How Much House Can I Afford?
Before setting out to buy a house, it’s important to know what you can actually handle in the monthly payment department. That brings us to the age old question, “how much house can I afford?” Not a simple question by any means, but let’s shed some light on it.
Typically, banks and lenders want prospective homeowners to use no more than 30 percent of their gross monthly income towards housing costs, meaning mortgage, taxes, and insurance.
To figure out what your monthly mortgage payment might be, or to determine the largest monthly mortgage payment you can afford, you may want to visit the bank for a pre-qual. They can figure out what mortgage rate you may qualify for, with what down payment (how much to put down on a house) and then figure in your income to give you a range of acceptable home prices you can bid on.
One measure you can use to determine how much house you can afford is the debt-to-income ratio, which measures both your monthly housing payment and total monthly liabilities against gross monthly income. It’s calculated by dividing your monthly housing payment and/or total liabilities by your income.
Let’s look at an example:
Gross Monthly Income: $6,000
Total Monthly Expenses (those that show up on credit report): $1,000
Proposed Housing Payment (including taxes/insurance): $2,000
In the above scenario, your front-end DTI ratio (housing expenses) would be about 33.3 percent, while your back-end ratio (housing and all other liabilities) would be 50 percent.
This would likely exceed the DTI requirements of many banks and lenders nowadays, as they may have limits of say 30/45 or lower. So even though you can afford that much house on paper, the bank may not be comfortable lending that amount based on its percentage of your overall income.
Remember, unexpected costs do come up, and not everything shows up on your credit report. You still need money left over for everyday expenses along with other unexpected costs of living.
Also keep in mind that banks and lenders will qualify you at the highest interest rate, meaning if you have an interest-only option, there’s a good chance you’ll still need to qualify at the fully amortized rate. Same goes for any short-term teaser rate.
That said, it’s important to get a good idea of an acceptable price range before shopping for a home. Get a realistic idea of the going interest rate for a mortgage, as that can greatly affect your buying power. You never want to cut it too close, as an unexpected rise in rates could push you out of affordability and jeopardize the entire transaction.
Remember, if you do your homework and really determine how much house you can afford, the sellers will likely be more willing to accept your offer as well, which could benefit you if there are multiple bids.