Purchasing a new home is an exciting time in anyone's life. Still, before you take the leap into homeownership, it is important to have a clear idea of how much you can afford to pay for a home. After all, you don't want to pay so much for a home that you are unable to keep up with the payments. As such, it is essential for you to have a good idea of how much home you can afford before you start looking at available properties. One simple way to make this determination is to have a better understanding of the debt-to-income ratio and how it affects the loan process.
How Your Debt-to-Income Ratio Affects Your Loan
The first step toward determining how much how you can afford is to get a good idea of your debt-to-income ratio, which is the relationship between your debt and the amount of money you earn. This figure, which is expressed as a percentage, is used by lenders to determine how much of a mortgage debt you can handle.
Ideally, mortgage lenders don't want to see a debt-to-income ratio of more than 36 percent. If your debt-to-income ratio is higher than this, providing you with a loan will be considered risky. As a result, the lender may either deny your loan application or may charge a higher interest rate.
Calculating Your Debt-to-Income Ratio
To calculate your debt-to-income ratio, you first need to calculate your fixed monthly debt expenses. If you are married, be sure to include your spouse's debt in these figures as well. Things to include in these calculations include car payments, student loans, child support, minimum credit card payments and any other regular debt payments. Bills such as utility and grocery expenses, however, should not be included.
After determining your total debt, calculate your monthly income before taxes and other expenses are taken out of your check. Then, multiply this figure by .36. This way, you determine the total amount of monthly debt you can afford to pay. For example, if your monthly gross income is $5,000, your total allowable debt will be $1,800 because $5,000 multiplied by .36 equals $1,800.
Hopefully, your total allowable debt is less than your total monthly debt. If not, you should seriously reconsider purchasing a home at this time. If your allowable debt is more than your monthly debt, however, you can use these figures to determine the amount you can afford to pay toward a mortgage each month. If you can afford $1,800 in debt and your total monthly debt comes to $800, for example, you can afford to pay $1,000 toward a mortgage debt each month because $1,800 minus $800 is $1,000.
After determining how much you can afford to pay toward a mortgage each month, it is important to remember that there are a number of costs that are included in the monthly mortgage payment. These include homeowner's insurance, property taxes and private mortgage insurance. Therefore, you should keep these costs in mind when trying to determine how much home you can afford.
At times, there are exceptions made regarding the 36 percent rule. If you live in an area with high home prices or if you are getting your mortgage through programs such as the Veterans Administration or the Federal Housing Authority, for example, lenders might be willing to accept a higher debt-to-income ratio. Even so, you should give some serious consideration to a high ratio in order to determine if you will truly be comfortable with making the payment amount required each month.
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Jolenta Averill, Principal
Lake & City Homes Realty