Before you can search for a home, you’ll want to figure out how much home you can afford. Getting approval for a certain loan amount is one thing. But figuring out how much you can comfortably afford to pay each month on a mortgage is perhaps just as important.
This can save you a lot of time, as you’ll be able to focus on homes you can afford rather than those you wish you could afford.
Your lender can help you with this by going over your financial records. They can explain all the loan options as well as point out any potential roadblocks you may run into that could affect your borrowing strength. Many factors come into play during the loan process, including your income and other assets, employment prospects and stability, debt ratio and credit history. Loan payments typically include the principal, the interest, taxes and home mortgage insurance. The sum of all these is generally known as PITI. The principal is the purchase price you agreed to pay for the home. The interest is what the lender charges you to use the money they lend you.
The lender may charge additional loan costs as well that are included in your monthly payment. Taxes are the property taxes your community levies, including those monies for schools, libraries, police and fire protection, etc. Mortgage insurance protects the lender from loss should you default on your loan. It is not assessed for home purchases where you put down at least 20% of the purchase price.
Most lenders consider two things when determining what you can afford:
- The total monthly mortgage payment, which includes principal, interest, taxes, insurance and homeowner’s association dues, if any. The total should not exceed 25% to 28% of your monthly gross income.The sum of total mortgage payments plus the sum of all other monthly payments of long-term debts (those that require payment of more than nine months such as credit cards and automobile loans) should not exceed 33% to 36% of total gross income.
- There are also upfront costs to be factored in. For example, a larger down payment can reduce your mortgage payment but most first time buyers can’t afford to put all their life savings into a down payment because of all the other upfront expenses. These expenses include closing costs (banking fees, points, insurance, escrow amounts, attorney fees, state, county and city fees, title insurance and inspections.) Other possible expenses may include moving costs, minor updates to the home such as paint and items not included in the purchase (washer/dryer, refrigerator, replacement light fixtures, drapes, etc.).