Mortgages Part 1: How much house can I afford?

When thinking about buying a home, no matter it is your first home or your fifth, the first question that comes to you mind is, “How much house can I afford?”.

You can google “How much house I can afford” and find 200 million results with online calculators that will figure it out for you. The result may disappoint you, or you may be amazed that any bank is willing to loan you so much money.

Essentially what all those online calculators do is calculate your debt ratio. There are two debt ratios to be calculated:

The first debt ratio is your housing ratio. It calculates your projected housing monthly payment of mortgage, insurance and taxes, and divide it by your gross monthly income – your income before taxes and deductions. Traditionally, lenders want to lend you at a maximum of 28%.

The second ratio is the debt-to-income ratio. It adds your projected housing monthly payments to any other debt listed on your credit report, and divide that by your gross monthly income. Lenders typically want a maximum of 36%.

When you are playing with the calculator, you will notice other important factors, including the current interest rates, the length, and type of the mortgage.

The monthly payment for a 30-year fixed mortgage of $300,000 at 4.5 percent is $1,520. But at 6 percent, the monthly payment on the same mortgage is $1,800 —a difference of almost $300. That is how important interest rates is. Your credit greatly affects the interest rates you will get, so we will devote a guide on improving your credit score on our website in the near future.

However, the debt ratio is no longer an end all and be all nowadays. There is a stronger emphasis on the your credit now, plus the size of your down payment, and the amount of savings you have – cash in the bank, stocks, mutual funds, IRA, 401k. So if you want to borrow more than the 36% debt-to-income ratio, you can probably get it if you talk to different mortgage companies, especially if you have great credit and are maybe putting over 20% down.

But you want to enjoy your life after you buy your house, instead of being cash-strapped. One good advice is to set aside your monthly mortgage payment before you buy: for example, if your current rent is $1500 but it is suggested you can afford a monthly payment of $2500 a month, try setting aside the extra $1000 per month now to see if it starts to stretch your budget.

Mortgage Guide Home | Next Article: How much down payment do you need?