When the thought enters your head that maybe its time to stop renting and buy your first home you are going to wonder “how much house can I afford?” This article will cover the basics so you can get a rough idea of how much of what a bank will lend you for your first home.
At the end of the day, take the time to sit down and get a proper mortgage pre-approval letter from your lender. There are too many variables to estimate a mortgage payment accurately without doing so. This is only meant to give you a ball park figure to determine if you would like to move forward with your first home purchase.
How Do The Banks Calculate How Much House You Can Afford?
To calculate how much house you can afford, we are going to take a look at what the bank is looking for from you to give you an idea of how much of a mortgage payment you can qualify for from your lender. Lenders calculate these numbers monthly so for our purposes we will as well.
Basically, your Debt to Income Ratio is used by lenders to make sure you are not taking on too much debt.
Your total monthly income before paying taxes and any other items subtracted from your pay check is your gross income. If you are a W-2 salaried employee this is quite easy. Take your yearly salary and divide it by 12.
Once you start getting into overtime, bonuses and self employment this is where your gross income can get complicated and you really need to get that pre-approval from your lender.
Debt to Income Ratio
This is the ratio of your housing expense and consumer debt compared to your gross income. Traditionally the debt to income ration is broken down into your front end expense (housing expense) and your back end expense (total debt including housing).
Front End Ratio (Housing Expense)
This is the percentage of your gross income that goes to your housing expense. The housing expense is compromised of principle and interest payment on your home loan, property taxes, property insurance, HOA fee (if any) and private mortgage insurance.
For example if your monthly gross income is $8000 and you are paying $2000 for your principal and interest payment, property tax, private mortgage insurance (if any) and property insurance your front end ratio is 25%.
Back End Ratio (Total Debt)
Your back end ratio is the percentage of your gross income that goes towards your housing expense and consumer debt. Consumer debt is basically any installment payment like student loans, credit card payments, auto loans, etc…
Take the numbers from above of an $8000 dollar monthly income with $2000 for you housing now add $500 for a car payment $250 for student loans and another $250 for credit cards… totaling $1000 of monthly consumer debt with total debt of $3000 (consumer and hosing combined) for a back end ratio of 37.5%.
What Do The Ratios Mean?
In years past the government recommended a front end ratio of no more than 28% for the front end and 36% for the back end. Over the years the two have sort of blended together and the banks don’t really pay attention to the front-end ratio. They are concerned with the total debt to income ratio or the back-end ratio.
Most loan programs will allow you to spend between 38% to 50% of your gross income on your back-end ratio. Conforming loans will allow up to 43%, FHA will allow up to 45% or sometimes more.
In the example above, with $8000 a month gross income and $1000 in consumer debt, the most the bank will allow you to spend a month on housing is roughly $2440 a month. This would translate into roughly a $345,000 home with a $17,250 down payment.
Now you have an idea of how much a bank will qualify you for in your monthly housing expense. Take that number and head over to Realtor.com. Realtor.com has an excellent House Home Calculator that calculates PMI, insurance and taxes for you and you can back end into a payment that fits the housing expense to give you the maximum cost of a house you can afford.
The fun part can begins as you start to research communities and search for the home of your dreams!!
Variables That Will Effect How Much Home I Can Afford
There are so many variables that will affect how much home you can afford. The strength of your credit score, your down payment, your PMI and the amount of debt you carry all work together to come up with a mortgage payment you can afford when buying a house.
Obviously, every buyer wants to secure the best interest rate on their home mortgage, but all of these variables plus others can impact the interest rate available to you.
What Is Consumer Debt?
One variable in determining how much house I can afford is consumer debt. Consumer debt can vary greatly from borrower to borrower.
Consumer debt is basically money you owe that you pay monthly. Examples of consumer debt are:
- Student Loans
- Credit Card Debt
- Car Loans
- Installment Loans
The minimum monthly loan payment for each line of consumer debt is subtracted from your gross income, lowering the income basis used to calculate the maximum mortgage the banks feel you can afford for a house.
Final Thoughts on How Much House Can I Afford?
I have given you a quick formula to get a rough idea of what you can afford so you can start your journey of buying a new home.
Once you decide you really want to buy your first home, take the time to get a pre-approval and really hone in on how much house you can afford. With a proper pre-approval you can talk real numbers on a house you are thinking of purchasing.
As a final thought, remember you need to be comfortable with how much house you can afford. You are the one making the payments. Just because the bank says you can afford X amount it doesn’t mean you have to spend that much if you are not comfortable with it. The final decision is yours and you need to live with it.
Other First Time Buyer Resources:
- Bill Gassett- First Time Home Buyer Tips
- Luke Skar- What is a Pre-approval vs Pre-qualification
- Lynn Pineda- Why Do I Need To Get a Mortgage Pre-approval
- Kevin Vitali- Avoid Last Minute Hurdles When Getting Your First Loan
Home Much House Can I Afford? is provided by Kevin Vitali of EXIT Group One Real Estate of Tewksbury MA. If you would like to buy your first home give me a call at 978-360-0422 and let’s get the process started.
Real Estate Services in the following areas: Northeast Massachusetts, Merrimack Valley, North Shore and Metrowest. Including the following communities and the surrounding area- Amesbury, Andover, Billerica, Burlington, Chelmsford, Dracut, Groveland, Haverhill, Lowell, Melrose, Merrimac, Methuen, Middleton, North Andover, North Reading, Reading, Stoneham, Tewksbury, Tyngsborough, Wakefield, Wilmington, Westford