How Much Can I Afford to Buy a House?
Buying a home of your own is still the American Dream, but knowing when and how to take
the plunge can be difficult. It is no secret that home ownership rates have been steadily
rising over the past several years, aided by both historically low interest rates and
unconventional mortgages which allow buyers to put down as little as 3% of the value of
the home.
When deciding how much home you can afford, it is a good idea to consult with a mortgage
lender before you begin your search for a home. Getting pre-qualified will make your home
search a lot easier by allowing you to focus only on those properties you can actually afford
to buy. Two of the most important factors lenders use in determining how much you can borrow on a
home mortgage loan are the debt-to-income ratio and mortgage-to-income ratio.
Debt-to-Income ratio
The debt-to-income ratio is the percentage of your monthly income that is committed to
repayment of outstanding debt such as credit card debt, car loan, student loans and etc.
Suppose your gross income per month is $5,000 and you owe $1,000 in debt
per month, then, your debt-to-income ratio is 20%. Typically, the mortgage
lender will balk if this ratio is more than 40%. Obviously the
lower this figure, the better your finances will look to prospective lenders and the more
you will be able to borrow on your home mortgage loan. If you think your debt to income ratio
is too high, it may be a good idea to retire some
of your outstanding debt before attempting to qualify for a mortgage. If you have outstanding
credit card loans or a personal loan, paying them off will increase your credit score and
allow you to borrow more to buy a home. For the same reason, it is a good idea to not take
on more debt when you are attempting to qualify for a mortgage.
Mortgage-to-Income ratio
Your monthly income will also be a major factor as your bank or mortgage company determines
how much they can lend you. In general, lenders will look at the mortgage-to-income ratio
of no more than 30%. Using the example above, a lender can expect that you can reasonably
pay as much as $1,500 per month in mortgage payments based on your gross income of
$5,000 per month. In addition, the mortgage lender will want to see a good steady work history
and good visibility of earnings. Be sure to provide proof of all your sources of income.
Things like pay stubs, cancelled checks, etc. are very important when applying for a mortgage.
It is important for the potential home buyer to realistically assess how much he or she
can afford in monthly mortgage payments. Be sure to include such home related expenses as
homeowners' insurance, real estate taxes and money for home repairs in your monthly payment
estimates. It is best to not over extend when determining how much home you can afford.
In other words, never buy the most expensive home you can afford.
Likewise, you should think twice before borrowing as much as you qualify. You are in a
'risky' position if you have a maximum mortgage payments, as unexpected events such as
unemployment or sickness could happen. Therefore, it is always a good idea to make as high
a down payment as you possibly can. Making a 20% down payment on the home you buy will not
only lower your monthly mortgage payments,
but it will also mean you are not subject to costly private mortgage insurance. Private
mortgage insurance is designed to protect the lender if you default on the loan. A higher
down payment means you will not need to pay the high cost of this insurance.
Once you have determined how much home you can afford, be sure to shop around for the
best home for your needs. Be sure you consider the nature of the neighborhood in which
the home is located and its prospects for growth. Remember that your home is not simply
a place to live. It is an investment as well. A good home in a good location can be a
great investment as well as your primary residence. Getting pre-qualified
will help you to concentrate only on homes that you can afford to buy.
Start your pre-qualification process now.
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