As of June 25, 2018, we’ve made some changes to the way our mortgage approvals work. You can read more about our Power Buyer ProcessTM.
You want to buy a home. Now is a great time, as rates are pretty low compared with other points in history. It also gives you a spot in this world that’s yours to do whatever you want with. Nevertheless, in getting ready, there’s one big question you want to make sure you answer before moving forward – How much can you really afford?
We’ll go over a couple of different ways to calculate that and how to avoid getting yourself in over your head. If you know how much you can realistically spend, you’ll be able to buy with confidence.
Before you take a look at what’s on the market in your area, it’s helpful to get a preapproval for your mortgage financing. This accomplishes two goals:
- You’ll get a real dollar figure that can serve as a solid basis for determining how much you can afford. Your preapproval letter represents the maximum amount that the lender can approve you for.
- It shows real estate agents your offer merits serious consideration because you’ve already taken concrete steps to secure financing.
When you get preapproved, your lender will pull your credit in order to determine the amount of your monthly debt payments. This is then put up against income documentation to get your monthly debt-to-income (DTI) ratio – a measure of how much of your monthly income goes toward paying off bills, including housing, car payments, student and personal loans, as well as credit cards.
The maximum DTI depends on the type of loan you’re getting, but this is important because it determines how high of a house payment you can afford to have, and by extension, the cost of the house you can afford.
Don’t Strain Your Budget
A preapproval will tell you exactly how much you can afford to spend for any given loan. Still, you may not want to push to the upper limits of the approval. The next couple of sections will go over some factors you need to consider to determine the price point where you’re financially comfortable.
Leave Room for Emergencies
You never know when an illness or a job loss could throw your budget into temporary disarray. You’ll want to make sure you leave some room in your budget every month to save for your rainy day fund.
How much should you make sure you’re saving every month? One strategy is to figure out the cost of everything you absolutely need: food and water, housing, medicine, electricity, etc. After that, take a look at anywhere you might be able to cut back. You can probably get by without some of your subscriptions as well as cable TV, for example.
You might also leave some room there in case you need to pay a medical deductible before your insurance kicks in.
Mortgage lenders understand life doesn’t always go perfectly. Stuff happens. That’s why one of the lending checks is to make sure your budget isn’t stretched so thin that a temporary life event puts the affordability of your home in jeopardy. For that reason, you have to have reserves in order to qualify for most home loans.
When lenders measure reserves, they take a look at the assets you have in the bank and determine how long you could continue to make your full mortgage payment in the event of a job loss or other source of financial stress.
You may be required to have anywhere between one and six months’ worth of reserves, depending on the loan program you’re trying to qualify for. This means having money to pay principal, interest, taxes and insurance, as well as any applicable homeowners association dues.
So how can you go about determining how much you can actually afford while still making sure you’re financially comfortable? I recommend using a home affordability calculator.
This is great because you can factor in the monthly income of everyone that’s going to be on the loan and your monthly debt payments. Then you add in the amount you’re willing to spend toward your down payment and closing costs. Based on these factors, you’ll be given an estimate of how much you can afford and what your monthly payment would look like.
If you’ve already been preapproved for a loan, you can attack the problem from a different angle. Using our purchase calculator, start by putting in the maximum purchase amount you qualify for and the amount you’re willing to put down at closing. If you find that this monthly payment amount would be leaving you’re a little light in the pocketbook for your liking, you can put in different purchase prices until you find one that gives you the breathing room you desire.
One thing to note is that most mortgage calculators don’t factor in taxes and insurance or homeowners association dues in your monthly payment by default. Insurance cost depends on what the policy covers and your area, among other factors. Taxes depend on the area you live in as well as any exemptions you qualify for. That’s different for everyone.
If you know the area you’re going to be living in, you can look online for estimates of tax and insurance cost based on your situation and add that onto your monthly payment.
Are you concerned about closing costs? Taking lender credits to keep closing costs down is definitely an option. However, in exchange for these credits, you’ll end up paying a higher interest rate than if they were paid at the closing table. It’s important to factor this into your monthly mortgage payment.
Are you considering buying a home in the near future? You can go ahead and get preapproved online through Rocket Mortgage® by Quicken Loans. If you’d rather get started by speaking with one of our friendly Home Loan Experts, they’d be happy to take your call at (800) 785-4788. If you still have questions, we can get you the answers. Leave them for us in the comments below.
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