You are ready to buy a house but don’t have the first idea how much a lender will give you for a mortgage. You also aren’t sure how much of your own money you should spend on the home.
Understanding how much house you can afford is one of the first steps you should take. You can get a pre-qualification from a lender to help you see how everything will pan out. Once you decide on a loan and a home price, you can take the steps to get pre-approved and start shopping for a home.
How Much do You Make?
First, you need to ask yourself how much you make. You need your gross monthly income. This is your income before paying taxes. If you get paid once a month, it’s easy to figure this out. It’s also easy if you get paid a salary as you can just divide the number by 12. If your pay is variable, take your W-2 from last year and divide the number by 12.
You will use this figure to determine how much mortgage you can afford as well as how high your total debt ratio will be once you add in a mortgage. These are numbers you will want as you try to figure out how much home you can afford.
Figure Out Your Housing Payment
Now you’ll figure out the maximum housing payment you can afford. We suggest using the conventional loan guidelines as a safe bet. They have the lowest debt ratio requirements, which means you’ll be in good shape to get any other loan program with looser debt ratio guidelines if need be.
Take your gross monthly income and multiply it by 28%. Let’s say you make $5,000 per month. It would look like this:
$5,000 x 0.28 = $1,400
This means you could afford a total mortgage payment of $1,400. Notice we said total mortgage payment. This includes your principal, interest, real estate taxes, homeowner’s insurance, and mortgage insurance.
What Other Debts do you Have?
Now you have to figure out what other debts you have outstanding. You can pull your free credit report here if you aren’t sure of all of your debts. You must include payments from all of the following:
- Minimum credit card payments
- Personal loan payments
- Car payments
- Student loan payments
- Any other debt with a monthly payment
Total up the monthly cost of these payments. You’ll then add them to your potential housing payment. Let’s say your total monthly debts equal $500. You would add it to the $1,400 mortgage payment for a total of $1,900.
You can then figure out your total debt ratio by:
$1,900/$5,000 = 38%, which is your total debt ratio
If you use conventional guidelines, your total debt ratio cannot exceed 36%, but FHA and VA loans allow you to go as high as 43%.
What’s Your Credit History?
Now don’t assume you will automatically qualify for this amount. Just because you make enough money for a $1,400 payment doesn’t mean you have the credit history to qualify for it. A lender will look at your credit history and/or FICO score to determine if you qualify. Like we said above, you can go the pre-qualification route if you aren’t quite ready to shop for a home, but just want to know what you can afford. This step doesn’t involve the lender pulling your credit, so you’ll have to give them a ballpark estimate of your score and history.
If you are ready to shop for a home once you know how much you can afford, you can get pre-approved. The lender will pull your credit with this step and will write you a letter stating how much money you can receive for a loan should you decide to move forward and if you can satisfy any outstanding conditions.
Don’t Forget About Maintenance
No matter how much a lender says you qualify to receive, don’t take it at face value. You still have to figure in the cost of yearly maintenance as well as any repairs or renovations you want. You can usually estimate annual maintenance at 1% of the home’s value. A $200,000 home would have an average of $2,000 in required maintenance per year. Of course, this doesn’t include large expenses, such as a new roof.
You’ll want to make sure you have an emergency fund or way to pay for these issues should they come up. If you run your finances dry to buy the house, you might have a hard time keeping up with it, so keep that in mind.
Learning how much house you can afford is a process. You’ll have to do some soul searching as well as consulting with a lender or two. This way you’ll know that you are comfortable with the proposed payment and the lender is willing to approve you for it.
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