Before you start looking at homes, you’ll need to have some estimate of how much you can truly afford to spend each month on your new home.
It can save you a lot time and heartache by making sure you are looking in the correct price range to start with. (Calculators).
There are four strong ingredients that will weigh into how much of a house you can afford:
- Monthly gross income (before taxes)
- Long-term debts
- Money available for a down payment and closing costs
- Your credit in general (late payments, collections, judgments) and of course the actual score is of huge importance
Mortgage lenders by and large say that your housing expenses shouldn’t be above 38% of the homeowner’s gross monthly income. The housing expense needs to include mortgage principal, interest payments, property taxes and homeowner’s insurance.
When looking at Federal Housing Administration (FHA) mortgage loans, this figure needs to be 41% or below the homebuyer’s gross monthly income.
If you have no idea of what your new homes taxes or homeowners insurance will be use 1% of the sales price (divided by 12) for the taxes and $50 a month for the homeowners insurance as a very rough estimate.
You are able to include many types of income besides your standard hourly or salary income:
- Commissions or overtime may be used when documented for 2 or more years generally (shows on your W2 form)
- Self employment net income (after taxes)
- Social security, veteran’s and retirement benefits may all be used
- Child support, alimony and income from public assistance programs
- Permanent disability or workman’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
Mortgage lenders will also use your regular long term (anything not paid off after 10 months) monthly debts and obligations to determine how much you can afford:
- Other mortgage loans
- Installment loans (bank loans, boat loans, auto loans, school loans etc.)
- Revolving accounts
- Alimony and child support
Mortgage lenders ordinarily define long-term debt as monthly expenses which extend more than 10 months beyond the close of your estimated closing day. It’s highly recommended borrowers pay-off as much long-term debt as possible before applying for a mortgage loan.
The Mortgage Home suggests to all borrowers that once they receive their maximum mortgage loan amount from the mortgage lender they reduce the amount by 10% and then go shopping for a house with that revised amount just to be safe.
So, if you’re approved for $200,000 then you should look for a home under $180,000. Borrowers are frequently approved for loans higher than what they can afford and it’s our opinion that borrowers will be better served by following this formula.
Getting an estimate of what mortgage loan payments you can afford helps you determine the right mortgage program for you.
Mortgage lenders require homebuyer’s to have enough money available to make the down payment (up to 3.5% to 20% or more of the selling price for the home) and to pay closing costs (normally between 3 and 6 percent).
You might consider the following areas for access to a down payment; savings, mutual funds, stocks and bonds and retirement accounts (401K).
Most mortgage programs allow you to use a gift of money from parents or relatives and all that’s generally needed is a gift letter stating the money was in fact a gift.
By following the above information you will have a huge head start on success towards owning a home you can afford.