How much can you afford?
You have made the decision to buy a house. You know it is going to cost a lot of money, but you are determined to get the biggest, best house you can afford.
Chances are that you will have to take out a mortgage to finance the house. There are certain guidelines and restrictions that determine how large of a loan you can borrow.
With some other factors involved, you want to know before you seriously starting hunting for homes, just how much you can afford.
“How Much can I Afford,” written by John Adams and posted on move.com, provides information that should help you determine how large of a loan you can qualify for and how much you should borrow to buy your new home.
“ As you think about applying for a home loan, you need to consider your personal finances. How much you earn versus how much you owe will likely determine how much a lender will allow you to borrow.”
The first thing you should determine is your gross monthly income. This includes any and all documented income. If you can not document certain incomes or if it does not appear on your tax return, you can not use it to qualify for a loan.
But you can claim unearned income such as income or lottery winnings. “And if you own income-producing assets such as real estate or stocks, the income from those can be estimated and used in this calculation.”
The next thing to do is to calculate your monthly debt. “This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other ongoing monthly obligation like alimony or child support. If it is revolving debt like a credit card, use the minimum monthly payment for this calculation.”
Add all of these debts up. This will be your monthly debt service.
Most lenders will not allow you to take out a loan that will overload your ability to repay everybody you owe monthly. Although every lender is different, here is a basic formula of how lenders calculate the figures to determine your loan qualification.
“Typically, your monthly housing expense, including monthly payments for taxes and insurance, should not exceed about 28 percent of your gross monthly income. If you don't know what your tax and insurance expense will be, you can estimate that about 15 percent of your payment will go toward this expense. The remainder can be used for principal and interest repayment.”
Also, your estimated monthly housing expenses and your total monthly debt service combined cannot exceed 36 percent of your gross monthly income. If it does, your application may not be approved because your lender could decide that you are not reliable enough to be able to make the minimum monthly payments.
“Depending on your individual situation, there may be more or less flexibility in the 28 percent and 36 percent guidelines. For example, if you are able to buy the home while borrowing less than 80 percent of the home's value by making a large cash down payment, the qualifying ratios become less critical. Likewise, if Bill Gates or a rich uncle is willing to cosign on the loan with you, lenders will be much less focused on the guidelines discussed here.”
Don’t get discouraged if you are denied the loan amount you want on the first attempt. Most lenders have varying guidelines, so you may want to try a different lender.
You may also benefit by taking out a smaller loan and purchasing a less expensive home. Through this you will be able to save on lower monthly payments (it is always wise not to stretch your monthly budget too thin anyways) while building equity toward buying you dream home in the future.