Home Affordability Begins With Your Mortgage Rate
You will probably notice that any home affordability calculation includes an estimate of the mortgage interest rate you will be charged. Lenders will determine if you qualify for a loan based on four major factors:
If lenders determine you are mortgage-worthy, they will then price your loan. That means determining the interest rate you will be charged. Youryoull get.
Naturally, the lower your interest rate, the lower your monthly payment will be.
What Is Mortgage Required Income
Lenders consider two main points when reviewing loan applications: the likelihood of repaying the loan and the ability to do so .
Nerdwallet.com explains that mortgage income verification, even if they have impeccable credit, borrowers still must prove their income is enough to cover monthly mortgage paymen
Rule : Consider Your Total Housing Payment Not Just The Mortgage
Most agree that your housing budget should encompass not only your mortgage payment , but also property taxes and all housing-related insurancehomeowners insurance and PMI. To find homeowners insurance, we recommend visiting . Theyre what we call an insurance aggregator, which means they compile all the best rates from around the online marketplace and present you with the best ones.
As for just how big a percentage of your income that housing budget should be? It all depends on whom you ask.
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Interest Rates And Your Credit Score
While theres no specific formula, your credit score affects the interest rate you pay on your mortgage. In general, the higher your credit score, the lower your interest rate, and vice versa. This can have a huge impact on both your monthly payment and the amount of interest you pay over the life of the loan. Heres an example: Let’s say you get a 30-year fixed-rate mortgage for $200,000. If you have a high FICO credit scorefor example, 760you might get an interest rate of 3.612%. At that rate, your monthly payment would be $910.64, and youd end up paying $127,830 in interest over the 30 years.
Take the same loan, but now you have a lower credit scoresay, 635. Your interest rate jumps to 5.201%, which might not sound like a big differenceuntil you crunch the numbers. Now, your monthly payment is $1,098.35 , and your total interest for the loan is $195,406, or $67,576 more than the loan with the higher credit score.
What Percentage Of Your Income Should Your Mortgage Be
Calculating the percentage of income for your mortgage payments will help you understand exactly how much you can afford to spend. Buying real estate via a mortgage is the largest personal investment that most people make in their lifetime.
For this reason, working out how much you can comfortably borrow depends on several factors. Its not just a question of how much the bank is willing to lend you. Factors such as the mortgage percent of your net income , finances, priorities, and preferences are all part of the equation.
As a general rule, most prospective homeowners can finance a property that costs anywhere between two and two-and-a-half times their gross annual income . Now, lets imagine that you earn $100,000 per year. This would mean that you can afford a mortgage between $200,000 and $250,000. However, this calculation is only a general guideline.
Ultimately, when you consider buying a property, there are several essential factors to consider. Primarily, you need to have a good idea of the amount your lender thinks you can afford . Next, it helps to take a personal inventory and think about the type of home where you would like to live. If you plan to live in your new home for many years, what sort of things will you be willing to trade-offor notto afford your dream home?
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How Much House Can I Afford With An Fha Loan
To calculate how much house you can afford, weve made the assumption that with at least a 20% down payment, you might be best served with a conventional loan. However, if you are considering a smaller down payment, down to a minimum of 3.5%, you might apply for an FHA loan.
Loans backed by the FHA also have more relaxed qualifying standards something to consider if you have a lower credit score. If you want to explore an FHA loan further, use our FHA mortgage calculator for more details.
Conventional loans can come with down payments as low as 3%, although qualifying is a bit tougher than with FHA loans.
Aim To Put 20 Percent Down
The amount of mortgage you can afford also depends on the down payment you make when buying a home. In a perfect world, we recommend a 20 percent down payment to avoid paying mortgage insurance, Neeley says.
When your down payment is less than 20 percent, your costs rise. You typically have to pay private mortgage insurance, which can cost up to 1 percent of the entire loan amount each year until you build up 20 percent equity in your home. On a $240,000 mortgage, thats $200 per month.
Keep in mind that you will have other ongoing costs related to homeownership as well, including taxes, insurance, and utilities. All of these expenses need to be estimated before you settle on a monthly mortgage payment.
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Ugh This Is Making My Head Hurt
Yup. Mortgages arent fun. Still, a house is one of, if not the, most expensive thing youll ever spend money on so its best to give it a ton of consideration. Being saddled with an unruly mortgage will affect you for years and years. To that end, the more thought you give it now, the less worry youll have later. So remember, the question isnt just How much mortgage can I afford? but How much mortgage do I want? for the long term.
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What Is The Required Debt
Online resource Investopiea.com explains that the lower an applicants debt-to-income ratio, the greater the chances that the borrower will be approved for a credit application.
As a customary rule, 43 percent is the highest debt-to-income read DTI ratio a borrower can have and still be qualified for a mortgage.
However, lenders prefer a debt-to-income ratio lower than 36 percent, with no more than 28 percent of that debt as a mortgage or rent payment.
In reality, though, the maximum DTI ratio varies from lender to lender.
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What To Do Before You Buy
Whatever you can afford, you want to get the best mortgage ratesand you want to be in the best position to make an offer on your house. Make these steps part of your preparation:
- Check your credit score. Your can have a direct affect on the interest rate you’ll pay. Check your score, and do what you can to improve it. You can get a free credit report at AnnualCreditReport.com.
- Get pre-approved. Go to a lender and get pre-approved for a loan before you make an offer on a house. It will put you in a much stronger bargaining position.
What About Your Other Goals
It’s easy to get caught up in whether the down payment and ongoing costs are affordable — but you also need to look at the opportunity cost.
While it’s classified as affordable to devote a full 30% of your income to your home, if you want to retire early or put five kids through college, this may be too large a portion of your income to spend.
Create a sample budget, factoring in housing costs and other expenditures, to see how much money you’d have left over after paying for houses valued at different prices.
If you’d scrimp to make payments on a $300,000 house and be unable to save for early retirement, you may only be able to afford a $200,000 house no matter what the “experts” say.
Only you know what your financial goals are — which is why it’s important to decide for yourself how much house you can afford instead of just borrowing what a lender tells you that you can.
Analyze Your Monthly Expenses
When estimating what you can afford, its also important to have a clear view of your monthly expenses. These can be hard to track and will likely vary based on the size of your household and your spending habits. According to the Bureau of Labor Statistics, the average individual has monthly expenditures that include:
- Food: $644
- Internet: $47
- Cell phone: $120
For an individual, these expenses add up to a monthly total of $2,463. Some of these items are discretionary and will fluctuate based on your lifestyle, city, the size of your home, and the size of your family. The goal is to estimate how much money youll need to spend each month after you pay your mortgage and other debts.
How To Calculate How Much House You Can Afford
Okay, all you really have to do is crunch a few numbers to figure out how much house you can afford. And if math isnt your thing, hang in there. Well walk you through it step by step. Weve never lost a patient.
And for you married folks, make sure you go over the results with your spouse. You both need to be on the same page when it comes to your budget and what you can actually pay. After all, shopping for your home sweet home will feeldare we sayromantic once you and your sweetheart set shared expectations.
Simply follow the steps below.
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Figure Out 25% Of Your Take
Lets say you earn $5,000 a month . According to the 25% rule we mentioned earlier, that means your monthly house payment should be no more than $1,250.
Stick to that number and youll have plenty of room in your budget to tackle other financial goals like home maintenance and investing for retirement.
What Lenders Like To See
Since there are various credit scores available to lenders, make sure you know which score your lender is using so you can compare apples to apples. A score of 850 is the highest FICO score you could get. Each lender also has its own strategy, so while one lender may approve your mortgage, another may noteven when both are using the same credit score.
While there are no industry-wide standards for credit scores, the following scale from personal finance education website www.credit.org serves as a starting point for FICO scores and what each range means for getting a mortgage:
740850: Excellent credit Borrowers get easy credit approvals and the best interest rates.
670740: Good credit Borrowers are typically approved and offered good interest rates.
620670: Acceptable credit Borrowers are typically approved at higher interest rates.
580620: Subprime credit It’s possible for borrowers to get a mortgage, but not guaranteed. Terms will probably be unfavorable.
300580: Poor credit There is little to no chance of getting a mortgage. Borrowers will have to take steps to improve credit score before being approved.
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Other Mortgage Qualification Factors
In addition to your debt service ratios, down payment, and cash for closing costs, mortgage lenders will also consider your credit history and your income when qualifying you for a mortgage. All of these factors are equally important. For example, even if you have good credit, a sizeable down payment, and no debts, but an unstable income, you might have difficulty getting approved for a mortgage.
Keep in mind that the mortgage affordability calculator can only provide an estimate of how much you’ll be approved for, and assumes youre an ideal candidate for a mortgage. To get the most accurate picture of what you qualify for, speak to a mortgage broker about getting a mortgage pre-approval.
Improve Your Credit Score
If you have debt, a mortgage lender may still approve your application if you have a very good or excellent credit score.
Payment history is the most important factor in your credit score, so make sure you’re paying all your bills on time. You can also request a credit report from one of the three credit bureaus to check for any errors. If you find you’ve been penalized unfairly, dispute an error with the bureau.
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Why Calculate Mortgage Affordability
When you’re looking to buy a home, it’s handy to know how much you can afford. Being able to calculate an estimate of how much you’re able to borrow is an important part of setting your budget.
You also need to determine if you have enough cash resources to purchase a home. The cash required is derived from the down payment put towards the purchase price, as well as the closing costs that must be incurred to complete the purchase. We can help you estimate these closing costs with the first tab under the mortgage affordability calculator above.
Taken together, understand how large a mortgage you can afford to borrow and the cash requirements will help you determine what kind of home you should be on the look out for. To learn more about mortgage affordability, and how our calculator works, have a read of the information below.
How Much Income Is Needed For A 250k Mortgage
A $250k mortgage with a 4.5% interest rate for 30 years and a $10k down-payment will require an annual income of $63,868 to qualify for the loan. You can calculate for even more variations in these parameters with our Mortgage Required Income Calculator. The calculator also gives a graphical representation of required income for a wider range of interest rates.
Tips For Lowering Your Monthly Payment
Theres plenty you can do in the months leading up to a mortgage application to drive down your mortgage rate and thus your monthly payments:
Start off with baby steps. You may not get to be a lenders ideal borrower overnight but most of us can make ourselves a better bet quite quickly.
Check Your Credit History
When you apply for a mortgage, lenders usually pull your credit reports from the three main reporting bureaus: Equifax, Experian and TransUnion. Your credit report is a summary of your credit history and includes your credit card accounts, loans, balances, and payment history, according to Consumer.gov.
In addition to checking that you pay your bills on time, lenders will analyze how much of your available credit you actively use, known as credit utilization. Maintaining a credit utilization rate at or below 30 percent boosts your credit score and demonstrates that you manage your debt wisely.
All of these items make up your FICO score, a credit score model used by lenders, ranging from 300 to 850. A score of 800 or higher is considered exceptional 740 to 799 is very good 670 to 739 is good 580 to 669 is fair and 579 or lower is poor, according to Experian, one of the three main credit reporting bureaus.
When you have good credit, you have access to more loan choices and lower interest rates. If you have poor credit, you will have fewer loan choices and higher interest rates. For example, a buyer who has a credit score of 680 might be charged a .25 percent higher interest rate for a mortgage than someone with a score of 780, says NerdWallet. While the difference may seem minute, on a $240,000 fixed-rate 30-year mortgage, that extra .25 percent adds up to an additional $12,240 in interest paid.
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Example Of Mortgage Payment Percentage
Based on the 28 percent and 36 percent models, heres a budgeting example assuming the borrower has a monthly income of $5,000.
- $5,000 x 0.28 = $1,400
- $5,000 x 0.36 = $1,800
Going by the 28 percent rule, the borrower should be able to reasonably afford a $1,400 mortgage payment. However, factoring in the 36 percent rule, the borrower would also only have room to devote $800 to their remaining debt obligations. Applied to your own financial situation, this may or may not be feasible for you.