Purchasing a home is likely the largest financial decision you will make in your lifetime. A pre-approval with a lender will give you an idea of the amount you could be loaned, but determining how much home you can afford weighs on multiple factors, including what you’re comfortable paying and your financial plans.
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Most lenders recommend that your mortgage payment, including principal, interest, taxes and mortgage insurance (Known as PITI), be less than 28 percent of your gross monthly income. Lenders will also analyze your debt-to-income ratio, which includes your monthly obligations such as: credit card minimum payments, student loans, alimony, child support, and car loans along with PITI. Lenders look at this to ideally be at or below 36 percent of your gross monthly income.
Factors considered when weighing affordability include:
- Annual gross income. You can get a rough estimate of an affordable home price by multiplying your annual gross income by 2.5. For example, if your household’s annual income is $100,000, an affordable home price could be in the $250,000 range. **This is a very rough estimate and varies on interest rates, debt and credit history.
- Current mortgage rates. Mortgage rates fluctuate constantly. For example, a $200,000 home purchase with a 3.75 percent interest rate would come to a $926 monthly payment. If the interest rate were to increase to 4.25 percent, the monthly payment would increase $57.
- Mortgage Insurance (MI). Unless you are planning on making at least a 20 percent down payment, you will be required to pay mortgage insurance. Your rate of mortgage insurance will be determined by which loan program you participate in and credit score. This can add additional costs.
- Home type. If you are purchasing a condominium, townhome or a home that belongs to a homeowners association, it is likely that you will have to pay a condominium or homeowners association fee. These fees usually cover the costs of maintaining common areas such as lobbies, patios, landscaping, swimming pools, etc.
- Credit history and score. Your credit can affect your ability to qualify for a mortgage and depending on your loan program, can affect what interest rate you are able to obtain.
- Fees and closing costs. A loan not only includes the purchase of the home but expenses pertaining to the loan. You will have to factor in the costs of closing, a home appraisal, home inspection and other services required to buying the house.
- Lifestyle and future plans. Consider what your current living standards are and any upcoming costly life events, such as a child’s wedding or college tuition. It is also important to remember to buy what you can afford now, not what you can afford 10 years from now.
Keep in mind that mortgage rates will fluctuate and depending on your down payment you may also have to factor in mortgage insurance. If you’re interested in a home purchase or about the affordability of homeownership, contact one of our loan officers.
Want more info like this? Our Mortgage 101 handbook gives you a simplified overview of everything you want to know about the mortgage process.