How Much House Can I Afford – The First Question in Home Ownership

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If the housing bubble bust taught the average American anything, it taught us to only take on debt we can realistically afford. Living beyond your means can mean a nice house and no time to spend enjoying it because you need three jobs to afford it. So, the first question you ask yourself is how much home can I afford? Think like a lender: look at the three factors they consider and decide for yourself, how much home you can realistically afford?

Factor #1: Your Debt-to Income Ratio

This is simply how much you owe versus how much you make. To figure out your debt-to-income ratio (DTI), add together your total amount of monthly debt and divide it by your total monthly income. Your projected home mortgage will add to your debt amount, and lenders are generally satisfied if the ratio is 36 percent (which means your debt takes up a little more than a quarter of your take home pay). But remember, this isn’t all about the lenders—this is about you, right? So, if you want your total DTI (including that future home mortgage) to only reach 25 percent of your income, then let your lender know how much you’re willing to take on. Maybe you can afford more, but if it’s not what you want, don’t take it on.

Factor #2: Your Credit Score

Your credit score is a meter of your credit health. The higher your score, the more likely you are to receive the loan you want at the interest rate you want. FICO credit scores, which range from 300-850, are used by most lenders, and generally a score of 760 or above will net you the best interest rate and terms on your loan. To make sure your credit is in the best shape before you apply for a mortgage loan, it’s a good idea to pull all three copies of your credit reports to verify that the information is accurate and up-to-date. You can do this for free at the federally mandated site www.annualcreditreport.com After you’ve verified that your credit reports are accurate, you’ll need to pull your credit scores to see where you line up. Unfortunately, you’ll have to pay to get your FICO scores but even then, it may not be the exact score your lender is using. To get a general idea of where your score stands for free, you can get your free credit score from Credit Sesame. If there are errors artificially lowering your score, fix those before going to a lender. If your score isn’t where it needs to be to get the best rates, you should work on boosting your score before applying for a loan. Credit Sesame’s free monthly credit score updates can also help you monitor and track your progress without spending a dime. Putting yourself in the best possible standing before heading to the lender’s office will give you the confidence to get the terms you want. And since you’ll be carrying this loan for a decade or more, it’s worth waiting six to 12 months to make sure you’re not paying more than you want.

Factor #3: Your Down Payment

Your down payment is a major factor in how much house you can afford. Your down payment is also a factor in what types of mortgage products you’re eligible for and can potentially score you a lower mortgage rate, so the down payment must be considered carefully. Technically, depending on the type of mortgage, lenders will accept as little as 3.5 percent of the total mortgage as a down payment. Some will even cover the closing costs in the home loan. However, these options usually mean adding other costs, such as the costs of interest on the closing costs over the life of the loan, or adding private mortgage insurance (PMI) to your mortgage. The conservative estimate as to how much a down payment should be with a traditional mortgage is 20 percent. Even for a more moderately priced home of $200,000, that’s a $40,000 down payment—not chump change. While somfae lenders have mortgage products with “zero money down,” this used-car salesman push should raise red warning flags that there will most likely be costs to make up for it elsewhere. In the end, though, it is your decision as to how much of a down payment you can pull together and to determine whether or not it’s worth your while to wait and save more, or act now and possibly pay more on the back end.

In any case, going to the lender knowing what you are capable of affording and what you bring to the table in terms of credit score and down payment puts the power in your hands. The lender, of course, gets to say what you’re eligible for, but only you decide what terms you’re willing to accept. Deciding this beforehand makes it less likely that you’ll be pushed into a product with which you’re not comfortable, so use the factors above to answer the question “how much house can I afford” before going to a lender.

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