Shopping for a new home can be addicting — how many hours have you spent on Zillow looking at all the houses you’d love to buy? Sadly, there comes a point in your home buying journey where you need to come back to earth and face the question of affordability.
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 fall in love with a property that doesn’t correspond with your budget in the slightest, it’s smart to take a hard look at your circumstances and determine what you can actually afford.
Determining your budget is just a matter of taking your income and subtracting your expenses from it. The hard part is being objective and not overly optimistic.
Make a list of all your regular monthly expenses like auto and student loans payments, groceries, and gas. Then, add up an amount for unexpected expenses. Your current rent payment shouldn’t be included in 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.
Mortgage lenders will calculate your debt-to-income (DTI) ratio when they’re deciding if they are willing to lend to you. DTI is calculated by dividing your monthly debt payments by your gross income. For example, if your monthly income is $6,000 and your monthly debt payment is $1,500, your DTI is 25%.
Lenders tend to use the 28-36 rule, which states 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.
Apply this rule to yourself, even if you don’t decide to buy a house right now. 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.
Your monthly mortgage payments are affected by:
You should also consider external factors that may increase your overall home payment. Calculate how much you might pay in homeowners’ association fees, residential taxes, 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 possible to have 2 homes with the same price tag, but with vastly different monthly costs due to outside factors.
One of the largest hurdles for first-time homebuyers is a down payment. You may be able to make monthly mortgage payments, but not financially able to make the initial 20% down payment that everyone has told you is a “must.”
Guess what? The myth about the 20% down payment is just that — a myth.
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.
With an online mortgage calculator, it’s much easier to understand how much you can expect to pay each month. Just plug in 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. This will also help you 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.
Just because you “qualify” for a $400,000 mortgage doesn’t mean you should get a $400,000 home. You may be able to afford your monthly payments now, but circumstances can — and often do — change.
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 $400,000 home, but not be able to take a vacation or go out to eat sometimes?
The best 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.