How Much Home can I Afford?

What’s on our minds these days?  Guys?  Sure.  Girls?  Sure.  School?  Sure.  Careers?  Sure.  Buying a house?  Sure.  As our generation begins to come into the “first time home buying” stage of our lives, it is important to realize the lending standards.  Many times people ask me, when starting to look for a house, how do I know how much house I can really afford?  Here is a simple breakdown of what you need to know to understand how much house you can really afford. 

Mortgage Amount Guided By Debt to Income Ratio

Your debt to income ratio is important because it tells a mortgage lender how much money you'll have left for mortgage payments after meeting other financial obligations. The ratio is one important part of the mortgage loan approval process, along with information on your:

• - Credit history
• - Credit score
• - Income and savings
• - Employment outlook

Conventional Loan Debt Limits

As you talk with mortgage lenders, you'll hear the term "28/38." Those numbers are percentages used to weigh your debt load. The 28 percent refers to your monthly gross income available for home expenses. The total typically includes:

• Mortgage loan payments, including principal and interest
• Private mortgage insurance (if applicable)
• Home owners insurance
• Property taxes
• Home owner's association dues (if applicable)

Understanding the 38% Figure for Mortgage Financing

The second number is the maximum percentage of your monthly gross income the mortgage lender allows for home expenses – plus recurring debt. If you have credit card payments or car loans, for example, those would be counted as part of the 38%.

 Mortgage Loan ExampleRates are subject to change.  This is just an example.  Results will vary based on circumstances.  

If your yearly gross income is $40,000, then your monthly income is $40,000 divided by 12 or $3,333. Your monthly income multiplied by .28 is $934. When multiplied by .36 the figure is $1,200. Your debt to income ratio is an important indicator of how much mortgage you can afford. Remember that these percentages are for conventional home loans. 

 

So take into consideration all of your other expenses.  For this example, we will assume that all other expenses total $300, leaving you with $900 for your mortgage principal, interest, taxes and insurance.  Using the prevailing interest rates of the time of 5% we use a financial calculator to find out that a $125,000 loan will cost you $671 for your principal and interest payments each month.  Add $250 a month for taxes and insurance and you come up with a total of $921 for the month.  This falls within range of your 28% loan to income ratio.  Most lenders require a 20% down payment ($25,000 in this example) so you can expect to reasonable qualify for a home worth roughly $150,000.

 

Your Income                                   =$40,000 or $3,333/ month

Your down payment                        = $25,000

Your Loan                                      = $125,000 (30 year conventional fixed)

Total home value                             = $150,000

Your loan to value ratio                   = 27% ($921 / $3,333)

Your principal/interest payment       = $671/ month

Your taxes/insurance                      = $250/ month

Total monthly expense                    = $921/ month