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How Much Can You Afford in a Mortgage?

Buying real estate with a mortgage is often the most significant personal investment that most people make. How much you can afford to borrow is determined by a variety of factors, not just how much a bank is able to lend you. You must assess not just your financial situation, but also your interests and goals. How much can I borrow for my mortgage based on my income?

Here’s what you need to do to figure out how much you can afford.

IMPORTANT TAKEAWAYS

The general rule is that you can afford a mortgage that is two to two and a half times your gross income.

Principal, interest, taxes, and insurance are the four elements of most monthly mortgage payments (collectively known as PITI).

Your front-end ratio is the amount of your annual gross income that goes into paying your mortgage, and it should not be more than 28 percent in general.

Your back-end ratio is the amount of your annual gross income that goes toward debt repayment, and it does not surpass 43 percent in total.

Identifying What Is an Affordably Priced Mortgage

In general, most prospective homeowners can afford to finance a house that costs two to two and a half times their annual gross income. A individual making $100,000 per year can only afford a mortgage worth $200,000 to $250,000. This estimate, however, is just a general guideline.

Finally, when selecting a house, many additional considerations must be considered. To begin, it’s a good idea to understand what your lender believes you can afford (and how it arrived at that estimation). Second, you must do some personal introspection to determine what sort of home you are willing to live in if you want to live in the house for an extended period of time, as well as what other forms of consumption you are willing to forego—or not—in order to live in your home.

Criteria for Lenders

Although each mortgage lender has its own affordability requirements, the willingness to buy a home (and the size and terms of the loan you will be offered) will still be based primarily on the following factors.

Gross Earnings

This is the amount of money a prospective home buyer makes before taxes and other commitments are deducted. This is your base pay plus any incentive money, and it can include part-time wages, self-employment earnings, Social Security compensation, disability, alimony, and child support.

Front-End to Back-End Ratio

The front-end ratio, also known as the mortgage-to-income ratio, is heavily influenced by gross income. This is the amount of your annual gross income that can be allocated to mortgage payments per month.

A decent rule of thumb is that your PITI front-end ratio does not surpass 28 percent of your gross profits. Many lenders, however, allow borrowers to exceed 30 percent, and some even allow borrowers to exceed 40 percent. 1

Back-End to Front-End Ratio

It measures the percentage of your gross income needed to cover your debts, also known as the debt-to-income ratio (DTI). Credit card fees, child support, and other unpaid loans are examples of debts (auto, student, etc.).

In other words, if you spend $2,000 a month in debt service and make $4,000 a month, your debt-to-income ratio is 50% — half of your monthly income is used to pay off the debt.

A debt-to-income ratio of 50%, on the other hand, will not get you your dream home. Most lenders recommend that your debt-to-income ratio (DTI) not surpass 43 percent of your gross income. 3 Multiply your gross income by 0.36 and divide by 12 to determine your overall monthly debt based on this ratio.

Your Credit Rating

If your salary is one side of the affordability coin, your debt is the other.

Mortgage lenders have devised a method to assess a prospective home buyer’s level of risk. The calculation varies, but it is usually based on the applicant’s credit score. 6 Applicants with a poor credit score should expect to pay a higher interest rate on their loan, also known as an annual percentage rate (APR). Pay close attention to your credit reports if you want to purchase a home soon. Maintain vigilance about your reports. If there are any incorrect entries, it will take time to delete them, and you don’t want to miss out on your dream home because of something that was not your fault.

How to Make a Down Payment

The down payment is the amount of money that the buyer can afford to pay for the house out of pocket, using cash or liquid assets. Lenders usually require a down payment of at least 20% of the purchase price of a house, although many buyers may purchase a home with much lower percentages. Obviously, the more money you can put down, the less money you’ll need to borrow and the better you’ll look to the bank.

For example, if a prospective home buyer can afford to pay 10% down on a $100,000 home, the down payment is $10,000, implying that the homeowner would fund $90,000.

Aside from the amount of financing, lenders want to know how long the mortgage loan will be needed for. A short-term mortgage has higher monthly payments but is expected to be less costly over the loan’s life.

How Lenders Make Their Decisions

Many factors influence a mortgage lender’s decision on home-buyer affordability, but they all boil down to wages, debt, assets, and liabilities.

Personal Factors to Consider for Home Buyers

A lender can tell you that you can afford a large estate, but are you sure? Remember that the lender’s guidelines are specifically concerned with your gross pay and other debts. The issue with using gross income is straightforward: You’re deducting up to 30% of your pay, but what about taxes, FICA deductions, and health insurance premiums? And if you get a tax refund, that won’t benefit you right now—and how much would you get back?

As a result, some financial experts believe that thinking in terms of your net income (aka take-home pay) is more practical, and that you should not spend more than 25% of your net income on your mortgage payment. Otherwise, even though you can afford to pay your mortgage on a monthly basis, you can end up “home bad.”

The costs of purchasing and maintaining a home may consume such a large portion of your income—far and above the nominal front-end ratio—that you will not have enough money to cover other discretionary expenses or unpaid debts, or to save for retirement or even a rainy day. Whether or not to be house poor is largely a matter of personal preference; just because you are eligible for a mortgage does not mean you can afford the payments.

Decoration and furniture

Until purchasing a new home, consider the number of rooms that will need to be decorated as well as the number of windows that will need to be covered.

In conclusion

Most people’s biggest personal expense would be the purchase of a home. Take the time to do the calculations before taking on such a massive debt. After you’ve run the calculations, think about your situation and your lifestyle—not only now, but for the next decade or two. Until you buy a new home, remember not just how much it will cost you to buy it, but also how your potential mortgage payments will affect your life and budget. Visit also: Finance Guide
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