Mortgage Affordability - How Much Can You Afford?
As a first time home buyer, getting a house and mortgage is an important financial milestone in your life. However difficult it may be, it's a good idea to have a good sense of a realistic budget in mind before you begin working with a realtor and house hunting. Just how much can you afford? You can determine your affordability by following three simple rules based on different percentages of your monthly income.
The Rules of Home Affordability
To help determine how much a mortgage lender will approve a borrower for, lenders use what is called the Qualification ratios. Although lenders do tend to use slightly different ratios, most are within the same range. Below are the average qualification ratios you should consider when looking at House Affordability.
1. Your Maximum Mortgage Payment (The 28% Rule)
The rule in determining the purchase price of a property is that your monthly mortgage payment should not exceed 28% of your gross monthly income (your income before taxes). For example, if you and your spouse have a combined annual income of $75,000, your mortgage payment should not exceed $1,750.
2. Your Maximum Total Housing Payment (The 32% Rule)
The next rule suggests that your total housing payments (for example your mortgage payments, homeowner’s insurance, mortgage insurance, property taxes, and condo fees) should not exceed 32% of your gross monthly income. Using the above example for combined annual gross income, their total monthly housing payment should not be more than $2,000 per month.
3. Your Maximum Total Monthly Debt Payments (The 40% Rule)
Finally, your total monthly debt payments - or Total Debt Servicing Ratio - this includes, your mortgage, auto loan, student loan, and credit card payments should not exceed 40% of your gross monthly income. In the above example, the couple with $75,000 income should not have total monthly debt payments exceeding $2,500.
This means that if you have a big car payment or a lot of credit card debts, you won’t be able to afford as much in mortgage payments. Banks and lenders may not approve you for a mortgage until you can show you have reduced or paid off all other debt entirely before approval .
Now that you have an idea of how much of a monthly mortgage payment you can afford, you will probably want to know what that amount can give you with regards to a purchase price on a property.
Although you will need to know the interest rate you qualify for before you will be able to determine an exact budget, you can still use the following to gain an estimated amount for a purchase price.
You can use your down payment as a benchmark to determine your maximum affordability. Ignoring income and debt levels, you can determine how much you can afford to spend using a simple calculation.
If your down payment is less than $25,000 you can find your maximum purchase price using this formula:
Down Payment / 5% = Maximum Affordability
If your down payment is $25,001 or more you can find your maximum purchase price using this formula:
(Down Payment Amount - $25,000) / 10% + $500,000 = Maximum Affordability
The minimum down payment lenders require is 5% of the purchase price. Add your down payment amount to your maximum affordability amount, and you have a good idea of the most you can spend on a home.