How Much of a Mortgage Can I Afford? You are looking forward to purchasing a house using a mortgage, but you are not really sure how much you can afford to make this happen. Don’t worry, this write-up will provide you with all the information you need concerning mortgage affordability.
How Much of a Mortgage Can I Afford?
Buying real estate using a mortgage is, in many cases, the most extensive personal investment most people make. And the amount you can afford to borrow strictly depends on so many factors, not just what a financial institution is willing to lend you. However, to get started, you will need to evaluate not only your finances but also your preferences and priorities.
Typically, you can afford a mortgage that is 2x to 2.5x your gross income. And the total monthly mortgage payment is made up of four components: principal, interest, taxes, and insurance (collectively known as PITI).
Your front-end ratio is the percentage of your yearly gross income that goes toward paying your mortgage, and in general, it should not exceed 28%. So, knowing this, how much can you afford?
How Many Mortgages Can You Afford?
On a general note, most prospective homeowners can afford to finance a housing property whose mortgage is between two and two-and-a-half times their annual gross income. Thus, based on this formula, one who earns $200,000 per year can only afford a mortgage of $300,000 to $350,000.
As you decide on getting a property through a mortgage, you need to consider several additional factors.
Factors To Consider When Getting A Property Through A Mortgage
Here are some factors to consider:
- Have a good understanding of what your lender thinks you can afford (and how it arrived at that estimation).
- Have some personal introspection and find out what type of home you are willing to live in if you plan on living in the house for a long time and what other types of consumption you are ready to forgo—or not—to live in your home.
However, as real estate has traditionally been considered a safe long-term investment, recessions and other disasters can test that theory—and make would-be homeowners think twice.
How Lenders Determine Mortgage Loan Amounts
As much as each mortgage lender maintains its own criteria for affordability, your ability to buy a home (and the size and terms of the loan you will be offered) will always depend mainly on the following factors:
Applicant Gross Income
It is simply the level of income a prospective homebuyer makes before taking out taxes and other obligations. In general, this is deemed your base salary plus any bonus income and can include part-time earnings, self-employment earnings, Social Security benefits, disability, alimony, and child support.
Applicant Front-End Ratio
Your gross income plays a vital part in determining the front-end ratio. The front-end ratio is also known as the mortgage-to-income ratio. It is simply the percentage of your yearly gross income that can be dedicated toward paying your mortgage each month.
However, the total amount of money that makes up your monthly mortgage payment consists of four components, known as PITI: principal, interest, taxes, and insurance (both property insurance and private mortgage insurance, if required by your mortgage).
Further, the front-end ratio based on PITI should not exceed 28% of your gross income. Although a lot of lenders let borrowers exceed 30%, some even let borrowers exceed 40%.
The back-end ratio is also known as the debt-to-income ratio (DTI). It calculates the percentage of your gross income needed to cover your debts. Debts such as credit card payments, child support, and other outstanding loans (auto, student, etc.)
Moreover, if you pay $2,000 each month in debt service and you make $4,000 per month, your ratio is 50%—half of your monthly income is used to pay the debt. A 50% debt-to-income ratio isn’t going to get you that dream home. Most lenders recommend that your DTI not exceed 43% of your gross income. So, to calculate your maximum monthly debt based on this ratio, multiply your gross income by 0.43 and divide by 12.
Applicant’s credit score
Mortgage lenders have developed a way to determine the level of risk of a prospective homebuyer. The formula varies but is mostly determined by using the applicant’s credit score. However, an applicant with a low credit score can expect to pay a higher interest rate, also known as an annual percentage rate (APR), on their loan. If you want to purchase a home, pay close attention to your credit report.
How to Calculate a Down Payment for a Mortgage
The down payment is the amount of money the buyer can afford to pay out-of-pocket for the residence using cash or liquid assets. Basically, lenders demand a down payment of at least 20% of a home’s purchase price, but many let buyers buy a home with significantly lower percentages.
That is, the more money you can put down, the less money you’ll need and the better you’ll look to the bank. For example, if a prospective homebuyer can afford to pay 10% on a $200,000 home, the down payment is $20,000, which means the homeowner must finance $180,000.
Moreover, apart from the amount of financing, lenders also want to know the number of years for which the mortgage loan is needed. Thus, a short-term mortgage has higher monthly payments but is likely less expensive over the duration of the loan. So, homebuyers will need to come up with a 20% down payment to avoid paying private mortgage insurance.
What is Principal, Interest, Taxes, and Insurance(PITI)?
Principal, interest, taxes, and insurance (PITI) is simply a term for the sum of a mortgage payment made of principal, interest, taxes, and insurance premiums.
What Does “House Poor” Mean?
House poor is a word used to describe someone who spends a large proportion of his or her total income on homeownership.
Federal Housing Administration (FHA) Loan Definitions
A Federal Housing Administration (FHA) loan is simply a mortgage that is insured by the FHA and offered by a bank or other approved lender.
What Is a Qualification Ratio?
“A qualification ratio is the proportion of either debt to income or housing expenses to income.
What is a Home Mortgage?
A home mortgage is a loan issued by a bank, mortgage company or other financial institution for the purchase of a primary or investment residence.
What kind of house can I afford based on my salary?
Your salary, or gross monthly income, is one of the factors considered by lenders when determining how much house you can afford. However, your DTI, down payment, and credit rating, it’s one of the most important things to consider when buying a new home. Use our home affordability calculator to determine just how much you can afford based on your salary.
What salary do you need to buy a 400k house?
The amount of income you need to buy a house in a specific price range may differ based on the type of loan, location, loan term, and other factors. For instance, with a 3.5% interest rate from an FHA loan and a down payment of $79,400 (20%), you would need to earn approximately $60,000 yearly to afford a $400,000 house