As fun as it is to go through home listings and picture ourselves living in the properties, eventually we need to face the question of affordability. While it’s temptingly easy to do mental gymnastics about how we can possibly afford a certain house if we only got a second job, applying for a mortgage and buying a house is not a decision to be made lightly. Buying a house will likely be the largest purchase you ever make, and your mortgage will affect your bottom line for the next 30 years — or longer.
Before you start looking through listings, it’s wise to objectively consider your circumstances and determine what you can actually afford.
Start by Calculating Your Budget
Determining your budget is pretty straightforward. It’s just a matter of taking your income and subtracting your expenses from it. The hard part is being objective and not overly optimistic. Start by making a list of all expenses you incur in any given month, including recurring expenses such as car and student loans payments, groceries, and gas, and add an additional amount for unexpected expenses. Don’t include your current rent payment into the calculation because that’s money you’ll dedicate towards your new mortgage payment. Once you have a realistic look at your budget, you can begin to calculate the mortgage you can afford.
Stay Below the 28-36 Rule
A metric used by mortgage lenders to determine if they are willing to lend to you is the debt-to-income (DTI) ratio. This ratio is calculated by dividing your monthly debt payments by your gross income. For example, if your monthly income is $4,000 and your monthly debt payment is $1000, your DTI is 25%.
A common rule of thumb that lenders use is the 28-36 rule. Itstates that your maximum household expenses shouldn’t exceed 28% of your gross monthly income, and your total debt, which includes student loans and credit cards, should not exceed 36% of your total income.
Since this rule will probably be used to gauge your ability to pay your mortgage, it makes sense to apply it to yourself before you go to a bank. Even if it wasn’t required by lenders, it’s a wise standard to use to ensure you can make your monthly payments and still maintain a comfortable standard of living for yourself and your family.
Study Other Factors That Determine Affordability
You monthly mortgage payments are affected by:
- Your credit score
- Your down payment
- The term length of your mortgage
In addition to your monthly mortgage payment, however, you should also consider external factors that may increase your overall home payment. Calculate how much you will pay in residential taxes, homeowners’ association fees, private mortgage insurance, and maintenance.
While not directly linked to your mortgage payment, also consider how much you’ll spend in commuting costs, city and county taxes, as well as utility costs. It’s quite possible to have 2 homes with the same price tag, but with vastly different monthly costs due to outside factors.
The Down-Payment Hurdle
One of the largest hurdles to owning a home is the down payment. You may be perfectly able to make monthly mortgage payments, but not have to cash to make the initial 20% down payment.
Thankfully, many government and bank program options allow otherwise qualified borrowers to purchase a home with a low down payment. Examples include FHA, VA, and USDA loans. Some of these mortgage products even have 0% down options for qualified borrowers.
The Affordability Big Picture
Just because you “qualify” for a $500,000 mortgage doesn’t mean you should get a $500,000 home. You may be able to afford your monthly payments now, but circumstances can — and often do — change.
For example, if you took a second job so you can qualify for your mortgage, will you continue to have 2 jobs for the next 30 years of your life?
- What if you decide to have children?
- How will your ability to pay your mortgage change if you become incapacitated for a period of time, or are laid off?
- Do you have an emergency fund to keep paying your mortgage in the event of hardship?
- If you don’t already have one, are you planning on building one? And if so, in what timeframe?
A common mistake many new homebuyers make is that they focus on the hypothetical amount of money they can pay each month, but fail to account other expenses in life. Do you really want to live in a $500,000 home, but be unable to afford to take vacation, or go to a nice restaurant every once in a while?
Equally important to consider is how the amount of money you put towards your mortgage payment will affect your quality of life.
Use a Mortgage Calculator
A mortgage calculator will make it much easier to see exactly how much you will pay each month. All you have to do is enter the mortgage loan amount, down payment, interest rate, and loan term in order to calculate your monthly payment.
A mortgage calculator makes it easy to play out different scenarios, such as a 15-year loan versus a 30-year loan, varying interest rates, and total loan amount. By doing so, you can determine which kind of loan you’re most comfortable with.
It’s important to note that while a mortgage calculator won’t be 100% accurate, since it doesn’t account for your credit score, it can give you a pretty good idea of what your monthly payments will look like.
Consult an Expert
The most accurate way to see how much mortgage you can afford is to speak with a professional. At Embrace Home Loans, we can help you find a mortgage that’s perfect for your budget, as well as your short-term and long-term needs. And with over 30 years of experience, you can count on us to provide you with the most competitive rates on the market, coupled with customer service you’ll be hard pressed to find elsewhere.