How Much House can you Really Afford?
One of the biggest questions that many prospective homebuyers,
especially first-time homebuyers, have is how much house they can
afford. It is only natural to be concerned that you might be
getting in over your head with more of a mortgage than you can actually
afford when you begin to consider the purchase of a home.
If you are thinking of buying a home in the near future, it can
certainly be helpful to have a solid idea of how much you can afford to
spend on the purchase of your next home. There are two different
perspectives that should be taken into consideration in regards to how
much you can afford to spend when buying a home.
First, you need to think of the mortgage amount that you will be able to
qualify for. This can depend upon a variety of factors, including your
income as well as your credit history, existing debts and your credit
score. There are many different guidelines that can be used to determine
how much you should spend on your home purchase. One of those guidelines
calls for spending no more than three times your current income. This is
a basic guideline that has been used for many years and it is quite
simple to calculate. Take your gross income and multiply it by three to
determine the maximum amount of home that you should purchase. For
example, if you make $100,000 per year; the maximum amount you should
spend would be $300,000. Of course, different factors can influence this
guideline including the interest rate you are able to qualify for. If
you are only able to qualify for a higher interest rate for some reason,
such as poor credit, then this will naturally affect the amount of your
monthly mortgage payment and the amount that you are able to spend on
the purchase of your future home.
Another common guideline is the 28% rule. Many banks use this rule, a
housing expense to income ratio, to determine how much you are able to
qualify for. This guideline is based on projected housing expenses,
including mortgage, principal, taxes and insurance, divided by your
total monthly income. For instance, if your income is $5,000 per month,
you would qualify for a mortgage with housing expenses not to exceed
$1,400 per month.
In addition to the 28% Rule, most banks also utilize another ratio, the
36% Rule. This is the debt to income ratio or the back-end ratio and it
is based on your total monthly debt payments divided by your gross
monthly income. Debt payments include your mortgage but also car loan
payments, credit card payments, etc. Based on this guideline, your total
monthly minimum debt payments, including mortgage, should not exceed
$1,800 if you have a gross monthly income of $5,000.
In some instances, the amount of house that you are able to afford may
be based on the type of loan that you take out. For instance, there are
special FHA rules that apply to certain loans such as a FHA mortgage.
The housing expense to income ratio on a FHA loan cannot exceed 29%
while the back end ratio for a FHA loan cannot exceed 41%.
You should also consider how much you are able to put down on the
purchase of a home. While there are many loan programs that offer low
down payment guidelines, it is still advisable to pay as much down as
you can afford to keep mortgage payments low and avoid private mortgage
insurance whenever possible.
Beyond these various guidelines, you also need to consider how much home
you actually need. Remember that just because you may be able to qualify
for a certain mortgage amount does not necessarily mean that you need to
spend that much. Based on their current underwriting guidelines, a bank
will usually qualify a borrower for the maximum amount possible. That
does not necessarily mean that you should take advantage of all of the
credit that is available to you. If something unexpected should happen
in the future, such as medical expenses or the loss of a job, you do not
want to find yourself in a position where your mortgage payment is
suddenly unmanageable. Making sure that you keep your mortgage payments
on the lower end of the spectrum of what you can actually afford will
ensure that you have plenty of leniency in the event that there should
arise a problem in the future.