One of the most common questions a first-time home buyer will ask is, “How much home can I afford?” The answer, as a mortgage lender will tell you, is that “it depends.”
There are no concrete rules for how much home you can afford, or how big your mortgage can be. This is partly because mortgage lenders determine your maximum home purchase price differently from how you might calculate it yourself using a mortgage calculator. Here, The Mortgage Reports offers two methods that can help determine your maximum purchase price.
1. Debt-to-income ratio
When calculating your maximum home purchase price, your lender will give little consideration to your existing home hunt or any properties for which you’ve considered making an offer. Rather than using a specific sales price, the lender will consider your annual income and your annual debts only.
The lender then will use that data to find the largest mortgage payment you could make without raising your debt-to-income (DTI) ratio above allowable maximums. Most conventional loans enforce a maximum DTI of 45 percent, with the exception of the HomeReady program, which allows up to 50 percent DTI. FHA, VA and USDA mortgage loans also enforce a maximum DTI near 45 percent.
Jumbo mortgages stop around 40 percent DTI. Once the lender has found your maximum mortgage payment, it uses current mortgage rates to back in to a loan size, which tells you how much you can borrow. One caveat: This method is based on borrowing the absolute maximum for which you can get approved.
2. Your Monthly Household Budget
As a home buyer, you can rely on a lender to tell you how much home you can afford, or you can figure it out on your own. If you purchase at your maximum upper-limit, this doesn’t leave you with much cash for saving, investing, living or paying taxes.
To determine how much home you can afford, first determine the maximum monthly payment you’d like to make each month by thinking about and paying attention to your household budget. Then, using a mortgage calculator, plug in your desired payment and today’s mortgage rates to find the loan size that kind of payment will afford.
For example, if you budget for a monthly housing payment of $2,500 with 2 percent annually going to taxes and insurance, assuming the current 30-year mortgage rate is 4 percent, the math worked backward reveals a maximum home purchase price of $385,000.