How Much Can I Afford?
The Home Buying Process
How Much House Can I Afford?
As you begin to shop for a home, knowing how much house you can afford is a critical first step. No one wants you to be house broke! The best way to determine your affordability is to meet with a reputable loan officer. You may meet them in person, but are just as likely to do everything over the phone and electronically. You will be able to discuss your financial situation and prequalify for a home loan.
During this process, known as pre-qualification, a professional mortgage lender or loan officer will be happy to help you without further obligation to prequalify for a home loan. It is during this time that it is recommended to shop around for loans and interest rates. Just like with a credit card, you may choose not to go with the first one that sends you mail. For a rough estimate of the house payment you can afford, you may follow the steps here:
Step One – Allowed Debt
There are several different types of loans and both advantages and disadvantages of each. A loan officer will tell you which loan best fits your current financial situation. For the purposes of this explanation, we are going to use an FHA loan. With an FHA loan, the maximum debt to income ratio is 43%.
Example: Knowing that Bob’s gross monthly income is $2,850, his total debt can only take up 43% of that income. We multiply the two to get Bob’s maximum amount allowed for debt to qualify for an FHA loan.
$2,850 x 43% = $1225.50 (Bob’s maximum amount allowed for debt to qualify for an FHA loan)
According to FHA guidelines, In order to qualify for the loan Bob can spend no more than $1225.50 each month on debt.
Step Two – Maximum Monthly Payment
In order know how much you can spend on a monthly mortgage payment, you also have to consider what other recurring debts you may have that also need to be paid. After subtracting the debts you currently know of like a car payment, loan payment or credit card payment, you will get the amount of money you have left in your income to put towards a mortgage payment.
Let’s say Bob has a $340 car payment and a $140 per month credit card payment. To find the amount that Bob could spend on a monthly mortgage payment, we subtract those from the $1225.50.
$1225.50 – ($340+$140) = $745.50
* If a difference exists between the amounts of your Estimated Maximum Monthly House Payment in Step One and Step Two, use the lesser of the two as your guideline. Before a lender makes a decision regarding your loan, additional information will be requested (credit history, other income sources, etc.). Formulas and ratios may vary based on loan type and lender.