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How Much House Can I Afford? A Look Into How to Calculate Your Home Affordability and Assess Your Finances
April 5th, 2023 | Tom Theewis
Buying a house is one of the most significant financial decisions you’ll make in your lifetime. It’s crucial to determine how much house you can afford before you start shopping for one. If you don’t, you might end up purchasing a house that’s too expensive for your budget, leading to financial difficulties down the road, commonly referred to as being house poor. How much of a mortgage loan you can qualify for depends on how much debt a lender thinks you can take on. Remember, just because you’re approved for a certain amount doesn’t mean you should buy a house that costs that much. Below is a deep dive into the factors that determine how much house you can afford and some tips for making a smart home-buying decision.
Factors That Determine How Much House You Can Afford
Income: Your income is the most important factor in determining how much house you can afford. Lenders use a ratio called the debt-to-income ratio (DTI) to determine how much of your monthly income should go toward your mortgage payment. For a conventional loan, a DTI ratio of 50% or lower is usually considered good. So, if you make $5,000 per month, your total monthly debt payments, including your mortgage, should not exceed $2,500. With FHA and VA loans your DTI limit is higher in most cases.
Down payment: The down payment is the amount of money you pay upfront towards the purchase price of the house. The larger your down payment, the less you’ll need to borrow, which means lower monthly mortgage payments. Lenders typically require a down payment of at least 5% of the purchase price, but a larger down payment is considered less risky for the bank since the borrower has more skin in the transaction. For first-time home buyers, the minimum down payment for a conventional loan is 3% and for an FHA loan, it is 3.5%.
Credit score: Your credit score is an important factor in determining your interest rate and your ability to qualify for a mortgage. The higher your credit score, the lower your interest rate will be, which means lower monthly payments. If you have a low credit score, you may need to make a larger down payment or pay a higher interest rate.
Monthly expenses: In addition to your mortgage payment, you’ll need to factor every liability on your credit report with a monthly payment in your DTI ratio. You will also want to factor in your typical monthly expenses like utilities, groceries, transportation costs such as fuel and insurance, and any other costs each month. Make sure to include these expenses in your budget to determine how much house you can afford.
Tips for making a smart home-buying decision
Stick to your budget: Once you’ve determined how much house you can afford, stick to your budget. Don’t let the excitement of owning a home lead you to purchase a house that’s out of your price range.
Shop around for the best mortgage rate: Mortgage rates can vary significantly from lender to lender. Shop around and compare rates to find the best deal. TIP: Mortgage Brokers typically have the best rates in the industry!
Consider all the costs: When determining how much house you can afford, don’t forget to factor in all the costs as described above.
Don’t forget about the down payment: A larger down payment can reduce your monthly mortgage payments and save you money in the long run. Make sure to save enough for a down payment before you start shopping for a house.
Get pre-approved for a mortgage: Getting pre-approved for a mortgage can give you a better idea of how much house you can afford and can make the home-buying process smoother.
To Wrap Things Up
Determining how much house you can afford is a critical step in the home-buying process. The only way to make sure your budget aligns with your home purchase goals is to talk to a Mortgage Broker and get pre-approved. It’s essential to consider all the factors that determine how much house you can afford and to stick to your budget. By following these tips, you can make a smart home-buying decision that fits your financial situation.