December 3rd, 2016
That question may be in the top-five, most-heard questions from prospective homebuyers. The best answer is, "Only you know how much house you can afford" - that means honestly assessing your entire financial picture and not just determining how much money you have for the down payment and all of the fees, but for all of the expenses that come with owning a home.
Here are some tips on how you can you prepare for the mortgage financing journey that ends at the front door.
Know the "magic numbers"
Assets and income form the essential elements of the equation a lender will use to determine your loan worthiness. But there are the other important numbers that will be factored into the final decision.
The strength or weakness of your credit score will help to determine if you can qualify for a mortgage and then how much and what kind of loan. A high score tells a lender that you are capable of taking on a greater level of debt and they can feel comfortable approving you for an equally greater-size loan. Conversely, a lower credit score will reduce the lender's confidence and the amount of the loan for which you can qualify.
The debt-to-income ratio is relatively easy to arrive at, but another very important number for you to know: it is the cost of all of your monthly debts divided by their gross income. So, if your monthly debts are $2000 and you make $5000, then your ratio is 40%. Unlike the credit score, you should aim for a lower ratio - the higher it is, the more a lender is going to question your ability to repay the loan. To qualify for a conventional loan, the debt-to-income threshold is 38%, while an FHA loan allows for a slightly higher ratio of 43% - which would make the buyer in the previous example better suited for an FHA.
This isn't an established number like the credit score or debt-to-income ratio. A credit score only takes into account reported debt obligations, like car payments and credit cards. The "reality check" is based on your self-evaluation of all of your monthly financial obligations in a nutshell - energy bills, train tickets for commuting, cable television, etc. After all of those outflows are accounted for, you must assess if you can realistically "cash" that "reality check" each month, along with a mortgage, drawing against what you have in the bank. And it's just not about today: you need to ask yourself hard questions like, "If I lost my job tomorrow or got sick and had to go on disability, could I still afford my monthly debts?"
Adding it up
Many websites, like Zillow and Bankrate, let you "stress test" your numbers using an affordability calculator. Some ask for as little information as annual income, total monthly debts, estimated down payment and interest rate to give you a ballpark figure for how much house you can afford. While not an exact number, it can help temper or alter your mortgage expectations - sometimes in a positive direction.
First steps - next steps
Once you are confident that you know your numbers, it's time to talk with a trusted Loan Officer who can help guide you to the mortgage solution that best fits your needs and assist you throughout the entire loan process, from approval to closing. Together, you can ensure that you will take the best step: into a new home.