What Factors Affect How Much House I Can Afford?
Although it’s a substantial consideration, how much you make isn’t the only piece of the puzzle. Other factors that play an important part in determining affordability are:
- Household income
- Monthly expenses (e.g. student loan payments, auto loans)
- Available savings for your down payment & expected closing costs
- Your debt-to-income ratio (DTI); and
- Your credit profile
First of all, be aware that you can’t start a full-time job and then immediately qualify for a house loan. Most lenders require you to have two years of historical income in that job function before they can determine your ability to repay the loan. If you’re married, both of your incomes can be included if you apply as “co-borrowers.” Depending on your joint financial profile vs. the home you're attempting to buy, applying as co-borrowers could boost the strength of your application.
Although more options are becoming available for those who don’t have much saved up for a down payment (e.g. Fannie Mae's HomeReady program), today you will generally need to have 10% of the house purchase price available as a down payment. As recently as 3-4 years ago, 20% down payments were the norm, so definitely take advantage of the fact that requirements have eased. If you don’t have 20%, you can still get a mortgage, but you may be asked by the lender to pay private mortgage insurance (aka “PMI”) every month until you build up 20% equity in your home.
The purpose of mortgage insurance is because, for your lender, you’re considered riskier to lend to. By agreeing to pay an extra amount each month, you’re convincing them that you’re serious about paying back your loan and giving them something extra for taking on your risky loan. PMI fees vary from around 0.25% to 1.5% of the original loan amount per year, depending on the size of the down payment and your credit score.
Note, there are programs in place these days that help people become house owners who don’t have a 20% down payment. They all have different requirements and contingencies. If you go this route, just keep in mind that you need to really, seriously consider how much you can spend every month and still be comfortable enough financially.
Debt-to-Income Ratio (“DTI”)
How much do you earn each month before taxes? Now, how much do you owe every month in bills and other debts? These two numbers form your debt-to-income ratio. Ultimately, mortgage lenders use both front-end and back-end DTI calculations — along with credit history — to determine a borrower's ability to repay.
Historically, lenders have used 43% as the ceiling for how high your debt-to-income ratio can be, in order to still have what's called a “qualified mortgage.” However, as credit requirements have eased, Fannie Mae & Freddie Mac have stated that they will now accept loans with DTI ratios of up to 50% under some circumstances (as of July 29, 2017).
That said, not everyone agrees with this decision by Fannie Mae & Freddie Mac, so you should still remember that the Federal Reserve considers a DTI of 40% or more a sign of financial stress. When you think about it, if more than $0.40 cents of ever $1.00 you make are going towards existing debts…that is likely a sign that you should re-evaluate your spending habits.
Other factors that affect how much you can spend are:
- Loan type
- Loan term
- Your interest rate
- Expected income taxes (based on historical income)
- Property taxes (remember, new 2018 tax rules limit property tax deductions to $10,000)
Consider Future Expenses In Years to Come
As a soon to be homeowner, it's important for you to understand your total monthly costs of owning in addition to your mortgage payments. Even if your income has been stable for years, and your monthly debts are declining — what you can afford can vary a lot depending on your risk tolerance. Have you thought about what % of your income you want to set aside for an emergency fund? What about future expenses on the horizon (ex. children, pre-school) that you want to start saving towards?
These are important questions to start thinking about as your mortgage lender is also going to assess just how stretched your monthly finances will be after buying this home. Most financial advisors will tell you to have between 3-6 months of living expenses saved, in case unexpected costs arise.
What You Can Afford vs. Qualify For
The number you get for how much house you can afford isn’t necessarily the amount you should spend. Remember that it’s easy to over-predict what you can spend every month on a mortgage, and keep in mind that you may want to save for retirement, have money on hand for emergencies, and be able to do fun things once in a while.
In fact, financial planners recommend you take on just 25-30% of your monthly after-tax income in a mortgage.
Stem Lending, a Jersey City-headquartered MortgageTech firm, with presence throughout Colorado, Connecticut, New Jersey, Pennsylvania, and Virginia, offers online, in-person and over-the-phone mortgage consultations from licensed mortgage experts to home buyers. As a FinTech mortgage broker, Stem Lending serves as the trusted advisor for homebuyers – bringing offers from multiple lenders onto one platform, so that homebuyers make the most rational decision on their mortgage options.
Take the first step in saving on your mortgage, reach out to Stem Lending’s mortgage approval team today: