Before you begin your search for a home, it’s important to understand how much a lender is willing to provide you, and more importantly, how the monthly payments will impact your budget. Mortgages that charge a fixed-rate of interest usually come in two varieties. Those with 30-year terms charge more interest than those with 15-year terms. Interest on variable rate mortgages can go up or down based on the Prime Interest Rate. The interest rate you qualify for is determined by several factors, but fortunately, there are online tools that can help you answer the question: Can I afford a house?
Know Your Current Monthly Expenses
The first thing you need to do is understand exactly what make up your current monthly payments. These include household expenses like food, clothing, credit card payments, personal loans, insurance, phone & internet, car payments & gas, and utilities, and rent. If you currently own a home, you’ll substitute a mortgage payment, home insurance, and property taxes for rent. Make sure you include everything you pay for.
Know How Lenders Determine What You Can Afford
Lenders calculate your Debt-to-Income (DTI) ratio that identifies the percentage of your gross monthly income (what you earn before taxes) that goes to paying your monthly debts using the formula ‘monthly debt / gross monthly income = DTI%. Generally, the lower your DTI%, the more likely you are to qualify for a loan. Most lenders consider a DTI of 25% (including your mortgage payment) quite affordable, while one of 45% they view as difficult to afford. Your DTI determines the amount the lender will finance through a mortgage.
Don’t let your lender ask all the questions, though! We’ve previously covered questions to ask when choosing a mortgage broker.
Can I Afford a House? Other Variables to Consider
Lenders prefer borrowers with higher credit scores because it suggests a lower risk of defaulting on the loan. Credit score also determine the interest rate you’ll be offered, so it’s good to understand what a good credit score is, and how to raise it if necessary. The amount of money you can access immediately is important to make a down payment, and pay any closing costs. Typically, a down payment of 20% of the purchase price is required unless you qualify for special loan programs based on income or military service. Realtor.com is a great resource to figure out a down payment that best suits your circumstances.