There is no one-size-fits-all answer to this question, as the amount of mortgage you can afford will depend on your individual financial situation and credit score. However, according to a 2013 study by the National Association of Realtors, the average American household can afford a mortgage of $179,000. So, if you’re thinking about getting a mortgage, it’s important to consult with a financial advisor to get an accurate estimate of your available funds. Additionally, make sure to keep your credit score in mind when shopping for a mortgage – a high credit score will help you get a lower interest rate on your loan.
This is all you need to think about in order to calculate how much money you have available to spend.
The basic rule of thumb is that the amount of your mortgage should be between two and two and a half times your annual gross income.
In most cases, the total monthly payments for a mortgage are comprised of four different components: the principal, interest, taxes, and insurance (collectively known as PITI).
The amount of your annual gross income that goes toward paying your mortgage is referred to as your front-end ratio, and in general, this percentage ought not to be higher than 28%.
The percentage of your annual gross income that goes toward paying down your debts is referred to as your back-end ratio, and in general, this number should not be higher than 43.
How much mortgage can I have?
In general, most people interested in purchasing a home have the financial means to pay for a mortgage between two and a half times the amount of their annual gross income. According to this calculation, an individual with an annual income of $100,000 can only have a mortgage from $200,000 to $250,000. Nevertheless, this computation should only be used as a rough guide.”
In the end, while choosing a property, you need to consider a number of different factors. To begin, it is important to understand the amount your lender believes you can pay back (and how it arrived at that estimation).
Second, you need to do some self-reflection and figure out what kind of house you are willing to live in if you plan on staying in the house for a long time, as well as what other kinds of consumption you are willing to forgo — or not — in order to live in your home. If you are going to live in the house for a long time, you should also consider what other kinds of consumption you are willing to forgo.
NB:Recessions and other catastrophes (such as the economic crisis in 2020) can put that notion to the test, which is something that would-be homeowners should consider doing. Real estate has generally been regarded as a safe long-term investment.
How Do Lenders Determine Mortgage Loan Amounts?
Your capacity to buy a home, as well as the amount and terms of the loan that will be granted to you, will always primarily be determined by the following elements, despite the fact that every mortgage lender has their own standards for what constitutes an affordable home.
The judgment that a mortgage lender makes on the affordability of a homebuyer is based on a number of criteria, the most important of which are the borrower’s income, debt, assets, and liabilities. A lender will want to know how much money an applicant makes, how many demands there are on that income, and the possibility for both of those things in the future; in short, anything that could compromise its capacity to get paid back will be of interest to the lender.
A person’s ability to qualify for financing is typically determined by their income, ability to make a down payment, and monthly costs, while a person’s credit history and credit score determine the interest rate on the financing itself.
This is the amount of money a potential homeowner makes each month before deducting expenses like taxes and other commitments. In general, this is considered your base wage in addition to any bonus income. It can include earnings from part-time work, self-employment, Social Security benefits, disability benefits, alimony, and child support.
The Front End Ratio
When calculating the front-end ratio, also known as the mortgage-to-income ratio, the amount of gross income is one of the most important factors to consider. This proportion is the proportion of your annual gross income that can be put toward the payment of your mortgage on a monthly basis. PITI is an acronym that stands for principal, interest, taxes, and insurance. This includes property and private mortgage insurance if your mortgage requires it. The total amount of money that makes up your monthly mortgage payment comprises these four components: principal, interest, taxes, and insurance.
The front-end ratio, which is calculated using PITI, should not be more than 28% of your total gross revenue, as a general rule of thumb. However, many lenders allow borrowers to have interest rates that are higher than 30%, and some even let borrowers have rates that are higher than 40%.
It is also referred to as the debt-to-income ratio (DTI), which determines the percentage of your gross income that must be spent to pay off your obligations. Payments due on loans and credit cards, as well as support obligations for dependents, are included among debts (auto, student, etc.).
To put it another way, if you make $4,000 per month and pay $2,000 in debt service each month, your ratio is 50%, which means that half of your monthly income is going toward paying down the debt.
However, if your debt-to-income ratio is 50%, you won’t be able to purchase the property of your dreams. Most creditors will advise that your debt-to-income ratio should not be more than 43% of your total income. 2 Multiply your monthly gross income by 0.43, and then divide that number by 12 to get your maximum allowable monthly debt based on this ratio.
Also read: how to get mortgage in italy as a foreigner
The Score of Your Credit
If your income represents one side of the affordability coin, then your debt represents the other half.
Mortgage providers have devised a method that uses a formula to evaluate the level of risk associated with a potential new customer. There is no one set formula; nevertheless, in most cases, the applicant’s credit score is used to make the determination. 3 Applicants with a lower credit score should prepare to pay a higher interest rate, often known as an annual percentage rate (APR), on their loan. Pay close attention to your credit reports if you plan on purchasing a property in the near future. Make it a point to check the reports you’ve generated carefully. If there are incorrect entries, it will take time to remove them, and you don’t want to pass up the opportunity to purchase your dream house because of something that is not your fault.
The Rule of 28/36 Percent
The 28%/36% rule is a heuristic that is utilized in order to calculate the appropriate level of mortgage debt for an individual. In accordance with this guideline, a person’s housing costs should not exceed a maximum of 28% of their gross monthly income, and total debt service should not exceed a maximum of 36% of their income (this includes their mortgage payment as well as other debts such as car loans and credit card debt). This guideline is frequently utilized by financial institutions to determine whether or not to provide borrowers with credit. Occasionally, the rule will be changed so that slightly different percentages are used, such as 29%/41%.
How to Calculate a Down Payment Amount
The down payment is the amount the buyer can pay for the home out of their personal funds, either in cash or other liquid assets. Although most lenders require a down payment equal to at least 20% of the price of the home being purchased, several of them allow purchasers to acquire a home with far smaller percentages of the total price. It stands to reason that the larger the down payment you are able to make, the lower your overall financing requirements will be and the more attractive you will appear to the bank.
For instance, if a potential buyer can make a 10% down payment on a home that costs $100,000, that buyer will only need to finance $90,000 of the purchase price.
Lenders are interested in the total number of years that the mortgage loan will be used and the total amount of financing required. Although the monthly payments for a mortgage with a shorter term are often greater, the overall cost of the loan is likely to be lower.
In order to avoid having to pay for private mortgage insurance, prospective buyers of homes need to have a down payment of at least 20%.
Personal Considerations for Homebuyers
It’s possible that a lender will tell you that you can afford a huge estate, but are you actually capable of doing so? Keep in mind that the primary considerations of the lending institution are your gross income and your other obligations. The issue with basing calculations on gross revenue is rather straightforward: You are factoring in as much as thirty percent of your income; however, this does not account for deductions like as taxes, FICA, or health insurance premiums. In addition, if you have children, you should consider contributing to a retirement account before taxes and saving money for college. Even if you are entitled to a refund when you file your taxes, it is useless to you now. Furthermore, how much money can you anticipate receiving?
Because of this, some people who specialize in finance believe that it is more practical to think about your net income (also known as your take-home pay), and they also believe that you shouldn’t spend more than 25% of your net income on your mortgage payment. In that case, despite the fact that you might be able to make the monthly mortgage payment, you risk becoming “home poor.”
It is possible that the costs of purchasing and maintaining your home will consume such a large percentage of your income — far and above the nominal front-end ratio — that you will not have enough money left over to pay for other discretionary expenses or outstanding debts or to save for retirement or even just a rainy day. Being home-poor is mostly a matter of personal choice; getting approved for a mortgage doesn’t indicate that you can afford the payments just because you have a job and a steady income.
When evaluating your capacity to make mortgage payments, in addition to the standards set by the lender, you should think about the following issues:
Are you planning to pay the bills with both of your paychecks combined? Is your work stable? If you were to leave your current work, would you easily find another one that paid the same or even a higher salary? If sticking to your monthly spending plan depends on every dollar that you bring in, then even a modest decrease in that income can be catastrophic.
The majority of your current debt obligations will be factored into the computation of your back-end ratio. However, you should also consider future expenses, such as the cost of college for your children (if you have them) or your hobbies after retirement
If you want to get the house you desire, are you willing to change how you live? Applying a greater back-end ratio could be successful for you if you don’t mind making fewer trips to the mall and aren’t bothered by the idea of somewhat reducing your spending. If you cannot make any adjustments or have balances on many credit card accounts, you should probably play it safe and adopt a more cautious strategy when looking for a new home.
4. One’s character
No two people will ever have the same personality, regardless of how much money a person makes. Some people are able to get a good night’s rest despite the fact that they have a payment of $5,000 coming out of their bank account every month for the next 30 years, while others have trouble sleeping since their payment is only half as much. Some people would go completely haywire at the idea of having to refinance their home to be able to afford the payments on a new vehicle, while others wouldn’t give it a second thought.
Expenses Apart from the Mortgage
Homeownership has many other costs, some of which continue even after the mortgage has been paid off. The mortgage is unquestionably the most significant financial responsibility associated with being a homeowner. The following items are ones that savvy consumers would do well to keep in mind when shopping:
1. Taxes on Real Estate
Expect to pay property taxes if you own a home, and figuring out how much you will owe is an essential element of the budget a homebuyer creates when they purchase a home. Your property tax is set by the local municipality (city, township, or county) on the basis of the size of your home and lot, in addition to other variables, such as the conditions of the local real estate market.
According to the research conducted by the Tax Foundation, the effective average rate for property taxes across the country is 1.1% of the home’s assessed value. This number differs from state to state, with some states having far lower property taxes than others. For instance, the average in New York is 1.4%, whereas the average in Oklahoma is only 0.88%. 5 Even when the mortgage on your home is paid off in full, you will still be responsible for making payments on the property tax.
2. Home Insurance
Each and every homeowner should purchase home insurance to safeguard their property and belongings against calamities, both natural and manmade, such as tornadoes and burglaries. If you are planning to buy a property, you should look into the cost of the insurance that is most applicable to your circumstances. You won’t be able to get a mortgage from the vast majority of lenders if you don’t have homeowners insurance that covers at least the amount you paid for the house. In point of fact, your mortgage lender may require you to provide documentation that you have home insurance before giving you approval.
As of the beginning of 2021, the most recent numbers that are available, the annual premium for the form of home insurance that is purchased the most frequently in the United States was roughly $1,200. However, the total cost might increase significantly depending on the kind of coverage you require and the state where you live.
Even if you construct a brand-new house, it won’t continue to look brand new forever, and neither will those pricey, important appliances like stoves, dishwashers, and refrigerators. The same is true for the house’s roof, the furnace, the driveway, the carpet, and even the paint on the walls. If you are living from paycheck to paycheck when you take on that first mortgage payment, you may find yourself in a challenging circumstance if your financial status has not improved by the time big repairs are needed on your property.
It costs money to pay for things like heat, insurance, power, water, sewage, garbage collection, cable television, and telephone service. These costs are not factored in when determining the front-end or back-end ratios because they are not included in those ratios. Despite this, the vast majority of homeowners are forced to deal with them.
You should also consider that a larger house will result in higher utility costs because of the increased amount of energy required for heating and cooling the larger space. When they view a large and lovely property, many individuals fail to take it into consideration.
5. Dues Paid to the Association
Association fees are required to be paid monthly or yearly in many condominiums and coops, as well as many gated areas and planned communities. There are times when the annual cost of these fees is less than one hundred dollars, and there are other instances when the monthly cost is several hundred dollars. Residents have access to a communal pool and amenities such as lawn maintenance and snow removal in many areas.
Some of the fees are used just to cover the administrative expenses associated with administering the community. It is essential to remember that even while a growing number of lenders are beginning to include association fees as part of the front-end ratio, these fees are likely to go up over the loan.
6. Furnishings and Decorative Items
Before investing in a new home, it is important to consider the number of rooms that will need to be furnished and the number of windows that will need to be covered.
Tips for Buying a Home
There are certain prudent steps that you can take to increase the likelihood that you will be able to afford your home and maintain it over time. First, you should put aside money for an emergency fund that is larger than the amount of your down payment and maintain it in a separate account in the event that you become unemployed or are unable to work. You are able to keep the house while seeking new work if you have enough savings to cover several months’ worth of mortgage payments in an emergency fund.
You should also seek strategies to save money on the monthly payments that you make for your mortgage. A mortgage with a term of 15 years will save you money throughout the life of the loan, but a mortgage with a term of 30 years may have lower monthly payments, making it simpler to afford on a month-to-month basis. Options for making a smaller or even no down payment are available through certain lending programs, such as the VA loan program for veterans and the USDA loan program for rural properties.
One more piece of advice: do not purchase a larger home than you can comfortably afford. Do you truly require that additional room or that basement that’s been finished? Does it absolutely have to take place in this specific locality? If you are ready to be flexible on matters such as this one, you may frequently negotiate for more affordable housing options.
How Much of a Mortgage Can I Afford Based on My Salary?
It’s common practice to use a rule of thumb to estimate how much of a mortgage payment you’ll be able to afford based on your income. For instance, according to the recommendations of certain industry professionals, you shouldn’t spend more than two to two and a half times your yearly gross income on a mortgage (thus, if your annual salary is $60,000, the size of your mortgage should be no more than $150,000). According to some other sets of guidelines, you shouldn’t spend more than 28-29% of your monthly gross income on housing expenses.
What Does It Mean to Be House Poor?
A person is said to be house poor when the majority of their wealth is invested in their home and a significant portion of their income is used to pay off their mortgage and other costs associated with it. An illustration of this would be if you had $100,000 in savings and utilized the entire amount to finance a home that cost $500,000 and had a mortgage payment of $2,500 per month, despite your monthly net income being $3,000.
If things turn for the worst, this arrangement can give the impression that the economy is doing well, but it can lead to foreclosure very rapidly.
How Much Debt Can I Already Have and Still Get a Mortgage?
Your income, and more specifically, your debt-to-income (DTI) ratio, will determine the maximum amount of debt you are allowed to carry at any given time. When applying for a mortgage, the rule of thumb is to have a DTI that is less than or equal to 30%, and once the mortgage has been paid off, it shouldn’t be higher than 43%.
The Crux of the Matter
The cost of a home represents the single most significant personal expense that the vast majority of people will ever incur in their lives. Take the time to figure out the implications of taking on such a massive debt before you do it. After you’ve done the math, take a moment to assess your circumstances and think about the kind of life you want to lead, not just today but also in ten or twenty years.
Before you buy a new home, you should think about not just how much it will cost you to buy the home but also how the ongoing mortgage payments will affect your life and your finances in the future. After that, seek loan estimates from a number of different lenders for the kind of home you hope to buy in order to get real-world knowledge on the kinds of offers you can get.