Home ownership should make you feel safe and secure, and that includes financially. One of the most important things that buyers can do is to be sure they can afford the home that they want. One of the best ways to do this is by calculating how much of a mortgage you can safely fit into your budget.
So how do you calculate that number? It’s a combination of your circumstances today, plus anticipated events down the way. For example: you will obviously want to consider how much you currently make at your job, but you should also give some thought to any major events you might be anticipating down the line and how those might have an influence on your budget. Are you planning to get married, or start your own company, or have another child, or even return to school? Anything along these lines will affect your budget and ability to comfortably swing your mortgage.
The best source of information for how much you can afford on a mortgage will always come from a mortgage lender. They will take into account the entire picture of your life, factoring in such things as income to debt ratio, employment type/status, employment history, credit score, and more. They will be able to compile all of the data and run the numbers to accurately help you determine what you can afford. It may vary from lender to lender, but it’s good to shop around anyway when looking for a mortgage so don’t be afraid to get a few different opinions.
Here are some helpful tips to help you get a ballpark idea of what you can afford and prepare you for your meeting with your lender.
1.) Create A Budget
I know, I know…creating a budget…yuck! But it will be a HUGE help you to figure out how much you can afford to spend on a home. Prepare a family budget that tallies your ongoing monthly bills for everything — credit cards, car and student loans, lunch at work, day care, date night, vacations, and savings. See what’s left over to spend on home ownership costs, like your mortgage, property taxes, insurance, maintenance, utilities, and community association fees, if applicable.
2.) Don’t Forget the Down Payment
How much money do you have for a down payment? The higher your down payment, the lower your monthly payments will be. If you put down at least 20% of the home’s cost, you may not have to get private mortgage insurance (PMI), which protects the lender if you default (and can cost hundreds each month). No PMI leaves more money for your mortgage payment. The lower your down payment, the higher the loan amount you’ll need to qualify for, and the higher your monthly mortgage payment. Also, the type of loan you choose will affect how much you will be required to put down, so keep that in mind and be sure to ask your lender to walk you through the different loan types and which one might be best for you.
3.) It’s All About the Debt
One of the first things a lender is going to want to know is: how much debt do you have? They will begin by looking at your debt to income ratio (DTI), which is calculated by dividing your monthly debts by your pre-tax (gross) income. Most lenders look for a DTI ratio of 36% or better, though this can vary depending upon the lender and the type of loan.
4.) Use Your Rent as a Mortgage Guide
A good benchmark for those who are renting is to use their monthly rental payment as a point of comparison. If you’re having a hard time making your current rent payment each month, you’re going to want to shoot for a monthly mortgage payment that is at or below what you’re currently paying. Homeowners incur additional costs that renters do not, such as taxes and homeowner’s insurance (which are often escrowed into a monthly mortgage payment), additional utilities, homeowner’s association dues, and repairs. Make sure you take all of these items into account when considering how much you might be able to pay. The last thing you want to do is end up doing is stretching yourself too thin financially.
Final Thoughts
Be sure to check in with your accountant to see how you normally structure your deductions on your taxes (i.e. do you itemize deductions or take a standard deduction?). If you take the standard deduction, you can’t also deduct mortgage interest payments.
Taking a mortgage out on a home is a big step, and you want to be sure you’ve got all of your ducks in a row before pulling the trigger. If you don’t already have a lender check with your real estate agent, as they should be able to point you in the direction of a fantastic lender who will take great care of you!
