Shopping for a new house is quite exciting. But since purchasing a home will likely be your biggest investment, figuring out how much you can afford is an important step for the home buying process. Unless you have the cash to purchase a house, the amount of home you can afford to buy is directly related to the amount of mortgage you can qualify for, and the amount of debt a mortgage lender or bank thinks you can take on. But how do you determine how much house you can afford to buy? Continue reading to find out the key factors’ lenders consider before approving your mortgage application.
Assess Your Debt
Mortgage lenders generally base the amount they approve for your mortgage application on your gross monthly income, which is your total compensation before deductions such as taxes. This will make them understand how much you have available each month to cover your overall expenses. In addition to your income, mortgage lenders will also consider your existing debt like tax liens, medical bills, credit cards, student loans, car payments, and many more.
The lenders usually look at your debt-to-income ratio (DTI), comparing your total monthly debts to your monthly pre-tax income. They usually use the “28/36 rule” as an indicator of a robust debt-to-income ratio. This rule states that you won’t spend more than 28 percent of your gross monthly income on a total mortgage payment and no more than 36 percent on total debt services.
If you have a DTI ratio that is higher than the 28/36 rule, some lenders and banks will approve your mortgage application. But you will be charged higher interest rates and add extra fees such as mortgage insurance which protects the lenders in case you can’t make your mortgage payments. If you want to buy a house but have too much debt to qualify for a mortgage, the first thing you need to do is to concentrate on improving your DTI. Some of the ways you can improve your DTI include consolidating your debt, paying off debt, and increasing income.
Savings and Investments
Now that you have looked at your debt-to-income ratio and any debt you may have, consider your budget. Does the mortgage payment fit into your budget? If you don’t have one, keep track of your income and expenses for a few months. During the mortgage process, it is essential to look at your savings and budget for certain reasons. For one, you will need to may a down payment.
Review Your Credit History
During the pre-loan approval process, lenders usually review your credit reports. Your credit report includes your credit card accounts, payment history, loans, and balances. They will check whether you pay your bills on time and also evaluate your credit utilization, which is the share of your available credit you actively use. With a credit utilization rate of not more than 30 percent, your credit score will be boosted, and it shows that you manage your debt prudently.
All of these add up to your FICO score, which is a credit score model uses by lenders, and it ranges from 300 to 850 FICO score. The higher the credit score, the higher your chances of having good credit and having access to more loan choices and lower interest rates, and vice versa.
Down payment is the amount of money you are expected to put down to buy your home. Some lenders require as little as a 3 percent down payment if you’re going with FFA. This may allow you to buy a house even if you don’t have enough savings. If you don’t have much money, you could still get a mortgage with a little down payment. However, it would reduce the amount you will get.
Mortgage Interest Rate
This is the amount charged by a mortgage lender in exchange for lending you the money. This is stated as an annual percentage of the entire mortgage loan amount but calculated into the monthly mortgage payment. This makes a difference in how much you spend on your new home. Keep in mind that interest rate changes often, and your mortgage lender decide your interest rate depending on your credit profile.
Eventually, how much house you can afford mostly depends on your financial situation and your personal preferences. Also, it is vital to understand the mortgage lending process as well as the price of your dream home so that you can plan ahead. Don’t be afraid to ask a lot of questions and explore your options.