Anyone who has ever perused Zillow knows how easy it is to convince yourself that spending that extra $25k for a slightly bigger home or prettier finishes is totally worth it. You start to bargain with yourself; with a kitchen like that, I’ll want to eat out less anyway. Or, I can save money on vacations because this place has a pool! But, do not let the siren song of soffited ceilings lure you into a debt you can not afford! Your dream home can quickly become a nightmare if you default on your mortgage payments. You need find out exactly what you can afford before you look for your new home. Here are a few ways to help you do that.
It’s a Matter of Factors
What you can afford in a mortgage depends on a few key factors; the total income of all borrowers on the loan, the cumulative debt between the borrowers, and the down payment on the home.
The first thing thing to consider is your debt-to-income ratio. To determine this the lender will look at your total household income and debts. To meet the Qualified Mortgage guidelines the debt ratio can be no higher than 43% for any loan. To find this figure all you need to do is calculate the total income of the borrowers and compare in to the total debt. For this purpose debt is considered any recurring monthly payments that shows on your credit report. This can include:
-Credit card minimum payments
Keep in mind that other payments like utilities, phone bills, internet, and child-care are not considered when calculating your debt ratio, but you still need factor them in when deciding what you can afford each month.
So now that you have figured out your debt ratio you can use an online mortgage calculator to estimate the cost of your mortgage. You will also need a rough estimate of how much you want to pay for a home and a general idea of what the taxes and insurance on your home will be.
To calculate your debt ratio simply add the cost of your monthly recurring debts to the principal, taxes, insurance, and interest of the new mortgage.
The amount of money you have saved is going to factor into your mortgage affordability. Many people think of savings only in terms of the down payment on their home. While a down payment can decrease your total mortgage payments it is not the only way to use your savings. And it’s important to remember that putting down less than 20% with conventional loan means you will be required to obtain private mortgage insurance which will, in turn, decrease your affordability.
Many people struggle with saving enough money for a 20% percent down payment. In these instances it’s worth considering keeping some of your savings in a reserve to help you secure a loan. This will mean a higher payment and lower affordability, but it some cases it’s needed to qualify for a loan. Your loan officer can assist you with making the right decision for your needs.
Putting Pen to Paper
Your debt ratio and down payment will allow you to understand what you qualify for. Get out a pad and paper and start calculating! Add your estimated principal, taxes, interest, insurance, and monthly recurring debt. Subtract that from your total monthly income and consider what is left over. Can you realistically live off that amount? Will it leave enough for emergencies? Does this actually save you any money when compared to paying rent? This is a big investment. Be honest with yourself when answering these questions and you’ll be prepared to make the right decisions for your mortgage.