How Much House Can I Afford?

Posted by Randy Lucka on Dec 12, 2015 06:00:00 AM

Topic: ALL

Couple looking at listings for homes

You’re ready to take the leap from renting to buying your first home, but you are unsure what to expect or where to even begin. Answering the simple question “how much house can I afford” is a great first step in the home buying process. Determining a budget will help you better navigate what houses are financially right for you and position yourself for a hassle-free approval process.

There are many factors lenders consider when determining how much house a borrower can afford. Factors such as income, expenses, and debt are taken into consideration and used to calculate what is known as the debt-to-income ratio, or DTI.

What is the debt-to-income ratio?

The DTI ratio is calculated by dividing total monthly debts by gross monthly income.

Typically, lenders prefer that the borrower’s debt-to-income ratio does not exceed 43 percent, however based on your down payment, credit score, and the loan program you are choosing, the DTI ratio can vary.

With the preferred DTI of 43 percent known, lenders often compute the above equation in reverse. Consider, for example, a young couple who has an annual household income of $90,000 or gross monthly income of $7,500 ($90,000/12 months = $7,500). The maximum monthly debt (i.e., revolving charges, installment loans, support payments, etc.) a lender would recommend for this couple would be $3,225. This amount is found by multiplying the couples gross monthly income of $7,500 by the desired maximum DTI ratio of 43 percent ($7,500 x .43 = $3,225).

To find the maximum housing payment (i.e., principal, interest, taxes, insurance, and association fees, if applicable) this couple would qualify for, the lender would then subtract their monthly debt from the total desired DTI.

For example, imagine that the same couple has a monthly credit card payment of $150, a student loan payment of $250, and a car loan payment of $425, making their total monthly debt of $825 ($150 + $250 + $425 = $825). To compute the maximum housing payment this couple would qualify for, the lender would subtract this total monthly debt of $825 from their maximum desired DTI or $3,225. As a result, the maximum housing payment this couple would qualify for would be $2,400 ($3,225 - $825 = $2,400).

While the DTI ratio provides a great basis for what you can afford monthly, before you can start shopping for your new home, you will still need to consider the total amount of house you can afford. Other elements that are used to determine your loan approval amount include current mortgage rates, mortgage term or the life of the loan, down payment amount, and credit score.

Want more help determining how much house you can afford?

Speak to a Loan Officer near you!