Financial Education: Home Ownership

Home  |  Renting Vs Buying?  |  Are You Ready?  |  Assistance Programs  |  Mortgage Terms  |  How Much Can You Afford?  |  Shopping for the Best Deal  |  Glossary  |  Resources

How Much Home can You Afford?

As a rule of thumb, many people estimate they can afford a mortgage of 2 or 2 1/2 times their household income. For example:

Annual Income = $30,000

$30,000 X 2 = $60,000

$30,000 X 2 1/2 = $75,000

Keep in mind that just because you qualify for that amount, it does not mean you can afford or be comfortable with those monthly payments. You need to consider your particular circumstances and your future financial needs and goals.

Lenders look at debt-to-income (DTI) ratios when they consider your application or pre-qualification for a mortgage loan.

They consider housing expenses as a percentage of income and total monthly debt as a percentage of income. Both ratios are important factors in determining whether the lender will make the loan.

Lenders usually require the PITI, or principle, interest, taxes, and insurance, or your housing expenses, to be less than or equal to 25% to 28% of monthly gross income. Lenders call this the "front-end" ratio.

In other words, if you gross $2,500 a month, or $30,000 annually, your mortgage payment should be $700.00 or less.

Lenders usually require housing expenses plus long-term debt to be less than or equal to 33% to 36% of monthly gross income. Lenders call this the "back-end" ratio.

In other words, if you gross $2,500 a month, or $30,000 annually, the combination of your mortgage and other long-term debt (like car loans and monthly credit card payments) should not total more than $900.00

Long-term debt is outstanding debt with a remaining term of more than ten or eleven months. It can include student loans, credit cards, car loans, and other non-housing expenses.

Other factors to consider:

Other factors can affect how much mortgage you can afford. Such as:

• The length, or term, of your mortgage affects how much mortgage you can afford. Most mortgages are for either 30- or 15-year terms. A 30-year mortgage is the most common because the mortgage payment is lower.

A 30 year mortgage allows you to borrow more money, but will generally have a slightly higher interest rate than a 15-year mortgage. In addition, over the life of the loan, you pay a lot more interest with a 30-year mortgage than with a 15-year mortgage.

For example, if you borrowed $75,000 for 15 years at 7.5%, your monthly principle and interest payment would be $675. The total interest over 15 years would be $46,500. If you borrowed $75,000 for 30 years at 8%, your monthly payment is less with this 30-year loan, however, the total interest paid over 30 years would be $121,200, compared with only $46,500 for the 15-year loan.

• Whether your mortgage is variable or fixed will also affect how much mortgage you can afford.

If you have a fixed rate loan, your interest rate stays the same for the term of your loan. Your payments are predicable and are not affected by interest rate changes.

If you have a variable rate loan, the interest rate can increase or decrease during the term of your loan. You might have a low rate at the beginning of the term. However, be aware that the rate and your payment can increase significantly throughout the term of your loan.