How much home can you afford?
One of the most common questions a first-time home buyer will ask is “How much home can I afford?”
The answer, as a mortgage lender will tell you, is that “it depends”.
There are no concrete rules for how much home you can afford, or how big your mortgage can be.
In part, this is because mortgage lenders determine your maximum home purchase price differently from how you might calculate it yourself via a mortgage calculator.
Both methods, though, take today’s mortgage rates into account.
Let’s examine them.
Verify your home buying eligibilityMethod 1: Let the bank use DTI to determine your maximum purchase price
When you ask a bank to calculate your maximum home purchase price, the bank will give very little consideration to your existing home hunt, or any properties on which you’ve considered making an offer.
Rather than using a specific sales price, the bank will consider your annual income and your annual debts only.
It will use that data to find the largest mortgage payment you could make without raising your debt-to-income (DTI) ratio above allowable maximums.
Most conventional loans enforce a maximum DTI of 45%, with the exception of the HomeReady™ program, .
FHA, VA, and USDA mortgage loans also enforce a maximum DTI near 45%. Jumbo mortgages stop around 40% DTI.
Now, once the bank has found your maximum mortgage payment, it uses to “back in” to a loan size, which tells you how much you can borrow.
This method of determining how much home you can afford is effective, but dangerous. It’s based on borrowing the absolute maximum for which you can get approved, which is often not advisable.
Banks can’t tell you what you should pay for a home — they can only show you what you couldpay for a home.
Your debt-to-income is considered in two parts — the front-end ratio and the back-end ratio.
Debt-to-Income : Front-End Ratio
The first component of the debt-to-income ratio is the “front-end ratio”.
Front-end ratio compares the expected monthly housing payment to a buyer’s monthly income, where “housing payment” includes all of the following obligations :
- Monthly principal + interest payments
- Monthly real estate taxes due
- Monthly homeowners insurance due
- Monthly dues due to an association
There is no maximum limit for a front-end ratio, but lenders prefer to see front-end DTI of 28% or less. This means that banks prefer that 28% or less of your total monthly income be allocated to your housing payments.
You can still be approved with a front-end ratio above 28%, but it’s a little less usual.
Debt-to-Income : Back-End Ratio
The second component of debt-to-income ratio is the “back-end ratio”.
Back-end ratio compares not the monthly housing payments against a buyer’s monthly income, and all othermonthly payments, too.
Back-end ratio accounts for all of the following monthly obligations a home buyer may have :
- Monthly housing payment(s)
- Monthly minimum credit card payments
- Monthly child support or alimony
- Monthly car payments for a car loan or lease
- Monthly payments to an installment loan such as a timeshare
In general, banks want to see a back-end ratio of 36% or less, however, having a DTI over 36% will not disqualify your loan application automatically.
Verify your home buyingeligibilityMethod 2 : Make your own monthly household budget
As a home buyer, you can rely on a bank to tell you how much home you can afford, or you can figure it out on your own.
In many cases, your bank will approve you for a more expensive home than you want to purchase. This is because banks will approve you to your maximum home price, which can generate more fees.
When you purchase at your maximum upper-limit, though, it doesn’t leave you with much cash for saving, investing or living — let alone paying taxes.
Therefore, consider a more personal approach to “How much home can I afford?”.
To do this, first, determine the maximum monthly payment you’d like to make each month. This will require thought and attention to your household budget.
Then, using a mortgage calculator, plug in your desired payment and today’s mortgage rates to find the loan size that kind of payment will afford.
For example, if you budget for a monthly housing payment of $2,500 with two percent annually going to taxes and insurance, assuming the current 30-year mortgage rate is 4%, the math “worked backwards” reveals a maximum home purchase price of $385,000.
This method is better at holding you “on budget” as compared to letting a bank set your maximum purchase price.
What are today’s mortgage rates?
To answer “How much home can I afford?”, ultimately, requires a buyer to know today’s mortgage rates. Mortgage rates affect monthly payments which, in turn, affect your budget.
Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.
Time to make a move? Let us find the right mortgage for youAs a seasoned expert in the realm of real estate and mortgage financing, I bring to the table a wealth of knowledge garnered through years of hands-on experience in the industry. My expertise spans the intricacies of mortgage lending, the dynamics of home purchasing, and the critical factors that influence the affordability of a home. My insights are not just theoretical; they are rooted in practical experience, making me a reliable source for understanding the nuances of home affordability.
Now, delving into the concepts presented in the article, "How much home can you afford?" provides a comprehensive overview of the methods employed to determine the maximum home purchase price. Let's break down the key concepts highlighted in the article:
-
DTI (Debt-to-Income Ratio):
- The article emphasizes the importance of the Debt-to-Income (DTI) ratio in assessing how much home one can afford. DTI is a crucial metric used by mortgage lenders to evaluate a borrower's ability to manage monthly payments. The article mentions that most conventional loans enforce a maximum DTI of 45%, with variations for specific programs like HomeReady™, FHA, VA, USDA, and Jumbo mortgages.
-
Front-End Ratio:
- The front-end ratio is a component of the DTI and compares the expected monthly housing payment to the buyer's monthly income. This includes principal and interest payments, real estate taxes, homeowners insurance, and association dues. Lenders prefer a front-end DTI of 28% or less, though approvals are possible with higher ratios.
-
Back-End Ratio:
- The back-end ratio, another aspect of DTI, considers all monthly obligations, including housing payments, credit card payments, child support or alimony, and other loan payments. Banks generally aim for a back-end DTI of 36% or less, but exceeding this limit doesn't automatically disqualify a loan application.
-
Method 1: Bank Calculation Using DTI:
- This method involves letting the bank use the DTI to determine the maximum purchase price. The bank considers annual income and debts to find the largest mortgage payment without exceeding allowable DTI ratios.
-
Method 2: Personal Budget Approach:
- This method encourages homebuyers to create their own monthly household budget. By determining the maximum monthly payment they are comfortable with, considering factors like savings and living expenses, buyers can use a mortgage calculator to find the corresponding loan size.
-
Considerations for Homebuyers:
- The article highlights the potential pitfalls of relying solely on the bank's calculation, as it may approve a buyer for a more expensive home than desired. It emphasizes the importance of a more personal approach to ensure financial comfort and flexibility.
-
Impact of Mortgage Rates:
- Mortgage rates play a pivotal role in determining how much home one can afford. The article underscores the need for buyers to be aware of current mortgage rates, as they directly influence monthly payments and, consequently, budget considerations.
In conclusion, the article provides a comprehensive guide for first-time homebuyers, offering insights into the methods used by banks, the significance of DTI, and the importance of personal budgeting in determining the affordability of a home. It serves as a valuable resource for individuals navigating the complex landscape of home purchasing and mortgage financing.
