How much home can you afford?
Before you get carried away scrolling for your dream home online, you need an idea of what is in your price range. Here are few pointers to help you determine how much home you can afford.
If you are already a homeowner, you can use a tool like LowerMyBills refinance calculator. You might be able to lower your monthly mortgage payments with a refinance.
There are plenty of online tools like FreddieMac’s home affordability calculator. Most of them will take the following factors into account.
Figure out your debt-to-income ratio
To calculate your debt-to-income ratio (DTI), divide your monthly debt payments by your monthly gross income. Your debt payments include things like student loans, car payments, or credit card debt. And use the income number you earn before taxes.
A great rule of thumb while crunching numbers is the 28/36 rule.
That first number is the “front-end ratio.” Essentially, you should spend no more than 28 percent of your pre-taxed income on housing. That number includes all housing-related costs like insurance or property taxes.
The 36 is the “back-end ratio.” You should spend no more than 36 percent of your income on all of your debts. Lenders are usually willing to give loans to people with a DTI ratio at or below 36 percent.
Don’t forget the extra costs of owning a home
If you’re a first-time home buyer, you need to remember you can’t just use the listing price to budget. After signing all the paperwork, you will have paid a lot of other fees. Closing costs alone can cost up to five percent of the total home price.
In addition to the actual cost of the mortgage, there are tons of extras you’ll encounter when buying a home. You don’t want to move into a home and realize come spring that you didn’t factor in a lawnmower and have no way to cut the grass.
By staying well within your budget, you’ll ensure that these surprise extra expenses don’t wreck your finances.
Know what your overall financial situation is
While figuring out what it is a feasible budget, you need to know what will work with your budget. Sometimes waiting a few more years to buy a house will allow you to come up with a bigger down payment. With a smaller down payment, you often must pay for mortgage insurance.
Being able to pay even just a little bit more initially will reduce the amount you owe over the life of the loan. You can also pay less overall if you have a better credit score. With a high score, you’re more likely to be given a lower interest rate.
Lenders also want to see what your work history looks like. Having a steady income over the past two years will make them more likely to approve your loan request.
Ultimately, you are responsible for knowing how much you can afford. While lenders will approve your loan requests based on your existing debts and income, they won’t factor in your living expenses for you.
It’s important to sit down and know how much you’re putting aside for things like retirement, college funds, or travel. That way you know you can afford the lifestyle you want.