What Can I Afford?
Understanding what you can afford has a lot to do with your income, but it also has a lot to do with your personal debts, savings, and credit, along with the other costs that will make up your total housing costs.
Make a Rough Estimate
A good start is to do some very simple math and get a rough estimate of what you can afford.
In general, a prospective buyer could likely afford a home that costs 2 to 2.5 times their annual gross income. With a salary of $80,000, you would likely be able to afford a house that’s between $160,000 and $200,000. But this estimate does not take into account a 20% down payment, credit score and, importantly, other current expenses.
Determine Your Debt-to-Income Ratio
There are two important debt-to-income ratios — the percentage of your monthly income would go toward your new home payments (front-end ratio) and the percentage of your monthly income towards your housing expenses plus all other ongoing expenses (back-end ratio).
A front-end debt-to-income ratio looks at how much of your monthly income goes toward your housing expenses. Lenders add up a home loan’s principal, interest, taxes, and insurance and divide it by your gross monthly income. It’s ideal if these home loan costs don’t exceed 28% of your gross income, but many lenders may accept a higher number.
A back-end debt-to-income ratio includes several more expenses including credit card payments, car payments, student loans, and more. This ratio is going to be a higher portion of your gross monthly income. Most lenders want to see this number below 42%, though many would accept a borrower with a ratio a bit higher.
Take Some Detailed Calculations
Getting an accurate figure for your debt-to-income ratio may take some work. Your gross income isn’t just your salary. Wages, bonuses, investments, dividends, alimony, and other sources of income should be factored into your gross monthly income estimate, too.
When you calculate your monthly expenses, factor in the minimum payment due for credit cards, your monthly car payments, student loan payments, alimony payments, and other recurring expenses.
Ask About Your Lender’s Requirements
Lenders may suggest an ideal ratio for a borrower, but when it comes to upper limits, there are strict requirements for your debt-to-income ratio.
You’ll often see these DTI limits expressed as 30/45, meaning your mortgage payment (principal, interest, taxes, and insurance) can’t exceed 30% of your monthly gross income and your housing expenses and other monthly debts together can’t exceed 45% of your monthly gross income. The debt-to-income limits of different lenders may vary slightly, but for some lenders these limits are non-negotiable.
Other Points to Consider
While a lender’s DTI limit may be fixed, there are moves you could make to bring your ratio down. For instance:
- A higher down payment would reduce your monthly housing expense, lowering your ratio.
- Paying a car off early or paying off and closing a credit card would also help your back-end ratio.
- Even securing a lower interest rate would help by reducing your monthly mortgage payment and lowering your ratio.
Lastly, just because you can afford to buy x amount of house, doesn’t mean you should. You don’t want to have a great home, but not much money for anything else.