What Mortgage Can I Afford? Understanding Mortgage Affordability

Buying a house is a big decision. Before getting excited about features, ensure it’s the right financial and personal choice for you at this time. Navigating an active housing market with rising interest rates requires careful consideration. Before deciding on a home, take a step back to evaluate your finances and priorities. Ask yourself, “How much mortgage can I afford?” Affordability involves more than the payment; it’s about your entire financial picture. 

The Focus Federal Credit Union is here to guide Oklahoma families through mortgage requirements and helps determine realistic loan options for a sound financial future. To better understand this concept, let’s unpack the concept of mortgage affordability.

What Is Mortgage Affordability?

The term “mortgage affordability” is thrown around a lot in the housing industry. As a home buyer, you’ll want to ensure a level of comfort in your monthly mortgage payments. Before looking at houses, it’s a good idea to understand what you can afford. 

So, what exactly is mortgage affordability? At its simplest, it’s determining whether a mortgage fits your financial situation. 

More specifically, it refers to the maximum loan amount and monthly payment you can comfortably manage without compromising your financial stability. 

Factors like your income, expenses, and debts all influence mortgage affordability. 

For example, if adding a mortgage payment leaves you short on essentials like groceries or your car payment, you can’t afford the house.

How Lenders Calculate Mortgage Affordability

Each mortgage lender uses its own formula to assess the risk level of a prospective homebuyer. Income, down payment, and monthly expenses are the basic criteria for financing. Lenders consider anything that could jeopardize your ability to pay your loan.  

When determining your mortgage affordability, lenders consider:

• Gross Monthly 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, disability, alimony, and child support. More income means greater financial security. Lenders also value stable employment. A stint of unemployment will stand out, even if you change jobs. 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 important, but lenders also calculate your debt-to-income ratio. A low ratio means debt payments take a small portion of your income. Lenders use this to estimate your ability to repay. To figure out your ratio, add up your monthly debts, including mortgage payments, child support, alimony, student loans, car payments, credit card minimums, and other obligations. Exclude fluctuating bills such as groceries and utilities. For example, $2,000 in debt payments divided by $4,500 income gives a ratio of 44%. Lenders usually recommend staying below 43%.
• Down Payment. Lenders compare your down payment to the loan amount. The less money you put down, the more risk you have to the lender. Say you only make a 3% down payment on a $150,000 loan ($4,500). But if you put down $30,000, a 20% down payment, on a $150,000 loan, you accept more risk, as you have more to lose if you default.
• Credit Score. Your credit score is one of several factors that will impact your interest rate. A good credit score means 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 make the monthly mortgage payment. 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. 
• Front- and Back-End Ratios. Lenders want someone who earns more than enough to make their mortgage payment and cover other monthly obligations, and as a borrower, you want to keep mortgage affordability as your goal. 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 goes toward housing expenses, while your back-end ratio measures how much of your income goes toward other monthly debts.

Other Factors That Affect Mortgage Affordability

Many buyers only focus on the mortgage payment and overlook other expenses associated with a new home. Part of your mortgage affordability is estimating the additional costs of owning a new home.

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

• Homeowner’s 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 down less than 20%. The larger your down payment and the higher your credit score, the lower this amount is.
• Homeowners’ Association Fees. Certain communities have amenities and require a homeowners’ association fee. Fees are typically charged monthly, quarterly, or annually.
• Home Maintenance. Yards, roofs, septic systems, A/C units, and more will require maintenance. The larger and older the home is, the more likely it is to require additional maintenance. You’ll want to set aside money each month for both upkeep and repairs.
• Utilities. Estimate your electricity, trash, and water. You might be paying these expenses where you live now, but if your new home is larger or in a different area, these costs may increase.

Using a Mortgage Affordability Calculator

Lots of sites offer online mortgage affordability calculators. Based on your information, the calculator determines your monthly mortgage payment. If you’ve already collected your financial information (annual gross income, monthly debt payments, down payment) it’s as simple as plugging the numbers in. Results will show the maximum home value you can afford, along with calculated or entered monthly payments.

Calculators let you play around with term lengths and down payment amounts to see how they affect your loan amount and monthly payment. Online calculators are a great tool to help you focus your housing search. But for the most accurate numbers, it’s important to reach out to a lender, who can also include estimated taxes and insurance, as well as interest and principal payments.

What Is a Good Debt-to-Income Ratio for Mortgage Affordability?

Lenders calculate your debt-to-income ratio to determine if you can make monthly mortgage payments. Lenders want a front-end ratio below 28%. If lenders see more than 28% of your income going toward monthly payments, they worry you will have trouble making payments. Your back-end ratio measures how much of your income goes toward other monthly debts. High back-end ratios indicate more of your income is allocated to other debt obligations, leaving less available for the mortgage. Lenders prefer less than 36%.

Let’s look at an example: say your monthly pre-tax income is $4,250. To calculate your front-end ratio: $4,250 x 0.28 = $1,190. Your total mortgage payment shouldn’t exceed $1,190. For the back-end ratio, if your total monthly debt payments are $1,500, your back-end ratio is about 35% ($1,500 divided by $4,250).

To maximize your mortgage affordability, focus on improving your debt-to-income ratio. To do this:

• Pay Off Your Debt. Focus on paying off debt before you buy a home. If you already have a significant car payment, student loan, or credit card debt, it’s difficult to make a mortgage payment, too. Work to pay off or down those debts first to put yourself in a better financial position.
• Increase Your Income. Easier said than done, but if the amount of money you have coming in increases, the amount you can afford to spend goes up. Consider starting a side hustle or taking on extra shifts at work.
• Avoid New Credit. Now is not the time to apply for a new credit card or to take out a personal loan.
• Keep Saving. Buying a home is expensive; it’s going to take longer to save, and that’s okay. You may just need to rent longer and save for a larger down payment. Waiting and being in a healthier financial position is better than buying and not being able to afford your mortgage payment.

How To Improve Your Mortgage Affordability

Mortgage preapproval is a lender’s conditional commitment to lend you up to a specific amount based on a review of your financial situation. It’s one way to improve your mortgage affordability. During mortgage preapproval, you’ll provide a lender with much of the same information and documentation you’d submit with a mortgage application, such as pay stubs, tax returns, bank statements, and identification. The lender then runs a credit check, calculates your debt-to-income ratio, and assesses whether your financial profile meets their underwriting standards. You may be required to pay a fee.

If successful, you receive a letter of preapproval that states the estimated loan amount and other details, including the interest rate. A pre-approval is valid for a specific period, usually 60 to 90 days, and the exact period is in the letter. A preapproval is not the same as final loan approval. The lender will still need to verify property details, conduct an appraisal, and recheck your financial situation before final closing.

A mortgage preapproval provides:

• Stronger Credibility With Sellers. In a competitive housing market, a preapproval letter can give you an edge. A preapproval letter demonstrates that a lender has already reviewed your finances and considers you a qualified borrower. Submitting a preapproval letter reduces a seller’s uncertainty about whether your financing will come through and can make your offer stand out.
• A Clearer Understanding of Your Budget. A preapproval gives you a clearer understanding of how much you can afford before you start your home search. Since a pre-approval is based on financial documentation rather than rough estimates, it gives you a realistic price range. This can prevent the disappointment of falling in love with a house that’s out of budget.
• Faster Loan Processing. Because your finances have already been reviewed, the loan process can move more quickly once you sign a purchase agreement. Lenders already have your income, employment, credit, debts, and assets, which can shorten the underwriting timeline.

How TFFCU Can Simplify the Mortgage Process

While home loans may seem daunting, familiarity with the process can improve your chances of getting the mortgage you need. If you purchase a house beyond your means, you could find yourself in a situation where you’re struggling to pay your bills. Focus Federal Credit Union can help you understand the home-buying process and prepare you for your next house. TFFCU offers competitive rates and low fees. We know this can be confusing; that’s why we provide one-on-one support to help you every step of the way. Ready to take the next steps? Contact us or visit one of our branches.