Before potential homeowners apply for a mortgage, they may ask themselves the all important variable, “How much home can I afford?” It’s always a good idea to ponder affordability in advance because it means you can look for houses that fall exactly within the your price range. Once you find your dream house(s) and know that you can afford it, you don’t have to be disappointed later by applying for a mortgage you couldn’t pay back.
Income is a huge factor in evaluating home affordability, Historically, home shoppers asking themselves “How much house can I afford?” could feel comfortable with prices as high as two to two and a half times their gross income. That generally meant that someone earning $100,000 before taxes could afford a mortgage of between $200,000 and $250,000. Today’s mortgage programs will consider your debt, as well as your income, making “How much home can I afford?” a more accurate depiction of your financial situation.
To estimate if the borrower can afford their new housing payments without any problems, the lender will look at all of their current monthly debts. These debts aren’t hard to find because they usually show up on your credit report. Debt considerations may include car loan payments, credit cards, student loans, child support or alimony payments and any other monthly oblibations. Once these monthly debts are totaled, they can be used to help determine the affordability of the new mortgage.
Your lender has the final say in figuring out much home can you afford. As such, they perform an in depth examination of the mortgage applicant’s finances using ‘debt-to-income ratios’, or ‘DTI ratios‘.
DTI “Front-End Ratio” or “Top Ratio”
The mortgage top ratio evaluates only the affordability of the proposed housing payment. Therefore, if a desired mortgage program limits housing expenses, including monthly principle and interest payments, taxes and insurance, to 29 percent of applcant monthly income, the home is considered affordable if an applicant’s percentage is less than 29%.
DTI “Back-End Ratio” or “Bottom Ratio”
The second method lenders calculate home affordability is the applicants’ bottom debt-to-income ratio. If an applicant’s total debt loan is below the maximum debt-to-income percantage of the applicants’ monthly income, they can likely afford the house.
Owning a house adds extra responsibilities that people do not have when they are renting. These extra expenses must also be taken into consideration when asking the question, “How much home can you afford?” For example, maintenance on a house can be highly expensive if major repairs are needed, such as roof repairs. Appliances do not last forever, and homeowners will need to spend hundreds of dollars replacing them. Thinking about these issues may impact the amount of money that people will have to spend on their monthly payments, and whether or not they can afford the house.
When people are renting, they will not necessarily have to pay for all of the utilities. Homeowners, on the other hand, definitely will. Asking the question, “How much house can you afford?” will mean that future homeowners must make a list of all of the new utility payments they will need to make and if they can afford to add them to their monthly expenses and the mortgage payments. If they can afford the maintenance and the utilities, they can, most likely, afford to purchase the house.
While most condo or homeowner Property Owner Association (POA) or Homeowners’ Association (HOA) dues are paid directly to the entity, they are still a factor when calculating “How much house can you afford?” and specifically debt-to-income.
Having a mortgage loan means you also have to have homeowners insurance to protect the lender. Generally speaking, the homeowners insurance policy must be large enough to cover the cost of replacing the home plus the outstanding mortgage amount. Naturally these insurance costs are a factor in your home affordability.
As you can see, future homeowners have several measurements that will help them answer the proverbial question “How much house can I afford?”. It can be to your ultimate benefit to examine these financial aspects before submitting a loan application.