Before going home shopping, knowing how much money you need to allocate for a home is essential, especially if you plan on getting financing. Now this part is tricky. While mortgage calculators are easily available online, what you calculate on your own may have different results from how much the lender decides to lend you.
There are a plethora of other factors involved aside from just the interest rate. Put in the appraised value of your home, your credit score, and of course your current financial health. Investing on more than you can afford can give you trouble in the long run, risking foreclosure, which could cause significant damage to your credit.
So how do you determine the amount you can get for a home loan?
Get Help from the Bank
You can ask the bank to tell you the maximum amount of payment you could make on your home based on your annual income and debts. The calculation does not necessarily factor in the sales price of the house you are interested in. They calculate the maximum amount of mortgage payment you will be able to make without raising your DTI or debt-to-income ratio above what is allowed on various mortgage products.
If you are taking a conventional mortgage, the highest DTI you can carry is 45 percent. If you plan to take on a mortgage under the FHA, VA and USDA loans, you would be required a cap of 45 percent maximum DTI as well. For HomeReady™ programs, the maximum allowed DTI is at 50 percent.
The Nature of DTIs
Debt-to-income ratios have two components in the context of calculating for home payments:
a) the Front-end ratio
This compares the buyer’s monthly income to his expected mortgage payment every month wherein this payment already includes:
– principal plus interest*
– real estate tax dues*
– homeowners insurance*
– association fees*
Lenders typically cap front-end DTIs to a max of 28 percent. If part of your monthly income goes beyond this percentage, you may have a problem.
b) the Back-end ratio
On the other hand, back-end ratios include:
– housing payments
– credit card debts
– child support or alimony
– car loan dues
– payments on other loans
All these are calculated on a per monthly basis.
The DTI back-end maximum is usually at 36 percent.
Plan a Budget
It’s a good start to know the full amount of how much you can spend on your mortgage per month. But it does not mean you need to follow this. You can use this as a baseline in helping you balance spending and savings to a healthy level. Consider that you are not only paying for your home. You may also be burdened by other costly debts such as car or personal loans, on top of your insurance premiums and other household payments.
Work out a budget and input how much you think is the amount you can manage to pay for home financing on a monthly basis. You can then use a mortgage calculator to calculate the potential size of the loan you are going to get.
Getting a mortgage is not a walk in the park. It requires looking into the details and an honest evaluation of your ability to repay. In this case, knowing your affordability limit is a good start.