How To Figure Out What You Can Afford For A Home Mortgage
Buying property through a home mortgage is known to be one of the largest investments anyone can make.
While having the bank lend off a sizable amount of money to you may help considerably, this is simply not a feasible option for many prospective homeowners. Most banks impose strict limits on how much they lend out.
In addition, the actual amount that a person can afford varies from area to area based on local market conditions as well as your lifestyle and priorities.
If you need help, here are some considerations—both lender-side and buyer-side—to help you sort out how much you can really afford for a mortgage.
A mortgage lender typically decides how much they want to lend out by determining the income, debt, assets, and liabilities of a prospecting homeowner. They want to ensure that there’s no major concern that may potentially jeopardize your ability to pay off the loan.
If you have a good credit score and no debt, then you’re likely fine as far as lenders are concerned. Still, they practice thorough discretion to ensure that you can maintain your debt responsibly.
These are the things they usually consider.
Gross income refers to the amount of money you earn per year before taxes. Some lenders include bonuses, tips, and commissions as part of this calculation while others exclude them, so ask around to determine where your lender falls.
As a rule of thumb, most potential homeowners are expected to acquire a mortgage that is between two and two-and-a-half times their yearly gross income.
By utilizing the formula above, a person making $50,000 a year can afford a home mortgage of $100,000 to $125,000. A person making $75,000 a year, on the other hand, can afford a larger mortgage of between $150,000 to $187,500.
Just as important as your income is how much you owe to your creditors. If you have a bad credit score, then the lenders may ask you to pay a higher interest rate—or annual percentage rate (APR)—as a way of compensating for the higher risk.
Even then, those who have lacklustre credit scores and lack assets will likely be turned down. If you don’t want to miss out on acquiring much-needed financing for your dream home, you’ll have to work on improving your credit score.
Front end ratio
The front end ratio refers to the amount of yearly gross income that you utilize to pay off your mortgage each month.
Your mortgage payments consist of four major parts, collectively known as PITI:
As a general rule, your PITI should fall below 28% of your gross income to be considered desirable. A few lenders may provide some leeway and allow clients to spend up to 40%, but it’s financially optimal to keep it below the 30% baseline so that you won’t become financially strained in the future.
The debt-to-income ratio refers to the amount of yearly gross income that you utilize to pay off all your debts—including your outstanding loans, child support, and credit card payments.
To calculate your debt-to-income ratio, perform the following steps:
- Add and total your monthly expenses and bills. (child support, student loans, electricity and utilities, etc)
- Divide your total monthly expenses with your monthly gross income.
- The resulting number, which comes in a form of a percentage, is your DTI ratio.
Lenders typically look for a DTI ratio of under 45%.
If you’re DTI is 50% and above, mortgage lenders see that as a red flag and may see you as an increased risk of defaulting on loans.
Even if the math looks sound in the lender’s eyes, it doesn’t tell the complete story.
The figures above don’t take into account any unforeseen difficulties or changes in your life. For example, you may be expecting a new member of the family soon, which is fairly common for people who are looking to buy a new home.
These considerations can increase your expenditures drastically—so you’ll have to keep that in mind before fully committing to a house purchase.
Here are some factors to consider while assessing your ability to pay off a mortgage.
Is your job stable? Can you find another job or start a business that can pay the same wages if things turn sour? Determine how secure you are in your current career path and whether your source of income is enough to pay off the mortgage. Even just a few months without steady pay can be disastrous.
All of us have wants and needs. Some of us can live without spending a dime on restaurants each month, while others like to live lavishly and enjoy their time more often.
Neither of these options is wrong or right, granted you have the money. But when you undertake something as major as upgrading your home, it’s best to be a bit more strict when it comes to budgeting your expenses.
Consider cutting dining out one day a week or making coffee at home instead of buying takeaway. This way, you’ll be able to cushion your savings for a rainy day.
It’s also important to consider how you act in response to financial problems.
Some people are naturally more forgetful than others and don’t worry about amassing a huge debt, while others work extra hard to keep their slate clean.
Be mindful of your personality. While having a more carefree nature can be fine, it can also cause you to rack up a lot of debt in the long run. So it’s up to you to determine your threshold.
If you have a family to care for, however, it may be time to get a bit stricter with your budgeting.
Final Additional Expenses
While the bulk of the financial burden of homeownership would be your mortgage, there are still a few notable expenses to consider even after the mortgage has been fully paid off.
These expenses include:
- Property taxes
- Home insurance
- House maintenance
- Electricity and utilities
- Administrative costs
To stay on top of your finances, it’s important to keep all these factors in mind before committing to anything—especially with big purchases like a property.
If you’re feeling a little overwhelmed, you may use a mortgage calculator like this one to fully assess your financial health before committing to any major purchases.