Before you start asking yourself what type of house you want to buy, you need to ask yourself how much home you as homebuyers can realistically afford. Your dream home can turn into a major nightmare if you can’t afford to keep up with your monthly mortgage payments. While lenders today are less likely to loan you more than you will be able to manage, you should take some time to determine what number is affordable and comfortable for you.
It’s important to know how much home you can afford so that when you do start house shopping, you are looking at houses that are actually in your price range. So how can you determine what that magic number is for you? Keep reading to find out.
One of the most basic equations you can use to figure out what you can afford is your debt-to-income ratio. Your debt-to-income ratio helps you (and lenders) compare how much money you make with the amount of money you owe, and how a house can fit into that picture.
It is suggested that you keep your debt-to-income ratio below 36%. How can you figure out just what your debt-to-income ratio is? Calculate how much you’re paying monthly on debt – like car payments or education loans – then divide that number by your monthly income. For instance, if you pay $500 to debts and you make $6,000 each month, your debt-to-income ratio is 0.083, or 8.3%. While that is significantly below 36%, you don’t have a mortgage payment to factor in yet.
Once you know what your income and debt is, you can take those numbers and plus them into a home affordability calculator – available online – to find out how much you can afford for a home while still remaining under the desired 36% debt-to-income ratio. Using the same numbers, if you have $30,000 for a down payment on a home and you are able to secure a 30-year fixed-rate mortgage with a 5% interest rate, you could afford a home worth about $248,800.
What do these numbers mean for your debt-to-income ratio monthly? To figure this out, you have to factor in more than just your mortgage payment. You also have to consider other expenses that come with homeownership including property taxes and home insurance, and adding those in will result in a monthly payment of about $1,580 to own your home.
The numbers you use to calculate how much home you can afford will change as your circumstances do. For instance, if you get a raise and your income increases to $8,000 each month, using the same numbers as above, you would be able to afford a home that is worth $274,600 for a monthly housing payment of $2,073. Or, if you make $8,000 each month but you can decrease your debt to only $250 monthly, you would be able to afford a home worth $313,100 with monthly payments of $2,201 each month.
When trying to determine how much home you can afford, every single detail matters, so be sure that you take them all into account during calculations. You can’t just look at your salary or the amount you’d pay each month for your mortgage; you have to look at the big picture. The clearer you can make your financial commitments picture, the easier it is to figure out how much home you can afford without getting in over your head.