When answering the question, “How much of a mortgage payment can I afford?” several criteria come into play to arrive at that magic number.
Obtaining a mortgage to buy a home is probably the biggest personal transaction the majority of people make. A number of factors will determine how much you can borrow including things like your total income, credit score, debt-to-income, and the ratio of the mortgage amount to your total income.
So, how much of a mortgage can I afford?
As a rule of thumb, most homebuyers can afford a mortgage that works out at between two and two and a half times their total income (before taxes). Using this as a guideline, if you earn a total of $200,000 a year, you should be able to afford a $400,000 to $500,000 mortgage comfortably, but this is just a ballpark figure.
Really, it isn’t how much you can afford, it’s how much you can borrow based on the mortgage company’s prerequisites. Every lender will have its own rules and regulations when it comes to calculating the amount and term of a loan they will offer you.
Generally, every lender will determine how much they are willing to lend you depending on the following:
Your gross income is the total of all your income before any taxes and other deductions and can include not only your salary but any other earnings from sources like part-time work, Social Security benefits, self-employment, etc. This is the starting point in any mortgage offer calculation.
Your gross income plays an important part in two critical ratio calculations.
1) Debt to Income Ratio (DTI)
The DTI ratio works out what percentage of your gross income is needed to cover all your debts, including credit card payments, loan payments, and more importantly mortgage payments. Your DTI should not be more than 36% of your pre-tax total income. While this percentage is “ideal”, there are occasions when you may be able to obtain a mortgage with a higher DTI. If you have a high credit score, but your DTI ratio is higher, then lenders may still look favorably on your application. Also, some loans, like an FHA mortgage, allow for debt to income ratios of 43% or more in certain circumstances.
2) Mortgage to Income Ratio
This is how much of your annual income can be used to pay your mortgage every month. The monthly mortgage payment will be made up of principal, interest, taxes, and insurance. Taxes and insurance are generally escrowed by the mortgage company each month, but if private mortgage insurance (PMI) is needed, then this is added to the monthly payment, not escrowed. This ratio, in a perfect situation, should be no more than 28% of your gross income. However, nothing is perfect in this world, and lenders know this and may let you go above 30% or even 40%.
Credit scores can be anywhere from 300 to 850. A score of 740 or above is considered to be very good, but you don’t need a score that high to get a mortgage. A person with a credit score below 580 is considered to be a risky borrower. Many lenders will approve loans to borrowers with a score between 580 and 669, and a score of 670 to 739 is deemed to be a good score, with anything above being very good to exceptional.
Just as a good credit score is important, so is your credit history. Lenders will look at your credit history and use that information to decide if you are a good credit risk or not. Your credit report lists all credit accounts, open and closed, the length of time they have been open, credit limits, and whether payments have been made on time.
Every lender will, in the course of any mortgage process, pull your credit report. So the best advice we can give is before you start shopping around for a mortgage, get a copy of your credit reports from all three credit reporting agencies. Go through them and look for anything that doesn’t look right. Mistakes happen over time and you should inform the agency of any discrepancies.
Calculate how much you can afford
Regardless of how much of a mortgage you qualify for, this does not mean you have to borrow that amount. Lenders are basing their offer on your gross income and any debts you have. But you never see up to 30% of your gross income. It goes towards income tax, FICA, and health insurance. It is widely thought better to use your net income in any calculation and to keep your mortgage payment below 25% of your net income.
How much deposit can you afford?
There is a misconception that you need a 20% deposit before you can get a mortgage. There are numerous options for mortgages with low or zero deposit requirements within the Boise real estate market. Shop around. Don’t take the first offer you get. (And if you need help finding a lender you can trust, just let me know and I can point you in the right direction.)
Think about the new house you are considering. Are there extra rooms that will need to be furnished? What about window treatments? Is there an HOA and if so, what are the fees? What about utilities? Do you have to sign up for new cable television services? Is there an internet service to pay for? Will the new house need more homeowners insurance?
These are things that are quite often forgotten about in the excitement of house hunting and getting your mortgage sorted out, but you should include them all in any calculations.
One final thought
Do your research on available mortgage loan types and choose the one best suited to you and your family. Make your decisions based on what you can comfortably afford, not what the lender qualifies you for. After you have done your number-crunching, think about your situation, now and in the future. Consider not only the cost of buying your new home but what impact the new mortgage and all the other associated payments will have on your lives and your budget.
Use this simple calculator to get an idea of what your monthly payment would be on a mortgage: