Seriously, How Much Can I Afford?

Most people, especially first time home buyers, have no idea what they can actually afford when they start looking at homes to buy. They may not even know where to start. Unfortunately many people start looking at properties under what they can afford - selling themselves short or ones they can't afford and would lead them to literally be "living beyond their means". They absolutely need to know what they can afford prior to looking. By doing some research and some performing some simple arithmetic on their own prior to jumping into any lender's office, they will find themselves feeling savvy and at ease when speaking to a lender or broker.

Doing the Math

The ratio you need to figure out is your debt-to-income ratio. This is the ratio between how much you owe each month on personal debt and how much you earn. This ratio shows lenders the percentage of debt you are carrying in relation to how much money you make. It helps to show just how much additional debt you will be able to handle.

In order to make the calculation, add up your fixed monthly expenses such as your car payments, minimum credit card payments*, monthly spousal or child support, and student loans. You don't need to calculate utilities, groceries and things of that sort. Add your expected housing payments (your mortgage payments plus, for example, private mortgage insurance (PMI), homeowner’s insurance and property taxes) and divide the total by your gross monthly income.

*Your minimum credit card payment is not your total balance every month. It is your required minimum payment -- usually between two and three percent of the outstanding balance.


What's the Bottom Line?

It all comes down to how much income and how much debt you have. A common rule when shopping for a mortgage is that your debt-to-income ratio should be no higher than 36 to 38 percent - this includes your mortgage payment and your monthly debt. Anything above this could lead to you being denied credit or charged a higher interest rate on your loan.

The price you can afford to pay for a home will depends on a few things:

1. Your gross income
2. The amount of cash you have available for the down payment, closing costs and cash reserves required by the lender
3. Your credit history - make sure your credit has been cleaned up if necessary and your FICO score is in good shape
4. The type of mortgage you select
5. Current interest rates - which currently are great!


The most important thing you need to remember is to be sure you are comfortable with the amount of debt you are accumulating. Keep in mind, the lower your debt-to-income ratio the better, so pay down as much debt as you can before starting the mortgage process.


Please remember, this information may vary from lender to lender and each office may have their own exceptions or way of performing business. It is good to interview a few lenders before making the big jump. Stay tuned for another BLOG in the near future that may help you in your search for that perfect loan agent!