We all know that shopping for houses is the most fun part of the homebuying process.
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Sure, you could tour the 4-bedroom, 2-bathroom new construction home with a large backyard. But you’ll be disappointed when you run the numbers and find that you can’t afford it.
While budgeting might not be so fun, it will help set you up for success.
Calculating how much of a mortgage you can afford when buying a new house will give you a number to aim for in your monthly payments and new home price.
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Let’s discuss how to make these calculations so that you can quickly get to house hunting.
Figure Out Your Budget
The main figures you’ll need to pull include your:
- Household income
- Monthly debts
- Savings available for a downpayment and closing costs
Take a look at your credit history. We’ll discuss later how it can affect how much money you spend.
Unexpected expenses can affect your savings — factor in a cushion for your budget. Designate an extra amount each month that you put away in your savings so that buying a house doesn’t entirely drain your savings.
The first few months of homeownership are expensive. A basic affordability guideline to follow is to make sure that you have three months of your monthly expenses saved. This way, if something unexpected happens during the month, you can still cover your mortgage payment.
If your expected mortgage payment is too high and doesn’t allow room to save, then it might be right to reevaluate that home purchase.
Ratios and Debt to Income
Housing expenses shouldn’t exceed 28% of your gross monthly income.
When you follow the 28%/36% ratio, your remaining monthly expenses aside from your mortgage payment shouldn’t exceed 36%. This is a guideline to follow to ensure that you’re not taking on more than you can afford in your monthly expenses.
Your debt-to-income ratio (DTI) is a figure that your bank or lender will use to calculate how much you can safely borrow. That figure is found by comparing your total monthly debts to your gross monthly income.
For example, let’s say your hypothetical monthly mortgage payment is $850, you have no other debts, and your monthly pre-tax income is $3000, the DTI is 28%. The formula is your debt divided by your income or $850 / $3000 = 0.28.
This shows you that your proposed monthly mortgage payment of $850 would be affordable enough with your income.
Another easy way to find out what number you’d want to aim for with your monthly payment is to take your gross monthly income and divide it by 0.28. In this example, $3000 / 0.28 = 840. You can use 840 when you start shopping for your loan to make sure your payments would be affordable with the house and loan you choose.
Know Your Mortgage Costs and Options
Once you have a simple budget of a monthly mortgage payment you can afford when buying a house, you should then calculate the amount you’ll need for other fees and consider the best loan options for you.
FHA loans or VA loans
When creating your budget for buying a house, figure out how much of a down payment you’ll really be able to afford. If it’s not 20% of the average home price of houses you’re shopping for, you may want to look into an FHA loan. A conventional loan with a down payment of less than 20% may come with expensive mortgage insurance.
FHA loans are typically easier to qualify for than conventional loans. The credit requirements are not as strict and they allow for a much smaller downpayment. Talk to an FHA-approved lender to see if it’s a good fit for you.
For veterans, service members, and surviving spouses, there is also the VA loan. These loans, backed by the Department of Veteran Affairs, often don’t require a downpayment. A one-time funding fee is required. But other requirements are lenient and you should talk to a lender familiar with VA loans to see if it’s right for you.
Your credit score and DTI will influence the rate your lender offers you. But there are other factors to consider as well.
Different loan products will have different features to adjust the mortgage rate to be higher or lower. This is to assist their borrowers with home affordability.
Rates are greatly influenced by the market conditions, so sometimes there’s not a lot the lender or you can do.
Generally, if you have a high credit score and a good borrowing history, you’re more likely to get a good rate. “Good” borrowing history, in this case, means that you pay all of your bills every month, on time, and don’t have any judgments against you.
Alternatively, if your score is not great, then you might get a higher interest rate. That’s why you should work on your credit profile before you prepare for buying a home. Even the difference between a rate of 3% and 3.25% will add up with the amount of interest you pay over time.
A big factor in the rate you get, however, is how open you are with your lender. Letting them know that you’d rather have a lower rate will help them put together your deal. The trade-off is that you’ll pay closing costs out of your pocket upfront and not in your mortgage payments.
It’s up to you to decide if you’d rather have a lower rate over time or lower closing costs upfront, and which would work better for you.
There are additional costs that you will need to budget for when you’re buying a home. Exact numbers will vary from case to case, but you should account and have savings for the following additional costs:
- Closing costs
- Appraisal cost
- Inspection costs
- Private mortgage insurance
- Homeowners insurance
- Property taxes
Closing costs are around 3-6% of the home’s cost. Things like insurance and property taxes will depend on the area you live in, the neighborhood, and the type of home you wish to purchase.
Appraisals are required and will assess the value of the home but they are an additional cost. An inspection will thoroughly investigate every aspect of the home to ensure it’s in working order. You can sometimes negotiate with the seller to cover inspection costs.
Find the Perfect Mortgage
My Perfect Mortgage provides you with the tools you need to figure out affordability and find the perfect lender for you.
Get started on the loan process today. We’ll help you connect with lenders who can help you determine your potential mortgage options.