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Personal Affordability Considerations
Your gross income goes a long way in determining the house you can afford. In general, most people can afford to finance a house that costs approximately two times their annual gross income.
Using this formula, if you take home $200,000 annually, then you can afford a mortgage of approximately $400,000. It's important to note that this formula is just a guideline.
Your house affordability will depend on how much your lender is willing to give you. And as you probably know, each mortgage lender applies their own criteria when it comes to the borrower's affordability or ability to buy a home. But generally, most lenders consider the following factors:
Your Gross Income
This is your total monthly income before deductions. Your gross income is more of your base salary.
It also includes part-time earnings, bonus incomes, self-employment earnings, alimony, disability benefits, child support as well as Social Security benefits. And if you are married, then your gross income will include that of your spouse.
Also known as the front-end ratio, this ratio refers to the percentage of your annual gross income, which can be deducted to cover your monthly mortgage payments.
Your monthly mortgage payment features 4 main elements. These are the principal, interest, insurance, taxes as well as insurance. The insurance component includes both private mortgage insurance where applicable and property mortgage insurance.
The mortgage-to-debt ratio shouldn't exceed 28 percent of your gross monthly income. While some lenders may allow you to exceed even 30%, it's always advisable to stay within the maximum allowed limit.
Debt-to-Income Ratio (DTI)
Also known as back-end ratio, the back-end ratio calculates the percentage of your gross monthly income that goes to paying debts.
The debts may include things like child support, student loans, credit card payments or any other outstanding debts that you may have.
That is to say, if your monthly income is $6,000 and $3,000 goes to pay your debts, then your back-end ratio or DTI is 50%, which is half your income. And with such a high DTI ratio, you will struggle to find a decent mortgage.
If possible, your debt-to-income ratio should not exceed 36%, if you want to get your dream home. So, if you are earning $6,000 per month, then your total debt payments shouldn't be exceeding $2,160 monthly.
The lower your debt-to-income ratio, the better the chances of qualifying for a mortgage. Also, you will find it easier to make your monthly mortgage payments if you don't have too many debts to service.
Your Credit Score
Apart from a strong financial history and a low DTI ratio, mortgage lenders will also check your credit score before approving your mortgage application. And this is to mean that your credit score, will also affect your house affordability.
So, why should lenders be interested in your credit score? Your credit score provides a picture of how you repay your debts. If you repay your debts on time, then there is a high chance that your credit score will be high. And lenders will not be hesitant to give you a mortgage on fair terms.
On the other hand, if you take forever to repay your debts or you don't repay them at all, there is a high chance that your credit score is poor. And you will struggle to find a lender that can agree to give you a mortgage. Consequently, your house affordability will be in jeopardy
Most lenders use the FICO scoring model to calculate credit scores, which range from 300 to 850. The higher the credit score, the better. For instance, if you have a credit score of 700 or above, you will enjoy better loan terms, compared to someone whose score is 600 and below.
Besides mortgage pricing, a strong credit score can also motivate the lender to be lenient in some areas where the borrower may be weak like down payment, income or cash reserves. On the other hand, if you have a poor credit history, then the lender will definitely adhere to the published requirements strictly.
So, if you have plans to buy a house soon, then you should start taking proactive measures of improving your credit score.
Some of the ways that you can improve your credit score include making your payments on time, paying off debts on time and keeping balances low on credit cards,
Also, it's advisable to keep unused credit cards open and constantly review your credit report to ensure there are no errors.
Your down payment plays an important role in determining how much house you can afford. The bigger the down payment, the lesser the amount needed to finance your mortgage.
And this translates to lower monthly mortgage payments as well as faster loan repayment.
In case you can't manage to make a sizable down payment but you still want to go ahead and buy a home, then you should consider refinancing the mortgage later into a lower rate.
Also, several assistance programs are available, designed for people who can't afford to make large down payments. So, ensure you talk with your lender or check with your local government about the availability and eligibility of such programs.
Buying a house doesn't end with making a down payment. You will also need to factor in closing costs.
Closing costs cover aspects like appraisal fees, credit reports, home inspections, attorney fees and home insurance.
Your realtor and your lender will tell you the exact amount that you will pay as closing costs. But in most markets, closing costs are approximately 4% of the property's purchase price.
For example, if you are buying a house worth $100,000, then you should multiply that figure by 4%.
And you will get an estimated closing cost of $4,000. You should then add this figure to your down payment, to determine the total cash amount needed to buy your dream home.
In case you can't raise the additional $4,000 fee, then you will have no option but to wait until you've raised this amount or go for a cheaper house.
Additional Home Ownership Costs
A mortgage is usually the biggest determinant of homeownership. However, there are several other expenses, which can determine your affordability, besides the mortgage. These additional expenses include:
Household appliances like dishwashers, stoves, cookers, refrigerators and others, will not last forever. Also, the carpet, driveway, roof or even windows will need regular maintenance. Hence, if you buy a house and you have nothing left in your bank to cater for major repairs, then you may find yourself in a tight financial position.
In some neighborhoods, you will be required to pay yearly or monthly association fees. These fees may cover things like snow removal, community swimming pools and law maintenance, among other services.
And in most situations, these fees tend to increase over time. If you can't manage to keep up with these fees, then you simply can't afford the house, and you should consider other options.
Water, electricity, insurance, heat, cable television, trash removal, telephone services and sewage all cost money. And while these expenses are not included in your mortgage pricing, they will add hundreds of dollars to your monthly mortgage payments thus affecting your house affordability.
Furnishing and Interior Decor
Chances are, you may want to change some aspects of the house when you move in. For example, you may want to change the curtains, replace the furniture, add a fresh coat of paint or install wallpapers. Therefore, you put that down payment and sign the mortgage paperwork, make sure you have some money left in the bank, which you can use to furnish the house once you move in. If you will not remain with any money after making the down payment, then you simply can't afford that house.
Should You Buy a House?
As you can see, several factors will determine your affordability for a certain house. Whether you should go ahead and buy a certain house will depend on your financial situation as well as your goals.
And just because your lender is willing to approve your mortgage application doesn't mean that you should take up the offer right away. Homeownership is a big financial responsibility that goes beyond putting a down payment.
But if you are in a strong financial situation and you've identified a house that aligns with your budget and personal preferences, then nothing should stop you from buying your dream home.