How much house can I afford?
Before you start looking for houses, you’ll need to have an idea of what you can buy. You can save yourself a lot of hassle by making sure you’re looking in the right price range.
There are 4 important elements that will influence the amount of house you can buy:
- monthly gross income (before taxes)
- long term debt
- money available for down payment and closing costs
- your overall credit (late payments, collections, judgments) and of course the actual score is of immense importance
Entry
Mortgage lenders generally say that your housing expenses should not exceed thirty percent to thirty-eight percent of the borrower’s gross monthly income. Housing expense should include mortgage principal, interest payments, property taxes, and homeowner’s insurance policy. For Federal Housing Administration (FHA) mortgage loans, this figure must be 41% or less of the homebuyer’s gross monthly income. If you have no idea what your property taxes or property insurance will be, use 1% of the sales price (divided by 12) for taxes and $50 a month for property insurance as a very rough estimate.
You can include many types of income in addition to your standard hourly or salary income:
- commissions or overtime can be used when documented for 2 or more years in general (shown on your W2 form)
- net income from self-employment (after taxes)
- Social security, veterans, and retirement benefits can be used.
- alimony, food, and income from public assistance programs
- permanent disability or worker’s compensation payments
- interest and/or dividend income;
- rental income after deducting expenses and mortgage payments;
- income from trusts, annuities, partnerships, professional corporations, and even long-term payments.
debts
Mortgage lenders will also use your long-term regular monthly debts and obligations (anything you haven’t paid after 10 months):
- other real estate loans
- installment loans (bank loans, boat loans, car loans, school loans, etc.)
- revolving accounts
- alimony and child support
Your housing expenses plus long-term debts must not be more than thirty percent to thirty-eight percent of your gross monthly income (before taxes). For Federal Housing Administration (FHA) mortgage loans, the number must not exceed forty-one percent of the homebuyer’s gross monthly income. Mortgage lenders typically specify long-term debt as monthly expenses that extend more than 10 months past your estimated closing day.
It is highly recommended that borrowers pay off as much long-term debt as possible before applying for a home loan.
Having an idea of how much you can afford will help you find the maximum loan amount you can borrow.
Some financial advisors advise consumers that once they receive the maximum loan amount from the mortgage lender, reduce that amount by 20% and then go home shopping. So if you’re approved for $200,000, then you really should be looking for a house under $160,000. Borrowers are often approved for higher loans than they can actually afford.
Having an idea of what loan payments you can afford helps you determine the right mortgage for you.
Deposit
Mortgage lenders require that the borrower have enough money available to make a down payment: up to 20% (or more) of the property’s sales price and to pay closing costs; usually between 3 and 6 percent. You can look for the following for a down payment: savings, mutual funds, stocks and bonds, retirement accounts (401K), etc. Most mortgage programs allow you to use a gift of money from your parents or relatives, and usually all that is needed is a letter stating that the money was actually a gift.
