If
you're like many homebuyers, chances are you're spending
your weekends driving around visiting open houses
and new model homes. This is a great way to get a
feel for what you want. The problem is that what you
want isn't always what you should get.
Before you start viewing homes for sale, it's important
to start off with a budget so you know how much you
can afford to spend. Knowing what mortgage payment
you can handle will also help you narrow the field
so you don't waste precious time viewing homes that
are out of your reach.
Where to begin
The key factor in figuring how much home you can
afford is your debt-to-income ratio. This is the figure
lenders use to determine how much mortgage debt you
can handle, and thus the maximum loan amount you will
be offered. The ratio is based on how much debt you
have in relation to how much you earn, and it's expressed
as a percentage.
The ideal ratio
Mortgage lenders generally use a ratio of 36 percent
as the guideline for how high your debt-to-income
ratio should be. A ratio above 36 percent is seen
as risky, and the lender will likely either deny the
loan or charge a higher interest rate. Another good
guideline is that no more than 28 percent of your
gross monthly income goes to housing expenses.
Doing
the math
First, figure out how much total debt you (and your
spouse, if applicable) can carry with a 36 percent
ratio. To do this, multiply your monthly gross income
(your total income before taxes and other expenses
such as health care) by .36.
For example, if your gross income is $6,500:
$6,500 (Gross monthly income)
x .36 (Debt-to-income ratio)
= $2,340 (Total allowable monthly debt payments)
Next, add up all monthly debt expenses, such as
car payments, minimum credit card payments, student
loans and any other regular debt payments. (Include
monthly child support, but not bills such as groceries
or utilities.)
Minimum monthly credit card payments: ____________
+ Monthly car loan payments: ____________
+ Other monthly debt payments: ____________
= Total monthly debt payments: ____________
To continue with the above example, let's assume
your total monthly debt payments come to $750. You
would then subtract $750 from your total allowable
monthly debt payments to calculate your maximum monthly
mortgage payment:
$2,340 (Total allowable monthly debt payments)
- $750 (Total monthly debt payments other than mortgage)
= $1,590 (Maximum mortgage payment)
In this example, the most you could afford for a home
would be $1,590 per month. And keep in mind that this
number includes private mortgage insurance, homeowner's
insurance and property taxes.
Exceptions
to the 36 percent rule
There are lenders that allow a debt-to-income ratio
as high as 45 percent. In addition, some mortgage
programs, such as Federal Housing Authority mortgages
and Veterans Administration mortgages, allow a ratio
higher than 36 percent. But keep in mind that a higher
ratio may increase your interest rate, so you may
be better off in the long run with a less expensive
home. It's also important to try to pay down as much
debt as possible before you begin looking for a mortgage,
as that can help lower your debt-to-income ratio.
