Financial experts generally advise that no more than 28 percent of your gross income should go to a mortgage payment. This means if, after expenses and debt, your monthly income is $5,000 per month then your mortgage payment should not be more than $1,400 per month.
That said, everyone has different financial goals and lifestyle needs. Some folks choose to underspend on their house and use the extra money for investments or travel, while others might need more space due to family size. Be sure to factor in your long-term goals so you don’t get stuck with more house (and mortgage) than you need. (See calculator below.)
One of the most obvious influences in your home loan application is your credit score. This gives lenders a glimpse of how risky it will be to lend you the cash you need to buy the home of your dreams.
However, in addition to helping a bank determine whether or not you pose a risk of defaulting on your loan, this three-digit number will also shape the interest rate, terms and conditions for financing your mortgage loan. The type of mortgage you choose can have a dramatic impact on the amount of house you can afford, especially if you have limited savings.
TIP: At least six months before you decide to start looking for a home, pull a copy of your credit report and credit score to correct any poor credit history and remove inaccurate information.
Your debt-to-income ratio (DTI) is calculated by adding up all of your monthly debt payments and dividing them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.
To determine how much house you can afford, the standard rule is that your monthly expenses should not exceed 36%. The 36% rule is based on dividing your monthly mortgage payments and other monthly debt payments by your gross monthly income.
TIP: Remember that each bank has its own minimums and limits, so before you apply for a mortgage, shop around before submitting an application to find the bank with the best fit for your financial situation.
Your credit report helps lenders to understand how you’ve handled your finances in the past, but your employment history demonstrates how likely you’ll be to manage your home loan in the future. The more job stability you have, the better chance lenders will be to help you get the keys to a place to call your own.
TIP: If you are self-employed, you will need to show at least 2 years’ worth of documentation.
Qualifying income is not just employment salary but other sources such as alimony, royalties, Social Security and trust income. Lenders will tally total income, subtract your debt and use the remainder to determine how much you can afford.
Lenders generally use the 28/36 rule for underwriting. This rule states that a household should spend 28 percent or less of their gross income on total housing expenses, including things like homeowner association (HOA) fees, home insurance and property taxes. Likewise, total household debt -- which includes everything from your mortgage to credit card bills and student loans, shouldn’t exceed 36 percent.
The down payment you put down on a house not only reduces your loan amount, it also inspires more confidence from your lender helping you qualify for more favorable terms when you apply for a mortgage.
Down payment requirements vary by the type of loan you get. For example, an FHA loan requires you put down 3.5% of the sales price of the home you wish to purchase. This means if you’re looking to purchase a home for $300,000, you would need a down payment of $10,500. A conventional loan will require a down payment of 3% or 5%, depending on the loan product you get. If you are lucky enough to be able to afford a 20% down payment, you get to forego mortgage insurance, which equals a higher monthly payment.
TIP: Check into different down payment assistance programs for first time home buyers. Some of these programs don’t even require that you be a first timer! Different banks offer different programs so it pays to shop around.