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How Much Home Can I Afford

When you get to the point of wanting to buy a home, you have to wonder just how much home you can get away with buying. “How much do I need to afford a home?” people sometimes wonder. Let’s look at a few factors.

Many people have dreams of owning a big house, but realistic buyers don’t ever actually expect that to happen. At least not so soon! Still, it’s easy to overestimate what you can afford. Variables like location, your credit score, and the quality of the housing market will have big influences. They will not only affect what kind of home you’ll be able to get, but also what kind of house you’ll be able to maintain. So, how can you determine what exactly you can comfortably get and keep?

Interest Rates

Interest rates will affect the amount you pay each month for your mortgage. These rates are constantly shifting, sometimes hour to hour, and even the slightest jump can have a significant impact on what will come out of your pocket each month. With a fixed-rate mortgage, you lock in a specific interest rate, so that you’re not constantly adjusting your monthly payments. The lower the interest rate, the better. In fact, even a one percent difference can mean thousands of dollars lost or gained during the life of your loan.

Mortgage Payment

Now, whichever lender you choose to go with will establish just how big of a mortgage payment you’ll qualify to pay each month. You don’t necessarily have to pay that specific amount. They will employ a formula looking at your income and debt to figure out the maximum monthly payment for what they’ll be willing to lend you. When looking at how you’ll be able to afford a home, it’s important to keep that in mind.

Front-end Ratio

Using what’s known as a front-end ratio, your lender looks at the gross monthly income you bring in (remember: not net income, but the actual amount you make before taxes). Then, they take a percentage of that amount to determine the maximum monthly payment you can afford. The percentage varies depending on the type of loan you’re looking at. For example, FHA loans carry a 31 percent ratio on the front-end. Conventional loans are 33 percent. So, they will take your monthly gross income and multiply it by the front-end percentage of the loan. The total amount of your PITI (Principal, Interest, Taxes, Insurance) couldn’t be more than this amount in order for you to be eligible for that loan and be able to afford a home.

Back-end Ratio

Back-end ratios take that mortgage payment and include any debt that you might have. Things like credit cards and any financing you have ongoing will come into consideration here. So, your monthly gross income is multiplied (for back-end FHA loans, by 43 percent, and for conventional loans, by 45 percent). The resulting amount is the limit for your monthly recurring debt. If the total of your recurring monthly debts is higher than the limit, you cannot qualify for the amount of the loan.

These calculations can be a bit tricky to understand. If you’re having difficulty with them, consult your real estate agent, or as your lender to walk you through the steps more carefully.

Down Payment

To be able to afford a home, after looking at loan possibilities you can start to think about how much of a down payment you’d like to make. Some people feel that putting everything they have in the bank on a down payment is the way to go, but that’s not always the case. It’s always a good idea to keep some money in the bank just in case something unforeseen comes up. Some lenders will have reservations about giving out loans to people with no backup should something happen that might make it difficult to make their loan repayments.

In some cases, you may qualify for a loan without any downpayment. Veterans are eligible for no money down VA loans. And some first-time borrowers will qualify for limited income loans.

Monthly Payments

But you should remember, the more money you’re comfortably able to put down, the less your monthly payment will be. Just as with buying anything else through financing or credit, the less you have to pay interest on, the less you’ll end up spending both monthly and in the long run. Certain loans will carry required down payments. FHA loan lenders will usually want between 3 and 4 percent of the total loan. Conventional loans can range anywhere from between 5 and 15 percent of the total loaned amount.

Set Aside Some Money

One exercise that you might want to consider is trying to make an example mortgage payment each month. If you’ve got an idea how much a payment would be, take that amount from each check and set it aside, maybe in a savings account. Try it for a few months and see if it’s feasible for you to afford a home of that price. If so, you’ll have a good indication that you’ll be able to make your mortgage payments when you do move into your new house. You’ll also have a nice little reserve for either a down payment or to keep in case of an emergency. If you’re not able to make it, then you’ll have saved yourself a lot of disappointment and work, and you can start to figure out exactly how much home you can safely afford.

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