What Mortgage Can I Afford? Understanding Mortgage Affordability

Buying a house is a huge undertaking. When looking for a new home, it’s easy to get excited about kitchens and bathrooms and forget about the financing. You need to be realistic about what you can afford. You need to evaluate your finances and priorities and ask yourself, “What mortgage can I afford?” Learning mortgage requirements can help determine realistic loan options and help you create a financially sound path forward. 

What Mortgage Can I Afford?

As a home buyer, you’ll want a certain level of comfort in your monthly mortgage payments. Before looking at houses, it’s a good idea to understand what you can afford and develop a payment estimation. This estimate will help you with the dollar amount you need to stay below to make a financially wise home-buying decision. 

To figure those numbers…

Multiply Your Annual Income

Prospective homeowners can generally afford to finance between two and two and a half times their annual gross income. For example, a person earning $70,000 per year can generally afford a home in the $140,000 to $175,000 range.

Calculate Your Ratios

Lenders want someone who earns more than enough to make the mortgage payments and cover their other monthly obligations. And as a borrower, you want to avoid getting over your head by asking yourself, “What mortgage can I afford?” 

Your front- and back-end ratios indicate how much you can afford without stretching your finances to the breaking point. Your front-end ratio measures how much of your income is taken up by your housing expenses. Lenders want a front-end ratio of less than 28%. If lenders see more than 28% monthly payments, they worry you will have trouble making payments.

Your back-end ratio measures how much of your income is used for other monthly debts. High back-end ratios indicate more of your income is allocated to other debt obligations, making less income available for the mortgage. Lenders prefer you to have a ratio of at most 36%. 

To calculate a front-end ratio:

Say your monthly pre-tax income is $4,250.

$4,250 x 0.28 = $1,063

Your total mortgage payment shouldn’t exceed $1,063. 

And a back-end ratio:

Using the income amount from above, $4,250 monthly, if your total monthly debt payments of $2,000, your back-end ratio is 33% ($1,500 / $4,500). Lenders like to see a back-end ratio of less than 36%.

We know this can be confusing, that is why we have mortgage loan officers that will help you every step of the way.

What Other Factors Affect What Mortgage I Can Afford?

Many buyers focus on the mortgage payment and overlook other new home expenses. Part of asking yourself, “What loan you can afford?” is considering the additional costs of owning a new home. 

While you can’t plan for every extra expense, anticipate paying:

• Homeowners Insurance. An insurance agent will give you an idea about the price of a policy. They’ll generally consider the home’s age, roof condition, size, and other structures such as fencing, a shed, or a pool. 
• Mortgage Insurance. You will pay private mortgage insurance if you put less than 20% down. The larger your down payment and the higher your credit score, the lower this amount will be.
• Homeowners Association Fees. Certain communities have amenities and require a homeowners association fee. Fees are typically charged on a monthly, quarterly, or annual basis. 
• Home Maintenance. The larger and older the home is, the more likely it requires more home maintenance. You’ll want to set aside money each month for fresh paint, repairs, or other expenses of home ownership.
• Utilities. Estimate your electricity, trash, and water. You might be paying these expenses where you live now, but if your new home is larger, these costs will increase. 

How Do Lenders Determine Mortgage Loan Amounts?

Each mortgage lender maintains their own formula to determine the level of risk of a prospective home buyer in terms of the loan you will be offered. Income, down payment, and monthly expenses are basic financing qualifiers. They consider anything that could jeopardize your ability to pay your loan.  

Income 

Your income establishes a baseline for what you can afford. Gross income is income before taking out taxes and other obligations. This income includes money you regularly receive from your salary, bonuses, part-time earnings, investments, Social Security benefits, disability, alimony, and child support.

Remember to consider the value of stable employment. While a stint of unemployment will stand out, even changing jobs can make lenders nervous. If you’re contemplating getting a mortgage, stay in your current position. The same holds for any co-signers. Once your mortgage is approved, you can pursue new career opportunities. 

Debt-to-Income Ratio

Gross income is vital in determining if you qualify, but the lender will also calculate your debt-to-income ratio. A low debt-to-income ratio means debt payments make up a small portion of your gross monthly income. Lenders don’t want you to be overextended, and the debt-to-income ratio helps them estimate how easily you can repay.  

To calculate your debt-to-income ratio:

Total your monthly debts, including rent or mortgage payments, child support or alimony, student loans, car payments, credit card minimum, and other obligations. Don’t include grocery bills, utilities, taxes, and other bills that vary from month to month. 

Next, do a simple calculation. If you pay $2,000 in debt services and make $4,500 monthly, your ratio is 44%. Lenders recommend a debt-to-income ratio below 43%. 

Down Payment

Lenders want to know you’re invested and usually give borrowers with a larger down payment a lower interest rate. The more you invest in the house, the less likely you will default on the loan. 

Lenders compare your down payment to the loan amount, which is your loan-to-value ratio. The less money you put down, the lender views you as a higher risk. Say you make a 3% down payment on a $150,000 loan. You put down $4,500. But if you put down $30,000, a 20% down payment, on a $150,000 loan, you have a lot more to lose if you default.   

Credit Score 

Your credit score will impact your interest rate. A high credit score means you’re less risky to a lender. You pay your bills on time and don’t take on too much debt. Lenders see you as a responsible borrower who is more likely to pay the monthly mortgage.

You’ll typically need at least a 620-credit score for a conventional loan. If you choose government insured FHA or VA financing, you’ll often need a credit score of 580 or higher.

Taking steps to check and improve your credit will put you in a better position to get a lower rate from your lender. Boost your credit score by paying off debts and making your payments on time, every time. 

Opening new accounts lowers your credit score. Hold off on getting new credit cards, personal loans, or anything requiring a credit check. Check for inaccurate entries. You don’t want to miss out on your dream home because of an error.  

Focus Federal Can Help

While borrowing for a mortgage may seem daunting, familiarity with the process can improve your chances of getting the mortgage you need. Focus Federal Credit Union can help you understand the home-buying process and how you can prepare before you head to your next open house.