How Much Home Can I Afford With My Income?
One of the key common questions by new homebuyers is how much home can I afford.
How much home can I afford? That depends on three factors:
- Ability to repay
- Debt to income ratio
- How much home can I afford versus qualifying ratios
How much home can I afford? That’s the first question new homebuyers should ask. Your mortgage lender can tell you what you qualify to spend, but only you know what mortgage payment works with your lifestyle.
Can I Afford a New Home Purchase?
How much home can I afford with my income?
This is one of the most important questions that every homeowner. This holds true especially for the first-time homeowner should ask before house shopping.
One of the most important factors lenders consider is income when qualifying borrowers is if they can afford the proposed housing payment. The Ability to Repay rule is federal law and mortgage lenders must by law make sure that their borrowers can afford the mortgage payment and their other debts.
However, borrowers should not just rely on how much their lender will allow them to borrow. You might qualify to borrow more than you are comfortable spending.
Lenders will only consider debt to income ratio (DTI) when calculating and qualifying income when determining if you can afford your mortgage.
How to Calculate Debt to Income Ratio
Here is how you calculate your DTI:
Take the sum of all of the monthly minimum debt payments of your debts, including the proposed mortgage payment (the principal, interest, taxes and insurance, or PITI). That might include credit card, auto loans, personal loans, student loans, etc. Then you divide this by your gross (before tax) income.
If your debt payments plus proposed mortgage payment total $2,000 a month and you earn $6,000 per month, your DTI is .3333, or 33.33%.
Lenders also call the DTI your “back-end” ratio. If they say you have a good back-end they are not talking about the fit of your jeans.
There is also a “front-end” ratio in mortgage lending. That’s just your mortgage payment (PITI) divided by your gross monthly income.
Debts Not Considered by Underwriters
Lenders do not take into consideration other monthly bills such as:
- child care
- auto insurance
- cellular phone bills
- after school activities
They are not included in the DTI. However, YOU should consider these expenses when you buy a home. If you have high commuting costs or expensive hobbies, you have less money available for mortgage payments. The lender won’t know this and you could end up with an unaffordable loan if you borrow too much.
The most updated Census numbers indicate that the new average home sells for $335,890. So let’s ask the question on what household income is needed to qualify for a $350,000 home.
According to the income numbers on the Census, the average household gross income of a typical American family is $60,000 in the United States. Gross income is before taxes so after taxes figure this family takes home $3,800 per month net.
The principal and interest on a $350,000 home purchase after the home buyer put a 3.5% down payment is $1,750 per month. Buyers then need to add property taxes and homeowners’ insurance to the principal and interest.
What Goes Into a Monthly Mortgage Payment?
Here is what monthly housing payment for an FHA loan mighty be. Again, this is an estimate on a $250,000 mortgage loan balance for a borrower making $50,000 per year:
- $1,250 principal and interest
- FHA monthly mortgage insurance premium $180 estimated
- $250 property taxes or $3,000 annually
- $100 per month for homeowners insurance or $1,200 per year
- Total housing payment: $1,780 per month
It leaves $1,420 for this family to pay utilities, home phone bill, insurance, child care, after school activities, education expenses, fuel, groceries, and other monthly bills.
Under the mortgage lenders’ qualification criteria, a borrower with a $50,000 gross income will qualify for a $250,000 home purchase. However, can you afford a $250,000 home? Remember that lenders qualify borrowers with the gross income they make and not net income.
When determining your ability to afford a mortgage on your income, you must also consider your savings and your job security. Don’t put every last cent you have into your down payment and closing costs. You need reserves.
What are reserves? Reserves are savings that can be used to pay your mortgage or other expenses if you experience an interruption in income or an emergency. Lenders measure reserves in months. If your PITI mortgage payment is $1,000 a month and you have $6,000 in savings after closing on your home, you have six months of reserves ($6,000 / $1,000 = 6).
Lenders like to see at least two months of reserves for salaried people and six months for self-employed applicants. It’s not a rule but it’s smart to have access to emergency cash. If you won’t have reserves after closing, have a plan to create emergency savings as soon as possible. Or at least establish a line of credit that you can use for emergencies.
You do not want to be house rich but live paycheck by paycheck. So when buying a house, qualifying for a mortgage is critical but considering your exact situation is more important.