For many of us, getting a mortgage on a home is the biggest purchase we make in our life. Sitting down with a mortgage broker is not the time to figure out how much house you can afford, so you’ll need to figure out that ahead of time.
Based on your income-to-debt ratio, how much house can you afford?
To determine how much house you can afford, calculate potential home loans and what you can realistically pay for based on your income-to-debt ratio. You also want to know your credit score, as the higher the score, the lower the interest rate.
You don’t want to sign onto a mortgage that you can’t afford, as it would end badly for you. Instead, make sure to read this article! I made sure to include everything you need to know below, so let’s get started.
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How to Calculate How Much House You Can Afford
Many experts use a specific strategy to determine exactly how much mortgage a person can afford. Using the following formula allows you to calculate your expected mortgage budget while still leaving funds for unexpected bills.
This formula, also known as the 28%/36% rule, comes from NerdWallet.
This rule states that your mortgage payment shouldn’t exceed more than 28% of your monthly income, nor should it be more than 36% of the total debts you have.
This rule uses the debt-to-income (DTI) ratio to determine how much mortgage you can afford.
As an example, if you make $5,500 each month before taxes and have $500 in monthly debt payments, that means you don’t want your mortgage payment to go above $1,480.
However, you want to calculate your payment based on your “take-home pay,” which is what you earn after taxes. It is the income you have access to.
This YouTube video helps to break down the basics of how much house you can afford:
Debt-to-Income and Affordability
Your bank will use the DTI ratio to determine how much they can lend you. You can borrow more with a higher credit score, but you still don’t want to go over 28% of your monthly income.
You can find your housing budget by using the following formula:
Monthly income x DTI = monthly mortgage budget
Let’s work out an example together. Say you make $5,000 before taxes every month and have a DTI of 28%. Your formula would then look like this:
$5,000 x 28% = $1,400 is your monthly mortgage payment limit
If you don’t know your debt-to-income ratio, you’ll need to figure that out first. Add your monthly expenses, including credit card payments, loan payments, and car payments, and anything else you need to pay every month.
Then, divide the debts by your monthly income before taxes.
The result is your DTI, which you convert into a percentage by multiplying everything by 100. The lower the percentage is, the less risky banks will see you. If you have a high DTI ratio, you’ll need to pay down some of your debts before applying for a home loan.
Let’s look at the formula to use, as well as an example:
- 100 (Monthly debts / income before taxes) = DTI ratio
- 100 ($600 / $4,000) = 15%
Most places consider 35% or less a good DTI ratio. At this rate, your debts are manageable, and you likely have some room to grow.
Anything higher than that, and you might be struggling and come across as a risk to lenders.
Know Your Credit Score
When the time comes for you to purchase your first house, you also want to make sure that you know your credit score. This score is what determines how much more you’ll pay in your monthly payment, as the interest rate will create additional fees.
You’ll want to have the number on hand before you apply for anything. You can check your credit report at one of these agencies:
You can usually receive one free credit report per year, so make sure to make use of it. If you notice any issues with the report, you can ask the agency to correct them. When they do, your score is likely to go up.
Keep in mind that you’ll probably need to prove the information is wrong.
For most home loans, NerdWallet recommends you have a credit score of at least 620. However, you can go lower.
If your score is at 740 or above, you’ll get the best interest rates.
Making the Down Payment
Many people believe they need to save up to 20% of their loan. While it’s a good idea to put as much as possible into the down payment, it’s not always required. You can get conventional loans for as little as 3%.
However, with the higher costs, you do get better interest rates.
Start Saving Now
The sooner you start saving for your new home, the more house you’ll be able to afford. You’ll also receive lower interest rates when you put more money into the down payment since the lender views you as less of a risk.
The best way to start saving is to set up automatic payments into a reliable savings account.
That way, you don’t have to worry about adding the money each week on your own. If you want to buy a home with a partner, you can open a joint savings account. That way, you can both deposit money into the account every week.
Overall, you’ll need to have a large sum of money for your down payment.
Additionally, it’s essential to have an emergency fund. With these funds, you know you can still pay for your mortgage for a few months if something were to happen. It would be best to have at least two months’ worth of payments in your account for emergencies.
There are a few different methods to calculate how much house you can afford and how likely lenders can provide you with the money you need. You’ll want to consider your monthly income and DTI ratio before you start looking into mortgage loans.
Overall, you don’t want to put yourself into a situation where you’re struggling financially.
You should always factor in various expenses, so you know you won’t spend your entire monthly income on your debts. You want to cover groceries, emergencies, and other costs too.
LendingTree makes financing easy and transparent. They help you find immediate, personalized offers from trusted lenders across the nation. In minutes you can get rates and payments to compare, saving you both time and money.
I’m Donny. I’m a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.