How Much Can I Afford to Buy a House?

Buying a home of your own is still the American Dream, but knowing
when and how to take the plunge can be difficult. It is no secret that
home ownership rates have been steadily rising over the past several
years, aided by both historically low interest rates and
unconventional mortgages which allow buyers to put down as little as
3% of the value of the home.

When deciding how much home you can afford, it is a good idea to
consult with a mortgage lender before you begin your search for a
home. Getting pre-qualified will make your home search a lot easier by
allowing you to focus only on those properties you can actually afford
to buy. Two of the most important factors lenders use in determining
how much you can borrow on a home mortgage loan are the debt-to-income
ratio and mortgage-to-income ratio.

Debt-to-Income ratio

The debt-to-income ratio is the percentage of your monthly income that
is committed to repayment of outstanding debt such as credit card
debt, car loan, student loans and etc. Suppose your gross income per
month is $5,000 and you owe $1,000 in debt per month, then, your debt-
to-income ratio is 20%. Typically, the mortgage lender will balk if
this ratio is more than 40%. Obviously the lower this figure, the
better your finances will look to prospective lenders and the more you
will be able to borrow on your home mortgage loan. If you think your
debt to income ratio is too high, it may be a good idea to retire some
of your outstanding debt before attempting to qualify for a mortgage.
If you have outstanding credit card loans or a personal loan, paying
them off will increase your credit score and allow you to borrow more
to buy a home. For the same reason, it is a good idea to not take on
more debt when you are attempting to qualify for a mortgage.

Mortgage-to-Income ratio

Your monthly income will also be a major factor as your bank or
mortgage company determines how much they can lend you. In general,
lenders will look at the mortgage-to-income ratio of no more than 30%.
Using the example above, a lender can expect that you can reasonably
pay as much as $1,500 per month in mortgage payments based on your
gross income of $5,000 per month. In addition, the mortgage lender
will want to see a good steady work history and good visibility of
earnings. Be sure to provide proof of all your sources of income.
Things like pay stubs, cancelled checks, etc. are very important when
applying for a mortgage.

It is important for the potential home buyer to realistically assess
how much he or she can afford in monthly mortgage payments. Be sure to
include such home related expenses as homeowners' insurance, real
estate taxes and money for home repairs in your monthly payment
estimates. It is best to not over extend when determining how much
home you can afford. In other words, never buy the most expensive home
you can afford.
Likewise, you should think twice before borrowing as much as you
qualify. You are in a 'risky' position if you have a maximum mortgage
payments, as unexpected events such as unemployment or sickness could
happen. Therefore, it is always a good idea to make as high a down
payment as you possibly can. Making a 20% down payment on the home you
buy will not only lower your monthly mortgage payments, but it will
also mean you are not subject to costly private mortgage insurance.
Private mortgage insurance is designed to protect the lender if you
default on the loan. A higher down payment means you will not need to
pay the high cost of this insurance.

Once you have determined how much home you can afford, be sure to shop
around for the best home for your needs. Be sure you consider the
nature of the neighborhood in which the home is located and its
prospects for growth. Remember that your home is not simply a place to
live. It is an investment as well. A good home in a good location can
be a great investment as well as your primary residence. Getting pre-
qualified will help you to concentrate only on homes that you can
afford to buy.

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