Most future homeowners can afford a mortgage loan even if the loan is significantly higher than their income. There are several ways to determine how much of a mortgage you can afford.
Understanding Your Options
Front End Ratio
Lenders consider a variety of ratios when deciding how much money a person can borrow for a mortgage. First, lenders look at your yearly gross income, or the Front-End Ratio. A general rule is to keep the mortgage from exceeding 28% of your gross income.
To calculate your Front-End Ratio, multiply your gross annual income by .28 then divide by 12 (months). The answer is your maximum Front-End ratio.
Lenders also consider your debt-to-income (DTI) ratio, which is also called the Back-End Ratio. That number determines what percentage of your income is needed to cover debts like car payments, credit cards, and other loans. The DTI should not exceed 36% of your gross income.
To calculate your DTI, multiply your gross income by .36 and then divide by 12. It’s important to try to lower your debt as much as possible before seeking a mortgage loan to help lower your DTI ratio. In areas with higher-priced homes, it’s harder to stay within the 36% so some lenders allow the DTI ratio to go up to 45%.
Most lenders require a down payment of about 20% of the price of the home. A down payment of 20% minimizes the property mortgage insurance (PMI) requirements and could influence your monthly mortgage payment.
Things to Consider
You should also consider personal matters when deciding how much of a mortgage loan you can afford. Even though you may be approved for a certain mortgage amount, that doesn't necessarily mean you can keep up with payments.Here are some personal questions to consider when deciding how much money to borrow:
- Are two incomes needed to pay the bills? How stable is your current job? Is it easy to find another job if you lose your current one?
- Are you willing to make lifestyle changes in order to afford the home?
- What are the potential future debts you could encounter? Are you considering having a child, sending a child to college, or buying a new car?
Other factors can influence the mortgage loan amount you feel comfortable paying. Those can include, but are not limited to, maintaining the home, utility expenses, and cable/internet fees.
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