Buying a home is usually the biggest purchase you’ll make in a lifetime. The first question you should ask yourself before getting started is, “How much can I afford?” In order to determine that amount, it’s important to take into account more than just your income.
Using a home affordability calculator can help you pinpoint that number quickly but you may want to dig a little deeper by considering these factors too.
Obviously, your household income is one of the major considerations for how much you can afford. You’ll need to have plenty of wiggle room to afford the mortgage payment and still have a financial buffer for unexpected expenses like repairs. Think about the stability of your job, and your partner’s if you have one. How might your income change in the coming years and how will that affect your ability to cover those house payments?
Debt to Income Ratio
Regardless of your income, if you have a high amount of debt, with a good chunk of your money going toward things like medical expenses, student loans, and car loans, you’ll need to consider that before house hunting.
Your debt to income ratio, calculated by dividing your monthly debt obligations by your gross (pre-tax) income, should typically be at 36 percent or less, as NerdWallet notes. That includes as much as 28 percent going toward your house payment, with 8 percent left for debts like car and student loans. For example, if your gross earnings are $5,000 a month, you should spend no more than $1,800 on your total monthly debts. If you’re already spending $150 on student loans and have a $350 car payment, you can spend a maximum of $1,300 on all home expenses.
How Much Do You Have Saved For a Down Payment?
The bigger your down payment, the better your interest rate as the lender is risking less money. The loan-to-value ratio takes into account the amount of your down payment, so the more you have saved, the more house you’ll be able to buy. The consensus among lenders has typically been a down payment of at least 20 percent, but it’s not always easy to save that much money for a large down payment – $60,000 on a $300,000 house, so many are allowing buyers to purchase a home with significantly smaller percentages. There are options for government, first-time buyers, and needs-based down payment assistance programs that may be able to help.
You don’t want to use all the cash you’ve saved on that down payment either, as you’ll want to make sure you have some leftover for furnishing the home and any equipment you’ll need to maintain it, such as a lawnmower and basic tools.
Your credit score will not only determine whether you’ll get approved for a mortgage loan, but how high your interest rate will be. If your score is around 680 or lower, that higher interest rate will mean higher monthly payments so you won’t be able to afford to spend as much on the home. Generally, you’ll get the best rate if your score is at least 760. Although it’s up to the specific lender to determine what score borrowers must have to get the best interest rates, the difference of even just a few points can affect your monthly payments significantly.