monthly mortgage payment.
So what price range should I be looking in?:
Perfect! We know how much we can spend on a mortgage. But how much does that equate into knowing what price range to look in for a house? Great question, and this is where a real estate agent will come in handy. A real estate agent will help you marry your needs and wants with how much you can afford. Talking to a real estate agent can help you determine an area to buy that fits within your budget.
The things that can greatly impact your mortgage payment are property taxes and homeowners insurance.
Another rule of thumb that is often used to guesstimate, without having to do a bunch of calculations, what you might qualify for is two to 2.5 times your salary/ yearly income. It might be reasonable to say that if you make $42,000/yr that you could qualify for a $84,000 – $105,000 mortgage.
With all that said…
…there are so many factors that play into qualifying for a mortgage. The least of which is your credit score. However, if you are not ready to really move forward with the home buying process then here is my advice to feel out the process:
- Start going out to open houses in different areas to see how much house you can get for your anticipated price range. Then narrow down the areas that you really want to be in. Don’t be intimidated. You don’t ever really have to sign in or give up your information…just say you are working with an agent. On the other hand open houses are also a great way to meet a few agents, have a quick conversation and see if there is someone you connect with. (Remember, I’m always available too!)
- At anytime during this process you can contact a real estate agent just to have that initial conversation. They may be able to provide some valuable insight!
Some Parting Thoughts:
- While it may seem fun to go out to open houses, really understanding what you can afford and being honest with yourself is important. The worst part about just assuming that you will be approved for a certain amount is that you start to look for houses in a that price point only to be approved for a lower amount – this is a total bummer. It’s heartbreaking to fall in love with a house only to find out that you can’t afford it.
- Talk to a lender, any lender. All you need to do is get the process started. Just because you get pre-approved with one lender does not mean that you are stuck with them. Feel free to call around to different lenders and ask about any special programs that they offer. Don’t forget to talk to your real estate agent, they will usually have at least a few contacts to reach out to.
- Think about it, right now you are paying rent. You get nothing back from renting, you gain no equity, you don’t accumulate wealth…you just simply help your landlord accumulate wealth, and I’m sure he appreciates it very much! If you put that money towards a mortgage you are building equity in a home, you potentially have tax advantages for owning a home and you have the pride of ownership. No longer do you have to deal with that deadbeat landlord and you get to make your home all your own.
- There are times when buying doesn’t make sense…and maybe it’s better to hold off for a bit. Just don’t be afraid to reach out to the professionals to help you determine what might be right for you!
What to just chat about the home buying process? Have real estate question, please contact me anytime!