How much house can you afford?
Congratulations! You’ve decided you’re ready to take the leap from renting to buying a home. And your credit is in order. So, your first step is review your finances and determine your budget before you start hunting. Not only will this make your home search easier, it will help you know which houses are goig to be affordable once you move in. It will also position you for a hassle-free loan approval process.
There are many factors lenders take into consideration when determining how much money they will loan someone to buy a home. Income, expenses and debt are taken into consideration to calculate what is known as your debt-to-income ratio, or DTI.
The DTI ratio is calculated by dividing your total monthly debts by gross monthly income:
Lenders prefer that borrower’s DTI ratio does not exceed 43 percent, but depending on your down payment, credit score and the loan program you choose or are eligible for, the DTI ratio can vary. Using the preferred 43 percent DTI, lenders often compute the equation in reverse to see how much total debt you can take on.
To determine the maximum housing payment (i.e., principal, interest, taxes, insurance, and association fees, if applicable) a lender would subtract your monthly debt from the total desired DTI.
For example, a couple with an annual household income of $90,000 or gross monthly income of $7,500 ($90,000/12 months). The maximum monthly debt a lender would recommend is $3,225.
$7,500 (gross monthly income) x .43 (preferred maximum DTI ratio)
= $3,225 (total monthly DTI allowance)
While the DTI ratio provides an indicator of what you can afford monthly, there’s still more to take into consideration when calculating the total amount of house you can afford such as revolving credit card balances and any installment loans such as car payments, student loans, etc.,
For example, the same couple has a monthly credit card payment of $150, student loan payment of $250 and car payment of $425, making their total monthly debt $825. A lender would subtract that amount from their maximum DTI ($3,225) to determine the maximum housing payment for which they would qualify.
$3,225 (maximum DTI) – $825 (other debt obligations)
= housing payment up to $2,400
Other elements lenders use to determine an approved loan amount include current mortgage rates, the mortgage term/life of the loan, the down payment you make, and your credit score.
Any of the Live Beyond Realty agents or a mortgage loan officer at your bank or credit union will be glad to help you estimate how much house you can afford.