How Much House Can I Afford?
Buying your first home is a huge financial milestone. Whether it happens in your 20s straight out of college, or later in your 30s with a few kids in tow, people become first-time homeowners at various stages in life. Regardless of when you buy, and the condition of the market, it’s always a good idea to start the process with a practical budget that covers monthly expenses. After all, your budget is the foundation for determining the answer to the big question “how much house can I afford?”.
You can look deep into your budget to find a comfortable range, but the best insight comes from a combination of factors that your mortgage lender can help you uncover...
This is combined annual income before taxes that includes base salary, commissions, bonuses, overtime, tips, rental income, side hustles, investment income, alimony, child support, etc. Any and all income should be accounted for in your annual total.
Credit history and credit score play a huge role in establishing available loan programs, interest rates and required down payment. Minor credit issues won’t make or break eligibility, but they can increase interest rates. The amount of minimum payments you make on credit cards each month impacts this as well.
Although it can account for a portion of your down payment, don’t place all bets on your emergency fund or savings account. You definitely don’t want to deplete savings, leaving nothing behind for home expenses that will come sooner rather than later. Make sure you have enough cash reserve remaining to cover unexpected repairs, financial crises, or other unforeseen events—whether home-related or not.
Determining monthly debt should be easy if you already have a solid, accurate budget in place. This includes all of your monthly debt including credit card payments, loan payments, and any other recurring monthly deductions from your checking account. The only items to leave out are bills you pay in full each month, existing rent or mortgage payments, or the new mortgage you’re in search of.
Importance of Qualification Ratios
Housing ratios and debt ratios are critical to judging how financially fit you are to handle a mortgage, and they indicate to lenders whether or not you can afford the added obligation of a monthly payment. Lenders will review your overall financial health and calculate two ratios:
Back-end ratio—This is the percentage of your income that you use to pay debts. It includes any debts reflected on your credit report that require monthly payments like student loans, credit card bills, child support, alimony and other personal debt. The back-end ratio is calculated by dividing your monthly debts by your gross monthly income. Ranges vary per lender, but according to BankRate, a desirable back-end ratio is no higher than 36%.
Front-end ratio—This is the percentage of your income that would go towards housing-related expenses. Also referred to as the housing ratio, front-end includes the mortgage payment, property taxes, insurance costs, HOA fees and other associated real estate costs. This is calculated by dividing estimated housing expenses by your gross monthly income. Again, preferred ranges vary by lender, but the ideal front-end ratio is 28% or less.
Can I Improve My Qualification Ratios?
Many borrowers are surprised to find out they aren’t able to get as much money as they’d hoped, or worse, they’re not approved at all. Since your front-end ratio is based on housing expenses, there isn’t too much fluctuation unless you reevaluate your home search entirely. In order to improve your qualification ratios, focus on the back-end. Strategize how to pay less each month on non-housing related expenses. Eliminate credit card, loan and other monthly debt payments if at all possible, or at least try negotiate lower monthly minimum payments to keep available income up. Just like it takes time to rebuild your credit, it’s a slow process to improve debt to income ratios when you’re trying to obtain a mortgage.
To chart your path towards home ownership, contact RiverTrace today at (804) 266-2767.