When we start clicking through photos of beautifully staged homes online, many of us don’t stop to consider what a monthly payment for a home like that would cost us. But clarifying what you can truly afford before you start your home search is key to your home buying journey. Calculating a comfortable monthly mortgage payment can help your decision-making process “to buy, or not to buy” — especially when we’re talking about a 30-year commitment.
The good news is you can figure out what you qualify for fairly simply — just reach out to a mortgage banker for a more accurate picture. Remember, qualifying for a certain amount doesn’t mean that’s how much you need to borrow. At the end of the day, only you know what you’re comfortable paying in a mortgage every month coupled with your other expenses and debts.
How Does a Lender Calculate What You Can Afford?
When you start your home buying journey, you’ll go through a pre-qualification process where your lender will let you know how much home you’re qualified to purchase.
Keep in mind, a pre-qualification is not a guarantee of a loan, although it does help you and your lender identify your next steps.
So here’s what lenders will look for in your pre-qualification process:
1. Your Credit History
One of the first things lenders look at is your credit history, which shows your ability to borrow and repay your debts. Since you’ll borrow quite a bit for a mortgage, this info is crucial. You can prepare for this by checking your own credit, which is something you can do once a year for free through each of the three credit reporting agencies — Equifax, Experian, and TransUnion.
2. Your Salary
The next bit of info revolves around your work. Your lender will evaluate details like where you work, your salary or commission amount, etc. You’ll be required to show at least two-year’s worth of taxes to show steady work history. If applicable, your lender will also look at your spouse’s salary to calculate your total household income for purchasing.
It’s recommended you stay in your line of work if you’re planning on switching jobs while buying a house.
3. Your Debts
Your debt-to-income (DTI) ratio plays a huge role in figuring out how much you can afford. Debts can include car payments, student loans, and other recurring monthly expenses. All that is added up and divided by your total household gross income (before taxes and insurance are taken out). The result? A percentage, or ratio, that shows lenders how much debt you have compared to how much you make. Try to keep your DTI under 42% — the lower the better.
4. Your Down Payment
And finally, lenders will look at your down payment amount. For most loans, it’s ideal to put 20% down to avoid private mortgage insurance (PMI), but some loan products allow as little as 3% down, and VA loans require 0% down. But having some money saved up is important, since there could be additional costs like closing costs. And it’s not just your savings account that will be taken into consideration, if you have other assets, lenders will evaluate those, as well.
5. Your Current Rent
Some mortgage bankers will ask you how much you currently pay in rent. Although this isn’t something that will impact the qualification itself, it will help you lender establish an initial zone of what you’re personally comfortable paying. Of course, there are other things to keep in mind, like utilities, maintenance, and upkeep — especially if that was included in your rent payment and it wasn’t something you thought about previously.
How Much Can You Actually Afford?
So, you know it’s important to build an understanding of your financial picture when you’re thinking about buying a home. The first thing to consider is your monthly gross income and how it impacts what a lender thinks you can afford, versus what you might be comfortable affording.
Understanding Your Income
When you get a paycheck, you likely pay closer attention to the amount deposited in your account, rather than your gross income. Let’s say your gross monthly income is $4,166 — that’s before taxes are taken out. That means your lender calculates your ability to repay using that amount; $4166. But really, you’re paying for certain things right off the bat, like taxes, so you’re likely thinking, “No, I make $2,916 a month because 30% goes to taxes and deductions.” This is called the “net” pay.
That’s a big difference — $4,166 versus $2,916. So keep this in mind when you’re trying to understand how much you can afford. You’ll also want to pay attention to your other debts and affordability comparisons on top of your net pay.
Figuring Out Additional Debts
It’s important to differentiate recurring debts from additional expenses, like the expenses you just can’t live without. Or maybe you’ll realize after reading this, those are the things you don’t actually need.
Debts can include car loan payments, mobile phone payments, student loans, and any personal loans you may have taken out previously that you’re still paying off.
These debts require you to pay monthly, making them “recurring.” Then there are additional expenses you should consider. For example, your gym membership. Yes it’s recurring, but you could easily choose to stop paying for the gym if you’re trying to save money.
Another thing to consider is pets or children — both of which sometimes require on-going payments, like medicine, doctors’ visits, etc. Even though this isn’t something a lender will look at, it is something you should think of when calculating your debts.
Your lifestyle is important to consider, as well. If you don’t want to give up traveling or going out to eat often, then it’s important to factor in those additional costs when figuring out how much mortgage you can afford.
If you save for your travels, then consider what you put away in savings every month as an additional recurring expense. It won’t technically be considered a “recurring debt” by a lender unless you set up a service that takes out exactly the same amount every month to put toward your vacation fund. But you can keep that in mind for your own budgeting purposes.
Consider looking at a couple different payment options for a mortgage — 29% of your gross income versus 41% of your gross income. With 29%, think, “I can likely afford this mortgage.” While 41% could be more a stretch, where your other monthly payments and debts would need to be smaller so your mortgage payment doesn’t turn into a burden.
To compare your monthly budgets based on each end of the payment spectrum, add all of your recurring debts, including how much you’d like to put away into savings every month and all other expenses: food, travel, medicine, gas, etc. Where do you feel most comfortable?
By doing the above, you can draw a better picture of your financial commitment with a mortgage, factoring in everything a lender doesn’t consider. This way, you’ll know how much of a mortgage payment you can truly afford while keeping up your lifestyle. For more financial tips on home buying, visit the Atlantic Bay blog and reach out to a mortgage banker to better calculate how much you can afford.