How Much House Can I Afford?
There are very few things in life more exciting than buying a house. For most people, it's most likely the biggest purchase they'll ever make. It's also a huge decision, the ramifications of which will impact your life for years to come.
SIRVA Mortgage works with first-time and experienced home buyers every day. One of the most common questions we hear from buyers is this:
How much house can I afford?
That's an important question and one that is essential to consider. After all, you need to be confident that you can afford your mortgage payment based on your monthly income and other debt payments. Here's what you need to know.
Why You Shouldn't Overspend on a Home
You might know that it's a bad idea in theory to overspend on a home, but you might not have considered the reasons why.
The first issue is financial stability. While nobody can predict with certainty what the future will hold, you can certainly estimate how much money you'll need to meet your monthly expenses. If you stretch yourself too thin, you may be trading in stability for a future that's more uncertain and stressful than it needs to be. Stability and predictability go hand-in-hand.
The monthly payment for your mortgage shouldn't put you in financial difficulty. If it does, it can impact your stability and lead to financial problems in the future.
The second major issue is affordability. It's not uncommon for people to overestimate how much they can afford based on their gross monthly income. Making your mortgage payment is a must, so that means that the payment needs to be in line with what you can afford to avoid delinquency and late fees. When your mortgage payment is nearly half of your monthly gross pay, your ability to pay for other necessary living expenses become in jeopardy.
In other words, overspending on a house will almost certainly make your life more stressful than it should be. If you have a solid budget, which you can work out using a home affordability calculator, then you can likely afford your monthly mortgage payment.
Debt and the Home Buying Process
One of the biggest factors that can impact your ability to buy a home and how much house you can afford is your existing debt.
How Does Debt Impact the Mortgage Process?
The primary concern of any mortgage lender is your ability to make your monthly mortgage payment. For that reason, they will look at your monthly debt in detail to determine whether they want to loan you the amount requested to buy a house.
The question of how you deal with debt starts with a review of your credit report and credit score. A person who pays on time and doesn't max out their credit cards is more likely to qualify for a mortgage than someone with a lot of delinquency and a high credit utilization rate. Credit utilization has to do with the ratio of your outstanding debt balances to the established credit limits on the accounts. For example, someone who has a $4,800 balance on a credit card with a $5,000 credit limit has a higher credit utilization rate than someone who has the same credit limit with only a $500 balance.
These two factors, your payment history and credit utilization, account for approximately 65% of your total credit score. While there are other factors, a mortgage lender's impression of you -- and their willingness to lend to you -- will be largely based on these two things.
Types of Debt That Can Impact Your Ability to Buy a Home
There are several types of debt that can have an impact on your ability to get a mortgage and buy a home.
Auto loans. An auto loan is considered secured debt because the lender has the right to repossess your car if you don't make your monthly payment. An existing auto loan with on-time payments may help you qualify for a mortgage, provided your payment isn't too high.
Credit cards. Credit card debt is unsecured debt. Provided you pay on time and haven't maxed out your cards, having a bit of credit card debt can help raise your credit score.
Student loans. Like credit card debt, student loan debt is unsecured. Here again, on-time payments can help you qualify for a mortgage, but a high balance can impact your debt-to-income ratio and the amount of home you can afford.
Mortgage loans. If you already own a home or you're looking to take out a second mortgage, the lender will need to be satisfied that you can make both payments. Delinquencies on either a first or second mortgage – even one time in the past twelve months – will have the greatest negative impact on your credit score.
Payday loans. Payday loans are unsecured and usually come with exorbitant interest rates. While payday loans are not typically reported to credit bureaus, any delinquency can have a negative impact on your credit score.
The two most important factors are your total monthly debt and your payment history.
Should You Pay Down Your Debt Before Buying a Home?
First-time home buyers often ask if they should pay down their debt before buying a home. It depends on a couple factors. If your monthly debt payments are high, then it may be beneficial to pay down your debt for two reasons. The first is that it will decrease your debt-to-income ratio. The second is that your credit score may get a boost. However, if your debt is in a manageable range and you have a favorable DTI, you might want to take any extra money you have and use it toward your down payment.
A related issue is closing existing credit card accounts. While it might seem like a good idea to close a card after you pay the balance, the opposite is true. Closing a card will decrease your available credit and will therefore increase your credit utilization ratio. However, also be mindful that having too much unsecured credit available to you can also lower your credit score. Your best bet is to leave those cards alone and refrain from using them.
Salary and DTI
We've already mentioned the debt-to-income ratio several times, so let's talk about how your DTI can impact your ability to buy a home.
You can calculate your debt-to-income ratio by adding your total monthly debt obligations, including housing and credit card payments, and dividing it by your gross monthly income.
You may have heard that your DTI needs to be below 43% to get a mortgage. That's not always the case. For example, you can qualify for an FHA loan with a DTI over 50%. There's no DTI guideline for a VA loan, but borrowers should expect additional scrutiny with a DTI over 41%. A low DTI can help you get a better mortgage rate.
Your salary also plays a role in how much house you can afford. Most financial experts recommend that you spend no more than 30% of your gross monthly income on housing.
We provide these numbers not because they're carved in stone, but because they can help you get an accurate idea of what you can afford to spend on a house. If your DTI is high, then paying down your debt may help you get a more favorable mortgage rate. Using a mortgage calculator can help you crunch the numbers.
How Down Payments Can Impact the Home You Can Afford to Buy
You may have heard that you need a minimum down payment of 20% to buy a house. That's a myth that can be discouraging because not everybody can afford a 20% down payment in addition to the other expenses associated with a mortgage home loan.
The truth is you don't need a 20% down payment to become a homeowner. You can get a mortgage loan with a much smaller down payment. For example, there are some lenders who will provide a mortgage loan with as little as a 3% down payment or less in some cases.
The benefit of making a significant down payment is that it provides you with instant equity in your new home and avoids having to purchase private mortgage insurance. Making a loan payment each month will help you build equity over time. However, since early payments are mostly interest, it can take a long time to gain significant equity. A larger down payment may also help you get a more favorable interest rate.
The good news for people who don't have enough savings to put 20% down is that there are multiple low down payment mortgage programs that can help you become a homeowner.
FHA loans have a minimum down payment of 3.5%.
VA loans do not require a down payment.
USDA loans (for rural and suburban home buyers) do not require a down payment.
To qualify for these programs, you'll need to meet their income requirements and other factors.
How Much House Can You Afford?
The ultimate question as you consider housing costs and other factors is this:
How can you figure out how much house you can afford?
The easiest method is to use a mortgage affordability calculator. You can find the SIRVA Mortgage affordability calculator here.
To figure out your budget, you'll need your monthly gross income, your total monthly debt payments, and the amount you can put toward a down payment. The calculator will help you determine the highest monthly payment you can afford and how that translates into a housing budget.
You can also take costs such as the loan term, insurance, property taxes, and your federal income tax bracket into consideration. Keep in mind that if you have no debt or minimal debt, your annual income may allow you to qualify for a larger mortgage than would be possible if you had a significant amount of debt.
After you calculate how much house you can afford, you may want to review closing costs, which incorporate additional expenses such as a home inspection and homeowners insurance, to make sure you have a firm grasp of what you can afford to buy.
Before you shop for a home, it's important to know how much house you can afford. Using our free home affordability calculator can help.Are you ready to apply for a mortgage? Click here to get started now!