How to Find Out How Much House You Can Afford
Thinking about money matters, especially for major, life-changing purchases like a house can be daunting, but do not let it stop you in your tracks. Read this guide for effective tips you can take to stay on track of your home buying goals.
Option A: Calculate on your own
● Step 1: Determine how much income your household generates
Do you know how much money you make every month? Consider all of regular sources of income, from your salary to any additional earnings and revenue from sources such as investments or even alimony, if applicable.
If you are married or are sharing the household (and you plan to continue sharing the new home you are planning to buy), combine your monthly income to get a more accurate base amount.
● Step 2: Identify and add up your total monthly debt payments
Determine how much you pay for relevant debt obligations. These include any of the following:
– Outstanding credit card dues
– Student loans
– Car payments
– Child support obligations, if any
– Other notable loans
Note that regular utility bills, such as electricity, cable, telephone and internet services, and pest control costs are not included. Lenders generally do not consider these when evaluating your credit rating.
If you are paying rent, exclude this from your computations, too. This expense will no longer apply when you buy your own home.
● Step 3: Apply the 28/36 rule
Lenders generally use this standard to assess borrowers’ creditworthiness. It should also guide budgeting and debt management for your household.
The 28/36 rule simply means you should spend no more than 28% of your gross monthly income on housing expenses (principal, interest, taxes, and insurance). In addition, the household’s total debt (including housing costs) should not exceed 36%.
For example, for a household that earns $45,000 annually:
$45,000 ÷ 12 = $3,750 monthly household income
To compute for 28% (or 0.28):
$3,750 x 0.28 = $1,050
To compute for 36% (or 0.36):
$3,750 x 0.36 = $1,350
This household can therefore afford a house that requires monthly mortgage, tax, and insurance payments not exceeding $1,050. But these buyers should also make sure that the total of their debt obligations, including what they pay for the home, is not more than $1,350 each month.
Option B: Get a mortgage pre-approval from a lender
If you have already made up your mind about buying a home, a faster way to get a clear estimate of your purchasing power is to apply for a lender’s mortgage pre-approval.
This process entails a lender’s thorough review of your financial and personal records, based on documents such as:
● W-2 statements from the previous two years
● Income tax returns from the previous two years
● At least two recent pay stubs, preferably indicating year-to-date income
● Proof of additional income, such as bonuses or child support payments
● Statements of assets, such as investments and retirement savings
● Credit report
● Proof of employment
● Social security number
Your mortgage pre-approval will come in the form of an official letter from the lender. The letter indicates the estimated amount that you are qualified to borrow, as well as the terms that apply to the loan.
In addition to providing you with accurate information to guide your home search, you can use this document to convince a seller of your ability to pay for their home. Just be sure to pitch your offer within 60 to 90 days – the typical duration for which pre-approval letters are valid. Otherwise, you will need to request a new one.
● Save up for a substantial down paymentWhile planning for your mortgage budget, aim to pay a large down payment up front. At least 10% of the home price would typically suffice, but if you can build it up to 20%, you will be in a better position to get lower interest rates and even a shorter loan life.
A big down payment can also help you avoid paying private mortgage insurance (PMI). PMI is a measure lenders use to protect themselves from instances of borrowers defaulting on their loans.
● Budget for closing costs and other recurring costs of homeownership
Set aside 3% to 5% of the purchase price for closing costs. These include home inspection, appraisal, homeowner’s insurance, and title review fees – all of which are essential in finalizing the sale.
Start budgeting for recurring expenses for your home, too. Cover the essentials such as water, electricity, and internet bills, as well as routine maintenance (HVAC, pest control, etc.) and repair costs.
● You do not have to spend the entire amount
Remember: The right home for your needs does not have to be the most expensive one that you can afford. If you find a house that costs less than the maximum amount you can borrow, save the extra money for future renovations or emergency needs.
New to the home buying process? Click here for Windseeker Realty’s first time home buyer guide. For more useful tips, in-depth market insights, and top-rated professional real estate services, contact our local experts at (715) 779-5000 or Agent@WindseekerRealty.com today.