One of the most common questions that I get is “How much home can I afford?”
A good rule of thumb on conventional financing is three(3) times your annual gross income. So if your household income is $80,000 per year then a good starting point is a $240,000 house. But, even if you can afford to buy that much, you may want to consider living below your means to save money for college, making debt payments, or anything else necessary in our modern financial lives.
However, once we get an idea of what your maximum house amount would be, let’s talk about what can be approved. The following information is assuming you are trying to get a conventional loan. There are other types of loans available such as FHA, VA and Rural Housing that might be more appropriate for your situation, so I would encourage you to get in contact with me so we can discuss specifics.
One of the things a lender will look at in approving your loan is what is called DTI or Debt to Income ratios. A good rule of thumb is that your monthly income vs. your total monthly debts (after buying your new home) needs to be at a ratio of 45% or less. Other debts besides your new house payment that are included in your ratios would be things like auto loans, credit cards, student loans and alimony/child support if continued for the next 12 months or longer. (A common misconception is that utility bills are included in this calculation. For our purposes, they are not. You still have to pay them, but in order to qualify for a new home purchase, utliities are left out of the equation).
To start to calculate your ratios, let’s begin with the house payment. Your new mortgage payment will be made up of the following 4 components:
Principle and interest - you can go to any principle and interest calculator online such as http://www.ajdesigner.com/fl_loan/loan.php
Homeowners Insurance – roughly ½% -3/4% of loan amount / 12
Property Taxes – roughly 1% of value / 12
PMI (Mortgage Insurance) - PMI is avoided if 20% down. If 5% down estimated amount is .78 x loan amount /12, 10% down is .52 x loan amount /12 and 15% down is .38 x loan amount /12. (Mortgage insurance can be avoided altogether if you do what is called piggybacking - or obtaining a second mortgage for the remainder of the amount you need to put 20% down - and closing the second at the same time as your new first. This is a common practice in avoiding mortage insurance with tax benefits).
You would add this payment to other monthly debts that you have and this will give you a rough idea of your debt to income ratio. If you were to obtain a second mortgage along with your first, that payment would also factor into your new debt to income ratio. Very important to not forget that!
So let’s look an example to pull all of this together. If you are buying a $240,000 house with 5% down then the loan amount is $228,000. Let’s use 5% interest rate for 30 years and it has a principal and interest payment of $1223. Insurance would be around 240000 x .005 = 1200 /12 = $100/mo, taxes would be about $240,000 x .01 = 2400/12 = $200/mo. PMI would be $228,000 x .0078 /12 = $148/mo.
So you have a total payment of $1671.
Now let’s assume that this person has a car payment of 300/mo and student loan payments of $100/mo and minimum credit card payments of 50/mo. and also pays child support of $100/mo. So the debts used in calculating the DTI are $1671 + $300+ $100+ $50+ $100 which total $2221.
Our annual income is $80000/12 = $6666 / mo.
So our debt ratio is 2221/6666 = 33%. We can have debt ratios of a maximum of 45% as a general rule so this person should be financeable as long as they have their down payment money and decent credit history.
Now, I know numbers don't appeal to everyone. But savings per month do! If you are at all interested in finding out more information, please do not hesitate to contact me or any of our representatives. Follow the link below to my personal page and let's get started today!