When shopping for a house, it can be easy to fall in love with the home of your dreams. Be careful, however, that you are aware of how much house you can afford so your dream home isn’t crushed at the lender’s office.
Lenders often talk about qualifying ratios or debt ratios. These numbers can seem a bit mysterious, but a few simple formulas will give you an idea of what size mortgage loan you may be able to afford. Although this is helpful to determine a house budget, never rely on these numbers alone when planning a purchase. Consider obtaining a pre-approval for a loan from your broker or lender, so you know the exact amount you have to work with.
What size mortgage can I afford?
Grab a piece of paper and follow these steps to determine how much you can afford for a conventional mortgage. (Formulas for governmental or FHA mortgages will differ.)
1) Determine your monthly gross monthly income (before taxes).
2) Multiply this amount by 0.28. This is your maximum monthly housing expense. (Lenders allow 28% of monthly gross income for housing expenses. This is also known as the front end ratio.)
3) Now multiply your monthly gross income by 0.36. This is the allowance for your long-term monthly expenses. (Our company is a bit more flexible with that number, and may stretch it to 40 or 45% depending on the strength of the application). Many lenders allow that percentage of monthly income to go toward long term debt that can’t be paid off in 10 months.
4) Add up your monthly long-term obligations including child support, auto loans, credit cards minimum payments, and other payments that can’t be paid off in 10 months.
5) Subtract the total of those obligations from your long-term monthly expenses in step 3. This is your monthly housing expense. (This number is used for the back end ratio, or debt to income ratio, to make sure your total debt does not exceed 36% of your monthly income.)
6) Compare the maximum monthly housing expense from step 2 and your monthly housing expense from step 5 and take the smaller of the two. This is the amount you can afford each month for payment of principal, interest, taxes, and insurance – also called PITI.
The length of the mortgage and interest rates will affect the total dollar amount of the loan, so talking with a lender will give a big picture view of what you can afford. Getting pre-approved for a mortgage will take the guesswork out of deciding a price range for a potential house and reduce stress in the home-buying process.
Give me a call about any possible mortgage scenario or if you need a pre-approval, I will be happy to help.