Dreaming of owning a home and wondering how much you can afford? You’re not alone. It’s one of the most important questions you’ll need to answer before you can begin house hunting — and many factors, aside from your income and car payment, come into play.
To determine how much you can afford, here are two important guidelines used by most lenders you’ll need to consider:
- The Housing Expense Ratio = This is the percentage of your gross monthly income that goes toward paying for your housing expenses. Your lender will look at how much your mortgage payment (principal, interest, taxes and mortgage insurance) is compared to your monthly gross income.
- The Debt–to–Income Ratio = The percentage of gross monthly income that goes toward paying for your monthly housing expense, alimony, child support, car payments and other installment debts, and payments on revolving or open–ended accounts such as credit cards. Your combined debt (credit cards, student loans, alimony, child support, car loans and housing expenses) should be less than 50% of monthly gross income at least.
In addition to these key ratios, all of the following will play a role:
- Your income. You can get a very rough estimate of your affordable home price range by multiplying your annual gross income by 2.5 (this, of course, varies depending on current interest rates, your debt and credit history).
- Your credit. Generally speaking, the better your credit, the lower the cost of obtaining credit and the greater your financing options.
- Current mortgage rates. Although mortgage rates are rising, they’re still historically low — below 4 percent — making homeownership affordable for many.
- Your downpayment. Plan to make a downpayment of at least 5 or 10 percent. If you are able to put down 20 percent or more, you avoid having to pay private mortgage insurance (PMI), reducing your monthly mortgage payment.
- The type of home. The type of home you buy influences the mortgage rate for your loan. For example, rates for condos are typically higher and you’ll also have to budget for monthly condo fees.
- Fees and closing costs. Remember to factor in the expenses and fees you will incur for a home appraisal, a home inspection, and other professional services required to buy a home.