The amount of a home loan you can qualify for is determined by how much debt a lender believes you can handle. This will eventually influence how much house you can afford.

However, just because you’ve been accepted for a certain amount doesn’t imply you should buy a home in that price range. Instead, before you begin your home hunt, you should consider how much house you can afford and set a hard budget.

Read on to determine how much house you can afford and what this means as you begin your hunt for your dream home.

What Size of a Mortgage Can I Afford?

Purchasing a home is a major undertaking, and it’s easy to get caught up in the thrill of the process. However, your excitement should not eclipse your understanding of your home-buying budget. It is critical to be honest about what you can afford, especially when buyer demand in today’s housing market drives up asking prices.

You want to look for houses in your price range so you don’t fall in love with one that’s simply out of your price range. Knowing and sticking to your budget helps make the house purchasing process go more easily.

The 29/41 Rule and Its Application to Home Affordability Calculation

Lenders compute your debt-to-income ratio (DTI) when they examine your mortgage application. This is the quotient of your monthly debt payments divided by your monthly gross income. Lenders use this figure to determine how much debt you can take on.

It’s ideal to keep your DTI within the range described by these two figures, according to the 29/41 rule of thumb. Here’s an illustration.

Your housing expense ratio is represented by the first number, 29. Divide your primary housing expense, typically referred to as PITI (principal, interest, taxes, insurance, and, if applicable, homeowners association dues and mortgage insurance) by your gross monthly income. The resulting percentage should be at or below 29.

The 41 indicates your overall DTI after all additional debts. This includes revolving debt (credit cards and other lines of credit) and installment debt (mortgage, auto payment, student loans, and personal loans). You will take PITI plus the aforementioned monthly obligations and divide that by monthly gross income. This number needs to be capped at 41.

The 29/41 rule is critical to understand when considering mortgage qualification because DTI assists lenders in determining your ability to pay your mortgage. Although larger housing expenses and DTI ratios are permitted in certain loan varieties (including conventional, FHA, and VA loans), the 29/41 rule is an excellent place to start. You must determine how much house you can afford while analyzing various lending choices.

Be sure that your primary housing expense (principal, interest, taxes, insurance, and HOA dues) is not more than 29% of your gross monthly earnings. Also, be sure that your overall monthly debt (mortgage plus vehicle loans, student loans, and so on) does not exceed 41% of your total monthly income.

How to Calculate Your DTI Ratio

DTI is an important qualifying factor for mortgage lenders. The quantity of debt you have is thought to be a fairly good indicator of the risk involved with mortgage loan approval. As a result, knowing your numbers is critical.

Let us now examine how DTI is calculated.

Step 1: Compile a list of your monthly debts.

Your debt payments could include the following:

• Rent or mortgage payments
• Child support or alimony payments
• Payments on student loans
• Payments for a car
• Minimum monthly credit card payments
• Any additional debts you may have

You do not need to include:

• Bills for groceries
• Bills for utilities
• Taxes and any additional bills that may differ from month to month

Step 2: Calculate your monthly debts by dividing your monthly gross income by your monthly debts.

After that, perform a basic computation. For example, suppose your monthly debts total $2,000.00. If gross income is $6,000 per month, your DTI ratio is 0.33, or 33%.

Other Factors Affecting Home Affordability

Although your DTI ratios are significant in mortgage qualification, other factors influence your monthly mortgage payment and how much you can afford.

Before you hit the pavement looking for a new home, consider the following criteria.

Mortgage Term

This refers to the amount of time you have to repay the loan. The most frequent loan lengths are 15 and 30 years, however alternative terms are available.

Your monthly payments are affected by the duration of your mortgage. The longer the term of the loan, the lower your monthly payments will most likely be. Here’s an illustration:

Monthly payments for a $200,000 house with a 15-year fixed-rate mortgage at 3.90% are $1,469.37 (without taxes and insurance).

Let us now modify the mortgage term. Assume you still purchase the $200,000 home at 3.90%, but the term is 30 years. Your monthly payments are $943.34 (taxes and insurance not included).

Once your house loan is closed, your monthly mortgage payment may be the largest debt payment you make each month, so make sure you can afford it. This is likely one of the two most important elements in determining how much you can afford, along with the down payment.

Interest Rates on Mortgages

The mortgage rate is the interest rate on your loan. Your lender determines mortgage rates, which might be fixed or adjustable. This means they can remain constant or alter over the course of the loan. Your interest rate will be determined by a combination of your credit score, down payment, and other criteria.

Assume you purchased the identical $200,000 home as described above with a 15-year fixed mortgage at 3.90%, but we increased the mortgage interest rate to 4.25% instead. Your monthly payment would increase from $1,469.37 to $1,504.56.

Even a minor bump in interest rates can result in significant changes in interest paid over the life of the loan. Interest rates can have an impact on your total monthly payment, which has the most direct impact on affordability.

Monthly Budget

Consider your budget now that you’ve examined your DTI and any debt you may have. What role does a monthly mortgage payment play? If you don’t have a budget, record your income and expenses for a few months. You can make your own personal budget spreadsheet or use one of the many budgeting applications or online budgeting tools available.

For a handful of reasons, it’s critical to examine your budget, savings, and assets during the mortgage process. For example, you may require savings for a down payment.

Reserves

This is the number of monthly mortgage payments you might make from your savings if you lost your job or had another incident that affected your capacity to make your payment. Every lending program is different, but a decent rule of thumb is to save at least two months’ worth of mortgage payments.

Down Payment

You may believe that a down payment of 20% of the buying price is required, however this is not the case. A conventional loan (one backed by Fannie Mae or Freddie Mac) can be obtained with as little as 3% down.

That is not to argue that a larger down payment does not have advantages. For example, increasing the amount you put down on your property may provide you with the following benefits:

• Lower interest rates: Interest rates are determined by two factors: the amount of the down payment and the median FICO® score. The more your down payment, the lower your interest rate. If a lender does not have to lend as much money, the venture is seen less risky.
• No mortgage insurance: If you put down less than 20%, you’ll almost certainly have to pay mortgage insurance, aka Private Mortgagte Insurance (PMI), which can include both a monthly fee and an upfront fee, depending on the loan program. PMI protects your lender and the mortgage investor if you default on your loan, but it can considerably increase the amount you pay each month.

Remember to consider down payments when determining how much house you can afford, especially if you want to avoid PMI. It’s worth noting that if you qualify for some government loans, you might not have to pay anything down at all.

Costs Not Included

Aside from the down payment and any private mortgage insurance, you’ll also need to factor in homeowners insurance, taxes, and closing costs:

• Insurance: The price of homeowners insurance is determined by where you reside, your community, and the sort of property you purchase. The value of your property, prospective rebuild costs, and the value of your at-risk assets are all factors in homeowners insurance estimates. It’s important to contact an insurance agent to get an idea of how much your homes insurance might cost.
• Property taxes: If you own property, you must pay property taxes, which are determined by multiplying the assessed value of your property by the local tax rate. For further information, contact your local tax assessor.
• Closing costs: Closing costs must be paid at the time of closing, which is the final stage in the process. Your lender will provide to you an estimate of closing costs. Loan origination fees, appraisal fees, title search fees, credit report fees, and other charges are examples of these. Closing fees on a house purchase can range from 2% to 6%.

A Parting Word from Jerome…

The information contained in this post can help determine the highest amount that a lender will allow you to finance. This does not mean that you have to borrow right up to that amount. Look to purchase a home at a lower price point if you feel more comfortable with a lower payment and a less expensive home.